Is it difficult to answer this question? Do you know that the expenses involved in your tax deferred 401(k) makes a huge impact on the size of your retirement nest egg?
Do you know that you are paying fees for 401(k)?
It appears that the Americans are being ripped off because of these excessive fees and still not many people are even aware of it. Truth hurts. But it is better to get hurt with truth than comfort ourselves with lies.
Last year AARP surveyed 800 people of which 71% people said they are not paying any fees for their 401(k). 23% said they do pay fees and 6% i.e., less than one in ten stated they did not know if they have paid any fee or not.
Do you know how much fees you are paying for your 401(k) plan?. If no, do not worry, soon you will get that information or you might have received the report already by this time. As per the instruction of the Department of Labor, 401(k) administrators will have to disclose the details of the various fees they charge to the participants. If you are one of the participants who does not know that there are fees for your plan, be prepared to learn about it.
Impact of fees on your nest egg
According to Demos study, these hidden fees may eat a big chunk of your nest egg, in the sense that it makes a huge impact on the amount that you can amass for your retirement. As per the example highlighted in the study, if a two income family having an average income contributes 7% of their income to 401(k) plan for 40 years, they may end up with paying nearly $150,000 as fees which is almost 1/3rd of their investment returns. This $150,000 could make a big difference in your lifestyle during your retirement. Higher-income families may pay as much as $278,000 in fees, the study found.
No doubt, the fees you pay should be a thing to consider while making investment decisions. Here’s a hypothetical example which shows how the increase in fees reduces the 401(k) balance over the long run. Assume you are contributing $5,000 every year for 40 years. If you get average 7% return on your investments the following will be the size of your nest egg after deducting the fees.
|Total Nest Egg
Many employees do not know how much fees they are paying and how the fees affect their nest egg in the long run. Because of lack of information and inefficiency of financial market, these costs may further go up and this in turn makes a big dent to your retirement corpus. On the other hand, using this information wisely could make a huge difference in your retirement plan results.
Assume that you have 35 years to retire and your current 401(k) balance is $25,000 and paying 0.5% fees. If return on your investments is 7%, your balance will grow to $227,000 at the time of your retirement even if there is no further contribution. However, if the fees and expenses are 1.5% then you will end up with having only $163,000 in your account balance. Thus, just 1% additional fees can chip 28% of your retirement corpus in the long run.
How much fees is reasonable?
It depends on the size of your organization and your individual investment options. Usually, it is observed that smaller companies have higher fees and bigger companies have lower fees. According to BrightScope, the fees can be as low as 0.20% in big companies and it may be as high as 5% in smaller companies. The plan cost varies depending on the size of the plan, type of the investment and the plan provider such as insurance company or mutual fund company etc., Further, actively managed funds are usually expensive than low cost index funds. Industry experts are of the opinion that fees which is beyond 1% of your assets is high.
According to BrightScope, nowadays the best 401(k) plans in America charge on average 0.29%. On the other hand, a small plan with less than $10 million in assets and less number of participants might charge 1.45% or more.
That said, fees alone should not be the criteria while making an investment decision; but at the same time you should know what you are paying and have to see if it is worth it. “If you’ve got a mutual fund that’s performing very well and it’s charging you 0.05 percent more than the next fund, you’re not going to care.” says a financial planner of the Financial Planning Association, Finally it boils down to how much you are paying for what.
This tax advantaged plan may be a big component of your nest egg and especially if you are young and have a long horizon, then the magic of compounding will work for you. But high fees may eat up a big chunk of returns and it may become a reverse compounding over time. In the famous words of John Bogle, it is “the magic of compounding returns overwhelmed by tyranny of compounding of cost.” While the returns add to your wealth the expenses erode your wealth. Nowhere is it truer that “penny saved is a penny gained.”
Retiring with dignity is everyone’s dream and to make this happen you have to earn more, save more and have to invest more. Saving money for retirement and investing the same prudently is challenging, especially in this tough economic situation and at the time of rising inflation, this is even more difficult and therefore every dollar counts. As your 401(k) savings is a big component of your retirement nest egg, your investment decision will have a real impact on your plan and how your savings grow; Therefore, you need to make an informed decision regarding your funds and the associated investment expenses. Understand the investment options you have in your plan and the costs involved with such options. Make some time for yourself to learn about it.