We all know we’re supposed to be investing into tax-advantaged retirement accounts — for the good of our financial futures. The foundation of your financial future is supposed to be your 401(k) or 403(b). And, for many people, these employer-sponsored accounts are a great option that allows them to save and prepare for the future…
BUT… and this is a big “but”…
Investing in a 401(k) or 403(b) is not always the best option. And this is because, as the employee, you are limited to 401(k) and 403(b) funds that your employer chooses. I’m sure your employer is great, but it’s possible they have chosen funds that have very high fees or that tend to be mismanaged. It’s in your hands to figure this out.
Fees, Fees, and More Fees
We all know banks love fees. And they are sneaky! Isn’t it crazy to think that it used to be legal for banks to charge you an overdraft fee at an ATM? I mean, why not just tell the customer there are not enough funds? Why charge them $35 to tell them they have no money?! Yes, this is how banks operate, and it's why we are trying to educate our readers.
So it’s no surprise that employer-sponsored retirement accounts come with fees. The question is how much?
Here are some of the fees that you might not even realize you are paying when you have a 401(k):
- Expense Ratios: The cost the bank passes to you for managing your money. Less than 1% is fair, but anything over that starts to really cut into your earnings, and investing into that account might need further investigation.
- Record-Keeping Fees: Some plans actually charge these on top of the mutual fund fees you could be paying. These types of administrative fees might be flat, or they might be a percentage of assets.
- Advisory Service Fees: Yes, if your employer hires a 401(k) consultant, that is a fee that can be tacked right on to the cost of your plan.
- Transaction Costs: It is common for banks to charge you if they make a change in the portfolio. For example, they might sell off a large position and buy into another one. But in doing so, they will charge you, and this can cut into earnings.
According to a study cited in the Los Angeles Times, the average nest egg sees a reduction of 30% due to 401(k) fees. The fees listed above might be only the beginning. And please remember that fees are applied whether the fund is making a positive return on investment (ROI) or not. That’s right — even if the fund managers are losing money, you are still charged the fees.
Really, fees are a huge concern when it comes to your retirement planning. Not only do fees cut into your returns, but they can also reduce your principal. A reduced principal means that you have less money working on your behalf. This can be a real problem later and can reduce your effectiveness.
Other Issues With 401(k)s and 403(b)s
Let’s say you did your homework — you signed up to Personal Capital or you downloaded the Blooom app. No matter your method, you learned that your employer-sponsored retirement fund is charging a reasonable 0.5%. Does that mean you should definitely contribute to a tax-sheltered 401(k) or 403(b)?
- Is the plan loaded up with your own company’s stock?
Let’s not forget Enron.
- Do the fund managers have a good track record?
Just because the fees are low, that doesn’t mean the fund manager is good. It’s tedious, but I recommend at least looking up your fund manager. Here is a list of some things you want to avoid.
- Are you SURE that your taxes in the future will be lower than they are today?
It’s important to remember the philosophical stance behind tax-sheltered accounts: Invest your pre-tax dollars today into XYZ fund. By the time you retire and want to use that money — and will have to pay income tax on it — your tax bracket will be lower. Are you certain about that?
I hope this article got you to think twice about investing blindly into your company’s 401(k) or 403(b). In general, these are great options, and we do indeed recommend most Americans take advantage and contribute. But make sure you're aware of what exactly you're investing in. After all, this is your money, and you care more about it than anyone else.