How Much Does your 401(k) Plan Cost?
By: Arvind Ven
Since its beginning in 1978, the 401(k) has become the most popular employer sponsored retirement plan in the country. It was all the more popular as pension plans once championed by corporations began going the way of the dinosaurs and employees were forced to contribute to their own retirement accounts. According to a recent study by the Investment Company Institute, there was $4.4 Trillion in assets and 52 Million active participants overall in 401(k) assets.
There is a lot to discuss about 401(k) plans. However, to stay within the parameters of this post, we will only attack the proverbial tip of the iceberg. For this article, we will focus on the most prevalent version of the plan, which is the tax deferred employer sponsored 401(k) plan where the employee can contribute up to $19,000 per year. Over the age of 50, the employee can contribute (catch up) up to $25,000 per year. Remember that these amounts grow tax deferred and not tax-free. That means that Uncle Sam will need his taxes sometime in the future. That age is 70 ½ when the RMD (Required Minimum Distribution) has to begin, regardless of whether you want to tap into the funds.
Some companies, especially larger and profitable ones, offer a 401(k) match generally up to 5%. Participating in the 401(k) even if to get the matching amount would make sense. Otherwise, it would be “free money” left on the table.
While many may have a 401(k) plan, most have no idea how it is costing them. An AARP study done a few years ago indicated that many thought that they were not paying anything to be part of a plan. That misconception could be a very costly one!
Calculating Fees in your 401(k) Plan
A 2015 expense ratio study by conducted by investment research firm Morningstar indicated that the average 401(k) expense ratio was 0.64%. Remember that for smaller companies with hundreds of employees or even less than a hundred, the ratio could be well over 1%. Smaller companies with lesser number of employees, are unfortunately, offered less fund choices and fees are generally higher.
Look for the expense ratio of each underlying mutual fund, target date fund or ETF. You want the number to be as low as possible as that is the percentage of your assets going out as expenses for these funds.
The expense ratio alone may not give you the whole story. There may be 12b-1 expenses (marketing expenses) that may be hiding somewhere.
What may not be stated explicitly is the plan manager fee. The 401(k) is managed and in addition to the expense ratios, there will be a plan manager fee. You may never speak to him or her but there will be a percentage cut from the overall plan to pay the plan manager annually.
Over the long term, all these fees significantly impact your bottom line while offering fewer choices and no advice from a competent and ethical advisor.
Find Information About your Plan
Your company’s HR and finance departments will be the best source to answer at least some questions. They may direct you to the 401(k) plan provider. However, after reading this article you now know to ask all the right questions.
Brightscope is a database and ranking of numerous 401(k) plans. You can check and see how your company’s plan ranks in terms of fees and performance.
If you really want to dig deeper into the weeds, then the Form 5500 filed by your employer will give even more detail.
You May Have Choices
You may have options to manage your own funds – while still employed at the same employer - provided your employer’s plan allows for that. Interestingly, most people are unaware that the following two options even exist:
1. An In Service Withdrawal/Rollover. While still employed at he same employer, for those above 55 years of age, and even more after age 59 ½, some companies may allow employees to withdraw or rollover part or most of the funds to a self directed IRA or to one managed by an advisor of the employee’s choice.
2. Brokerage Window: Many companies, and in the SF Bay Area, offer this option. If the employer provides this option, then you can roll over your funds to manage it yourself or by a competent and trusted financial adviser. Terms involved in this option are SDBA (Self Directed Brokerage Account) and PCRA (Personal Choice Retirement Account).
For the two options above, you will, of course, need to check with your employer’s HR and finance Departments for more information.
Post Tax Contribution: This is an important feature available in some retirement plans, especially those in larger companies, where an employee can add an after tax contribution amount up to a limit specified by the plan. This feature allows high income earners to contribute to an after tax pot of money that could be rolled over to a ROTH IRA. Otherwise, such high income earners would not qualify for a ROTH IRA as their adjusted gross income (AGI) would be above the allowable threshold to contribute to a ROTH. Unlike a traditional IRA or 401(k), ROTH IRA’s grow tax free, and do not have RMD (Required Minimum Distribution) requirements. However, these IRA’s also have a 10% penalty if withdrawals are made prior to age 59 1/2.
Finally, when your employment terminates, you are allowed rollover your 401(k) to an IRA of your choice.
Arvind Ven is Founder/CEO of the Capital V Group, a Registered Investment Advisory firm. He has an MBA from the MIT Sloan School and a Master’s Degree in Computer Engineering.
Arvind Ven is a Registered Representative with, and securities offered through LPL Financial. Member FINRA & SIPC.
Note: This article is for educational purposes only and should not be considered financial or tax advice. Please consult with your financial advisor or tax consultant.