By Mari Hansen The majority of people can tell you the exact cost of their streaming subscriptions. A gym membership that costs more than $40 a month will be cancelled. When you ask the same person how much they pay for their 401(k), you typically get a pause, a guess, and something along the lines of “I don’t think I pay anything for it.” The financial sector has long been aware that this blind spot is the entire issue.
The explanation is straightforward and a little awkward. You never pay these fees with a check. Before the amount ever appears on your statement, it is silently skimmed from your balance and subtracted from returns. There isn’t a transaction line that states, “We took this.” Every year for thirty or forty years, the pile is just a little bit smaller than it should have been. That math is brutal in a way that doesn’t feel brutal at the time.
Think about the spread. The Department of Labor’s own example shows that a 1% difference in fees and expenses can result in a 28% decrease in your account balance at retirement. Not a single percent less. Twenty-eight. The difference between a cheap plan and an expensive one could result in savings losses of over half a million dollars, according to one analysis that used a typical forty-year horizon. It’s difficult not to read that number twice.
The fees are not particularly exotic. They can be divided into three categories: individual service fees for things like loans or rollovers, administrative costs, and investment expenses. The largest one is typically the investment expense ratio, or the portion that your plan’s available funds take. The part that truly surprises people is that your plan’s “index fund” isn’t always the good deal it seems. An index fund that is truly low-cost can operate at less than 0.10%. Many plans covertly default participants into something that charges five or ten times that amount, sometimes disguised as an insurance product or covered by revenue-sharing arrangements that give the recordkeeper a cut.
A Reddit thread that went viral a while ago comes to mind. A man at a company with 100 employees found that his John Hancock plan was adding about 1.11% in fees to the expense ratio of his fund; these fees were paid by the employees, not the employer. After doing the math himself, he came to the conclusion that it might cost him hundreds of thousands of dollars over the course of a career. Almost everyone said, “Make a fuss.” It’s a modest, everyday tale, but that’s precisely why it’s important. These are not examples of edge cases. They represent the average experience. For smaller plans, the average investment expense is approximately 1.37% of assets; however, the total amount that most participants actually pay is close to 0.71%, which is almost three times what the headline expense ratio indicates.
It’s amazing how little has to change for things to get better. The disclosures are already in place. Plans are required by federal law to provide a 404(a)(5) fee disclosure notice at the time of enrollment and each year thereafter. This notice details your payments, fund by fund. Very few people open it. The obscurity may be partially intentional, or it may simply be the result of inertia, most likely both. In any case, the document is in an unread email.
It’s worthwhile to sit with this larger tension. As legal fiduciaries, employers who sponsor these plans are expected to maintain reasonable costs. However, overpriced plans are frequently sold to small businesses without their knowledge. The HR manager who chooses the plan often has the same poor choices as everyone else. As a result, accountability spreads and the expense always ends up with the person who can least afford to pay attention.
The market is beyond your control. The next recession, tax laws, and inflation are all beyond your control. However, you can actually see and occasionally alter this one cost, which is nearly unique. Examine the disclosure. Select the most affordable broadly diversified fund that your plan provides. Pose a difficult query to HR. It seems tiny. When you do the math backwards, your retired self won’t think it was little at all.