RETIREMENT PLAN FEES: MAXIMIZE SAVINGS, UNDERSTAND YOUR INVESTMENT

“I thought I was investing for free.”

It’s one of the most common responses when asking prospective clients why, instead of consolidating them, they have left a breadcrumb trail of money in old 401(k) plans over the course of a career.  For what it’s worth, the remainder jokingly answer that they were simply lazy.

The average worker nearing retirement is believed to have held an average of nearly thirteen jobs over the course of a career. Through this progression they participate in an average of roughly nine retirement plans over that period (the difference represents jobs which don’t offer a retirement plan).

Here, we explore what workers should do with their old retirement accounts.  Do most 401(k)plans offer “free” investing, and what are common fees?  What are the limitations of leaving money in a 401(k) plan?  What other factors should be considered prior to consolidation?

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FEE CONFUSION

In 2010 and 2012, the Department of Labor finalized regulation updates to ERISA rules that were intended to enhance the transparency of employer-provided retirement plans such as 401(k)s.  The revised rules require plan administrators to provide participants with a clear transparency of fees.

Interestingly, the rule changes seem to have little impact on the common investor’s actual understanding of fees.  A survey conducted in 2010, prior to the ERISA revisions, found that 40% of participants did not grasp fee information in their 401(k) plans.  In 2021, long after the rule changes, an updated study found that an identical 40% of participants “do not fully understand or have difficulty using the fee information provided in disclosures”. Clearly, there remains a murkiness in being able to identify and understand the fees involved in retirement plans.  

Ongoing fee confusion can be demonstrated.  Another study, post the ERISA rule changes, found that, when given the chance, 89% of retirement plan participants were unable to calculate their fees accurately and that 58% were unaware that fees were being withdrawn automatically from their retirement account.

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FREE INVESTING

More telling, the same 2021 GAO survey found that 64% of respondents believed they paid no fees to participate in 401(k) plans, or they were uncertain if they did. While it dates back to 2011, an AARP study of 401(k) participants found that a similar 70% thought that they were participating in “free investing” through their employer retirement plan.

RACE TO THE BOTTOM

Retirement plan fees have been on a gradual decline for years thanks to a combination of factors. These include lower-cost investment fund options, increased competition among 401(k) providers (resulting in more competitive pricing), and an increased number of participants spreading out the average fee paid.

While fees have been reducing over time, they are still higher than the average participant realizes. A Capitalize survey found that nearly half of respondents estimated their fees to be below 0.5% per year.  In reality, less than 10% of plans average fees this low.

While fees tend to be cheaper in large plans, the majority of participants are invested in the “small plan” category of 401(k) plans (denoting total investments of combined participants of under$100,000,000).  As Investopedia reports on a survey published by BrightScope/ICI in 2020, the average total fees for smaller plans, “were between 1.5% and 2% per year, with plenty of plans with less than $50 million in assets paying more than 2% a year [per participant] in fees.”

If measured by company size, as opposed to the size of the retirement plan, fees break down similarly. The 401(k) Averages Book (20^thEdition) reports that companies with two hundred to five hundred employees pay average total fees of 1.51% per year, and the costs increase sharply for smaller companies.  Participants of plans with under fifty employees pay fees that average over 2% per year.

While it is a minority of the market representing 5-10%of 401(k) plans, plans administered inside of an annuity wrapper carry even sharper fees.  It has been reported that these plans can strap on an additional fee of 1%-2.5% per year.  Further, for the average participant it is difficult to determine if this applies to them without delving into the Summary Plan Description or other plan documents.

To summarize it succinctly: while costs in smaller 401(k)plans range from roughly 1.5% to 2% per year, the average participant in those plans believes that they are investing for free.

While fees remain higher than most plan participants realize, they have been in a gradual decline. This creates a logical inference for old, “abandoned” retirement plans: the older the 401(k) plan, the higher the likely fee still being paid.  Any former employee with a 401(k) from, say, fifteen years ago, is likely paying substantially higher fees compared to their current investment options.

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FORGOTTEN ACCOUNTS

One of the risks inherent in failing to consolidate retirement plans over the course of a career is the potential to eventually forget that they exist.  If that sounds outlandish, a 2023 analysis by Capitalize found that there were approximately 29.2 million forgotten 401(k) plans holding about $1.65 trillion in assets (an average balance of $56,616 per account). A separate survey from the Employee Benefit Research Institute (EBRA)arrived at a similar $1.5 trillion in “orphaned” accounts.  There are millions of potential retirees who have forgotten about old retirement plans. Consolidation may help to avoid this pitfall.

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WHAT TO DO

None of this is to say that some people aren’t better off remaining in old retirement plans.  There are a number of factors to consider and potential steps to take in evaluating your old 401(k) plans:

• Enter your information in the Department of Labor’s “Retirement Savings Lost &Found Database” to see if you have any forgotten retirement plans.
• Work to determine the fees inside of each plan.
• Also, evaluate the quality of the investment options inside of each plan.

A capable Financial Advisor should be able to help you through these steps.  They should be able to quantify the quality of investment choices, along with the fees inside of each plan, to help you determine the most advisable strategy.

In many cases, it is a misconception that hiring a Financial Advisor is akin to accepting a new layer of fees.  In practice, consolidating old retirement plans through an Advisor can match—or even cut—fees, while hopefully adding a level of service and advice.

Reach out to our office today!