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Do you know how much you're paying in fees for your retirement accounts? If you are like most Americans, the answer is no. While it may not seem like a big deal, the truth is fees can shrink your savings faster than anything.
Retirement account fees can easily add up to 3-5% per year. And this is regardless of the performance of your account.
Yet, just a 1% difference in fees and expenses can significantly reduce the size of your savings over time.
How High Fees Erode Your Ability to Save
Let's take a look and see the impact of high fees over time.
Say you save $5,000 per year for 35 years, and you earn an 8% annualized return after fees. At the end of those 35 years, would end up with just over $861,000.
Now let's take a look at someone who also saved $5,000 per year over 35 years. However, this person earned only a 7% annualized return because their account maintenance fees and other expenses were 1% higher.
After 35 years, that second account only has $691,000 in it. The 1% increase in fees applied over 35 years left the second account with 25% less.
Like I said, even seemingly small differences in how much you are being charged for your retirement account makes a huge difference over time.
Are Retirement Account Fees Really Hurting Me?
This is not just me complaining. According to a recent study by the Center for American Progress and backed by government and industry data, a 1% per year difference in 401(k) fees would erase about $70,000 a year from the average worker's retirement account over a 40-year career.
This would force the average employee to work an additional 3 years before retiring.
In August 2016, three prominent universities -- MIT, New York University, and Yale -- were sued by their employees and accused of charging excessive fees for their retirement accounts. These lawsuits deal with 403(b) plans, which are similar to 401(k)s. Just an example of how high account fees can be a problem with any type of retirement savings plan. Even your self-managed IRAs.
I know you want to ensure your nest egg grows as much as possible. So let's take a look ar what you should know about reducing the cost of your retirement account.
What are You Paying for Administrative Fees?
Virtually all major retirement accounts, including Individual Retirement Accounts (IRAs),have some administrative fees. As demonstrated above, it pays to find out how much you are paying.
If you have a plan outside of a 401(k), it's usually easy enough to find out what you are paying. Not so much with your firm's 401k plan.
About three-quarters of all 401(k) plan expenses fall into three categories: (1) administrative; (2) investment management; and (3) distribution. Administrative fees, sometimes called account maintenance fees, go toward legal advisers, trustees, bookkeepers and other professionals that keep the account running.
With a 401(k), it can be virtually impossible to find out the administrative fees you pay for your account because this information does not need to be disclosed.
The median fee for administrative services on 401(k) plans in 0.72% of total assets, or $346 per year for the average participant, according to the Investment Company Institute. Still, 10% of plans charge 1.72% or higher.
Worse for you: only 25% of employers foot this bill for company-sponsored plans. The rest are paid by employees (i.e., you and me!).
If you want to find out if your 401(k) has average or better administrative fees, you may try speaking with the human resources representative at your company or compare your 401(k) fees to competitors at Brightscope.com.
What Do You Pay for Management Fees?
Sometimes known as investment advisory fees, these fees are paid to the company that operates the mutual funds in which you invest. The fees will depend a great deal on how much management your investment type requires. An actively managed fund with live experts who choose stocks will have significantly higher management fees than a more passively managed index fund.
While actively managed funds charge an average of 1.5% a year, index funds usually charge around 0.25% or less. As shown above, this seemingly tiny difference will actually make a major difference over your investment horizon.
On top of that, research has found that actively managed funds do not actually offer better performance for your money than low-cost counterparts. In fact, a 2008 study found that the S&P 500 outperformed 75% of actively managed funds over the course of five years.
If you have a 401(k) and your plan offers index funds, you may want to look into transitioning some or all of your money into these funds can be easy. Unfortunately, not all employer-sponsored plans offer index funds.
What Do You Pay for Distribution Fees?
Service fees are designed to compensate brokers and advisers who advertise and sell mutual funds and they can easily eat up a large portion of your savings. Also known as 12b-1 fees, some mutual funds have fees between 0.25% to 1% of your assets per year.
Luckily, there are many funds that do not have 12b-1 fees at all.
You do not need to necessarily look for a mutual fund without distribution fees. However, it is a good idea to make sure you aren't paying an unreasonable amount and that "no-load" investments (or mutual funds in which you can buy and sell without a sales charge) don't incur extra 12b-1 fees.
No-load funds do not charge loads but they can charge up to 0.25% in service fees.
Aim for 1% or Less in Fees
Reasonable fees depend on the type of investment you want. But the best way to grow your savings is looking for an account that offers 1% or less in annual fees. (That is after adding up all the fees, both stated and hidden.)
Keep in mind index funds and passive investment options always have lower fees compared to active management accounts. If you choose exchange-traded or index funds, your annual fees may be as low as 0.20%.
In a recent online survey by Wakefield of small business owners, 45% expected their employees to pay up more than 1% in fees. A whopping 27% felt their employees should pay 4% or more annually.
You can avoid the costs of these high fees. By opting for an account with fees under 1%, you can save hundreds of thousands more over the course of your life than a plan with fees of 3-4%.
Look for Low-Cost Funds
401(k) fees can easily erase the tax benefit of 401(k) investments for long-term investors. According to a study by Yale University and University of Virginia involving more than 3,000 401(k) plans with combined assets of over $120 billion, high fees cause investors to pay 86 basis points on average more than they would if they chose low-cost index funds.
401(k) providers are required by law to provide fee information for each investment option so you can choose a low-cost fund that matches the risk exposure you want.
This means it may take some digging, but you can get the answers you need to make more affordable decisions on the funds you choose for your retirement account.
Watch Your Trading Costs
This final word is for everyone who has a self-directed account. (This is an account where you can trade in whatever securities you desire.)
Watch Out for Trading Costs!
If you have a brokerage account or manage your own account by trading, be careful that you aren't losing money by paying too much for brokerage fees and trading costs.
If you do not have a broker, you will probably pay $7 to $10 per trade. With a broker, you may pay anywhere from $40 to $100 per trade.
If you like to make your own trades, try to place your retirement account with an online firm with discount trades. And, like anything else, always do comparison shopping before selecting a broker.