Today’s topic is all about 401K. We are focusing on figuring out the fees in your 401K and how to optimize around them.  Sounds like a snooze but 1% in fees could cost you >$500K in retirement income so get on it!  Step 2: What’s a Roth 401K and when should you consider using it?  Third topic: when you leave your job, when should you roll over your 401K and when should you not?

I’m assuming that you all know the benefits of investing in a 401K – many employers give a match (take it, that’s free money).  Pre-tax 401K let’s you reduce your taxes in the short-term (~$7K for someone making over $200K) and a Roth 401K gives you some long-term tax advantages (earnings grow tax free).  More on that in two weeks.

401K and 403b Fees

So once you are invested in a retirement account through work, why do higher fees matter?  Over a 40-year investing timeline, Nerdwallet estimates paying 1% more in fees can have a $500K+ impact on your retirement.*  Investor fees create a double whammy – they are taken out of the portfolio’s value and actually reduce the amount of capital upon which you are earning interest.

what 401k fees are considered high?

If your 401k options have anything over a 0.1% fee, then you should be looking for an escape hatch or for creative ways to cut your fee costs.

I did the math – even with high fees, it still makes sense to invest in a 401K – first, if you’re getting an employer match, that’s free money.  Second, the tax deferral for someone making > $200K are ~$6K / year while the fees you are paying are probably in the ball park of $50-$200 / year.

how the heck do you find the fees in your 401k or 403b?

Your company should have issued a form called an ERISA 404a Participant notice.  You can find this in the forms section of whoever manages your 401K.  What are some key fees to look for?   Plan administration fees, investment advisory fees are two lesser known fees to look at in addition to your fund expense ratios.  This article is a great review of the 7 top fees.

what do you do once you realize you’re in a high-fee plan?

• Find the lowest fee option in your plan – then rebalance accordingly. For example, at many employers, the default option if you make no election is a balanced mutual fund with fees at close to 1.3%. Find the cheapest investment choices (look at the expense ratios) – it will probably be an S&P 500 stock fund with a cost lower than 0.02%. If the next cheapest option is still relatively expensive (e.g., a bond fund with a cost of 0.55%), then go all in on the cheapest option putting 100% of your allocation in that fund. This only works if you have the luxury of other retirement assets (e.g., a Vanguard IRA that you rolled over from your last job). In that case, you would change the allocation of your Vanguard fund to tilt more heavily towards bonds and cash to offset your riskier stock allocation. More examples of how to be creative to cut your 401K costs here.

• Call to find out if you have a “brokerage window” – over 20% of employers (and rising) offer a brokerage window option. Many brokerage windows require you to pay a $50 annual maintenance fee but then give you option to invest in the broader market with a wide variety of ETFs (often with less than 0.1% fees) making the upfront fee well worth it. Just do your homework and figure out if there are other fees (e.g., transaction fees per trade) that would price this out as an option.

Actions for this week:

– Pull your 401K’s fee disclosure document (probably called an ERISA 4041a Participant notice) and figure out where you are invested & what you are paying in fees.  Call your plan administrator if you need to – it takes 5-10 minutes!

– Go back to any past employer’s 401Ks that you haven’t rolled over and figure out fees from your old 401K accounts and / or your roll over accounts

– Get your money out of anything with a 1% expense ratio unless your plan doesn’t offer low fee options

That’s enough femsplaining for today

Eryn

*This analysis is based on someone 25 with $25K in a 401K investing another $10K / year with a 7% return for 40 years.  While the 7% return may be high, many people on this email list are hopefully contributing the full $19K / year into their 401K as a result the total impact of fees is actually higher for someone maxing out their 401K each year.

The information provided in this email is for informational purposes only.  It should not be considered legal or financial advice.  You should consult with an attorney or other professional to determine what may be best for your individual needs.