Saving for retirement is not easy under any circumstances. It is tougher if you are paying excessive fees along the way. Here is a look at some of the fees and expenses you may be incurring, and tips to reduce or avoid these fees.
Mutual funds, ETFs, closed-end funds and other types of investments have expense ratios. The net returns on mutual funds and ETFs are expressed net of the fund’s expense ratio. The lower the expense ratio, the more of the fund’s gross returns you keep.
The 401(k) plan offered by your employer is not free. There are a number of expenses associated with any 401(k) plan.
The mutual funds or other investment options offered will all carry some sort of expense ratio. In making your choices, you will want to be conscious of the expenses of the funds you choose. Many plans offer lower-cost index funds, and these might be a good choice for you.
There are also costs associated with running the plan, including record keeping, administration, the cost of an outside investment advisor/consultant and others. Your employer may or may not cover some or all of these costs from company assets. To the extent they don’t, you will be paying these expenses from your account.
While you don’t have a say in your employer’s choice of plan providers or investments, you owe it to yourself to read all of the statements and disclosures you receive regarding the plan. Since 2012, plan sponsors have been obligated to monitor and disclose the costs of the plan that you pay for.
Become knowledgeable about these costs, and if you feel they are out of line, discuss your concerns with your employer.
Financial Advice Costs
A knowledgeable financial advisor can be a great help in your planning and financial preparation for retirement. Their advice and guidance is not free, however.
A financial advisor can be compensated in one or more of several ways:
- “Fee only” means that they do not receive any compensation from the sale of investments or any type of trailing fees, such as 12b-1. In other words, their compensation is derived only from the fees you pay them. Under the fee-only model you might pay:
- A percentage of the assets under advisement. 1% of assets on an annual basis is considered the standard, but clients with larger portfolios might pay less.
- A flat retainer for ongoing advice.
- A flat project fee for something like a financial plan or a review of your portfolio.
- Commissions are generated from the sale of investments and can occur on the front end, as a surrender charge if you sell some investments or an annuity too soon, or as a level load as with C shares.
- “Fee based” is a combination of fees and commissions. Fee based is the new mantra of the brokerage world in the wake of the Department of Labor’s new fiduciary rules set to go into full effect on April 10, 2017. The broker might suggest a wrap account that charges a fee (these can often be very high, on the order of 1.50% or more annually), with the broker and their firm also collecting trailing commissions via 12b-1 fees or other types of revenue sharing. Be very wary of brokerage wrap accounts. Do your homework before investing.
Regardless of the compensation arrangement, be sure to ask — no, demand — to know exactly how much your advisor or broker will earn from their relationship with you. With the new fiduciary rules they will be required to disclose this information for retirement accounts. Be sure to read and question all disclosures you receive.
Some mutual funds carry sales loads and other charges designed to provide compensation to brokers and financial advisors. These charges might be in the form of a front-end sales load (with A shares), for example, 5%. In this example, only $9,500 of every $10,000 would actually be invested. The remaining $500 goes toward sales commissions.
C shares carry a level load that never goes away-usually, 1%.
With the advent of the fiduciary rules, many brokers are changing the way they use load funds in retirement accounts. Merrill Lynch, Edward Jones and LPL Financial have made drastic changes to the use of commissions in retirement accounts already.
Annuity Fees and Expenses
Annuities are an insurance product that is widely sold as a retirement savings vehicle by brokers, insurance agents and commissioned and fee-based financial advisors. They come in many varieties. You pay a premium (the amount you invest) with the option to create an income stream for your life with a number of variations.
Among the major expenses in an annuity are the mortality and expense charges — in other words, the expenses assessed by the insurance company to guarantee the lifetime benefits and other options (riders), such as a step-up in the minimum value of the contract at various intervals.
For variable annuities, the M&E costs can run up to 2% or more. These are reflected as expense ratios in the sub-accounts, which are investment vehicles similar to mutual funds. Providers such as Vanguard, Fidelity, Schwab and others offer lower cost options, often with minimal or no surrender charges.
Surrender charges are common with annuities and some mutual funds, though less so with the fact that B shares are no longer sold.
As an example, a surrender charge may start at 8% and last ten or more years. In year one, if you were to surrender or try to withdraw all or most of your money from the annuity contract, there would be a penalty charge of 8%.
If the balance was $100,000, it would cost you $8,000 to surrender the contract. This even pertains to a 1035 tax-free exchange into another annuity. The surrender charges will gradually reduce until they go away. Best advice: Don’t buy an annuity or anything else with a surrender charge. There are annuities offered from companies like Vanguard and others that are no-load, with no surrender fee.
Taxes are often cited as one of the biggest expenses faced by retirees. Withdrawals from traditional IRA and 401(k) accounts are subject to taxes. This will certainly come into play when it comes time to take your required minimum distributions or RMD at age 70½.
If you are using a taxable investment account for some or all of your retirement savings, this money will be subject to taxes along the way.
Roth accounts are funded with after-tax dollars, and converting a traditional IRA to a Roth will cause you to incur taxes in the year of the conversion.
The gains on annuities are taxed as ordinary income.
The point here is that during the years in which you accumulate assets for retirement, and when you begin to draw those assets down in retirement, tax planning is key to your success.
Impact of Expenses
Vanguard cited an example of the two mutual funds, one with an expense ratio of 0.30% and the other with an expense ratio of 1.30%. Over 30 years and assuming a 6% annual return, the less expensive fund would provide about 15% more annual income in retirement. Other studies have shown a similar impact of higher expenses on your retirement nest egg.
The amount that you save each year, and managing these and other costs that can erode your nest egg, are two ways to help maximize the money available to you in retirement.