401K funds and fees ?

[wodehouse]

Several years ago I became disenchanted with 401K plans due to a perception that there are high costs involved. But maybe I need a reality check.

So my plan offers 3 different "equity income" funds from major players. I looked up equity income funds at each fund company's website and in each case the expense ratio is 1/4 to 1/2 percentage points higher to go through my 401K plan. I can't guarantee that the plan funds are identical to those offered by the individual fund companies. But here is the comparison:

expense ratio	401k	OTS-FR*
American Century	1.22%	0.97%
Fidelity	1.28%	0.74%
T.Rowe Price	1.21%	0.73%

* OTS-FR = I walk in Off The Street-Full Retail pricing

For comparison, Vanguard's Equity Income fund has expense ratio 0.31%

Before I go storming off to my plan representative might there be some mitigating explanations?

[The funds I pulled off the group sites are the "full retail price" funds, no special pricing for large ownership]

thanks!

[Savoir Faire-Demogague in NJ]

Without seeing the plan documentation it may be the class of mutual fund shares that the plan is offering.
Just a guess.

[wodehouse]

Please let me add to my OP question "or are they just ripping me off?"

[Plain Old Petunia]

Are they ripping you off? Yes and no. They are charging extra for their services, but that is why they are in business. They won't administer your plan for free, someone has to compensate them. It is very typical for the costs to be passed along to the employees.

So what to do?
1. Contribute enough to get the match, if any. If you still have money to invest, then
2. Contribute to your own IRA. Make sure you keep your costs low. If you still have money to invest, then
3. Contribute more to your 401k

[SVT]

Feb 28, 2011 18:06:35 GMT -5 Plain Old Petunia said:

Are they ripping you off? Yes and no. They are charging extra for their services, but that is why they are in business. They won't administer your plan for free, someone has to compensate them. It is very typical for the costs to be passed along to the employees.

So what to do?
1. Contribute enough to get the match, if any. If you still have money to invest, then
2. Contribute to your own IRA. Make sure you keep your costs low. If you still have money to invest, then
3. Contribute more to your 401k

Unless you have an HSA and/or high interest rate debt.

[wodehouse]

The thing about 401k plans is that there can be so many parties at the trough: the employer, the plan administrator, the plan offerings (often from companies other than the administrator...and I may have the jargon a bit mixed up with "administrator"); in my case, there are one or two additional companies as well.

I agree that someone has to pay for all of this; they're not all working for free. But I think it's important to understand what costs are involved and if they're reasonable or not.

My general impression from 30 years of reading about 401k plans and participating in them is that usually the employer picks up the direct expenses of running the plan, these aren't generally passed on to the employee. The expenses of running the individual offerings of the plan are going to be passed on to the employee, just as they would be for any other mutual fund type of account.

My points with the offerings in my current plan are:

(1) the fees seem to be higher than for the equivalent funds if bought at retail. I remember reading magazine articles describing how the funds in 401k plans are often the discounted-fee versions offered to very large customers (commercial banks, pension funds, etc, where the huge amounts of money invested permit smaller costs), so that the 401k participant benefits from these lower costs. The higher expense ratios for the actual funds in my plan seem to fly in the face of these articles.

(2) the expense ratios for these funds seem to be relatively high as well; they seem to be much higher than low-cost providers such as Vanguard.


Speaking of expenses, my IRAs charge just a pittance each year to cover the additional administrative costs of the IRA but the expense ratio is the same as a non-IRA fund. They even drop the fees in most cases due to the large balances. And my employer's former plan, a SIMPLE IRA, was through Schwab and there was a small annual fee (as I remember) and you had a selection of hundreds of funds, none with "upcharges".

Because the expense ratio in my plan funds are wrapped up into the fund itself, and the Fund's funds is somehow commingled with those of all the other 401k holders', I think that this additional expense is going to the plan administrator rather than the Fund. If so, then I am paying for it, and they are ripping me off...by not offering the lower-priced funds from Vanguard, this is what irks me.

How to twist the arm of my employer though is the question.

What do I do? I put in the minimum amount necessary to get the full matching, then I have my private savings, which includes money going to Roth IRAs for my wife and I, as well as taxable accounts earmarked for retirement. I try for "tax diversification" as well as market diversification. I read about this once in an article, how since the future tax laws and rates are unknown it may be wise to diversify account types as well.

[Savoir Faire-Demogague in NJ]

Wode,
You are micro and over analyzing, what is really pointless minutea.

You are likely, though you have not indicated this, looking at a different share class of retail mutual funds outside your plan.

You are engaging in analysis paralysis.

I recommend getting into your plan, contributing as much as you can, get the match, and also get the tax deferred benefits.
The tax benefits of putting in deferred contributions, yields you a guaranteed 25% return at least in the first year, if you are in the 25% fed bracket.

[schildi]

My 401(k) is with Fidelity, and we get excellent choices. Some funds fees are so low, I could not get that outside of the 401(k) because these funds would require Millions in initial investment. One example is an S&P500 index with a 0.02% expense ratio. We got index funds for everything, including international, for under 0.2% expenses, no loads.
I guess it really depends on the plan.

[wodehouse]

If I was truly paranoid I would think that 401k's were a plot of the 'overclass'. Here we are, taking the risk of investing in equities, a risky asset class, but when we take the money out we will be taxed at full income rates, we won't get the favorable treatment of capital gains given to the 'overclass'. So the government in effect is using us like sheep, letting us take the market risk, then they will come along in future years to sheer the fleece and harvest their higher percentage of the gains than it would have otherwise. Meanwhile, all the big financial companies can take their pound of flesh off the accounts for "managing".

[schildi]

Mar 1, 2011 9:34:24 GMT -5 Savoir Faire-Demogague in NJ said:

The tax benefits of putting in deferred contributions, yields you a guaranteed 25% return at least in the first year, if you are in the 25% fed bracket.

No, I don't think the tax deferment is equal to a guaranteed 25% return.

[wodehouse]

SF, thanks for your comments. I will review. I am reviewing all possibilities right now. The past 2 tax years I was beyond the ceiling for Roth IRA so I couldn't contribute to those. I realize that if I put more into the 401K that would reduce the AGI and might allow me to fund the Roths as well (but I think I still can't get it low enough given the IRS and plan contribution limits). But I wouldn't want to do that if the 401k is crummy and overpriced (my current plan is to withdraw the funds at 59-1/2 as an inservice distribution and put into an IRA). I could also do that trick of funding a non-deductible IRA and transferring it to a Roth, but that sounds like a big headache.

[Savoir Faire-Demogague in NJ]

No, I don't think the tax deferment is equal to a guaranteed 25% return.

Depends on your tax bracket. I am in the 25% federal bracket.
If I put in $1833 each month( I am over 50 and I max), my fed taxes for the month are reduced by roughly $458, because this is pre-tax.
Since I work in NYC, NY/NYC taxes are also affected. I am taking a broad conceptual view.

[Savoir Faire-Demogague in NJ]

Hey Wode,
When you say the ceiling, do you mean you were completely phased out from any contributions to a Roth?
A couple of years ago, I bumped up against the ceiling and was partially phased out.
You can always put money into a taxable account into any one or several indexed funds. There is a tax benefit in that they rarely do any trading as they track certain indexes.

[wodehouse]

SF, yes, due to large year-end bonuses I was totally, entirely above the ceiling and ineligible. The first year I had been putting in my monthly automatic purchase and then had to get that back. To add injury to insult, I was given back more than what I had contributed (apparently due to gains, etc, I have never understood the arithmetic behind this). So last year I didn't even contribute and again I was above the ceiling. I never would have thunk it.

I think a single person making a good income might run into this problem pretty easily.

[skubikky]

Mar 1, 2011 9:46:22 GMT -5 Savoir Faire-Demogague in NJ said:

No, I don't think the tax deferment is equal to a guaranteed 25% return.

Depends on your tax bracket. I am in the 25% federal bracket.
If I put in $1833 each month( I am over 50 and I max), my fed taxes for the month are reduced by roughly $458, because this is pre-tax.
Since I work in NYC, NY/NYC taxes are also affected. I am taking a broad conceptual view.

And what is likely to happen is that when you retire, you'll be living outside of NYC and won't be subject to NYC taxes when you make the withdrawals. Total avoidance of that nasty income tax! Priceless. I love it.

[schildi]

Mar 1, 2011 9:46:22 GMT -5 Savoir Faire-Demogague in NJ said:

No, I don't think the tax deferment is equal to a guaranteed 25% return.

Depends on your tax bracket. I am in the 25% federal bracket.
If I put in $1833 each month( I am over 50 and I max), my fed taxes for the month are reduced by roughly $458, because this is pre-tax.
Since I work in NYC, NY/NYC taxes are also affected. I am taking a broad conceptual view.

I would agree with your statement that this results in an immediate 25% guaranteed return if the average person would then never have to pay taxes on that money. But that's not the case. The taxes paid in retirement could be even higher, nobody really knows.
Calling it a guaranteed 25% return is definitely not right imo.

[runewell]

Mar 1, 2011 9:34:24 GMT -5 Savoir Faire-Demogague in NJ said:

Wode,
You are micro and over analyzing, what is really pointless minutea.

I happen to think Wode has a very good point that you are wrongly blowing off. For years I have dumped lots of pretax money into 401k's plus some partial Roth IRA funding. And I'm thinking I should have gone about this differently for two good reasons:

1) If you are in the 15% tax bracket, the deferal of taxes really isn't a benefit. You can pay 15% now, or X% later, and I seriously doubt that X<15%.

2) If you contribute to a 401k you are limited to the investment choices they provide. And I too am disappointed in the higher expense rates that come with these funds, they are clearly higher than other expense offerings from similiar style funds/ETF's.

Just this year I have finally adjusted my contribution rate from $16,500 to the minimum to get the company match, and I am going to fund the Roths completely (up to $10,000) before any more money goes into the 401k. It is going to mean a bigger hit to my paycheck to do this, but investing $6,000 pre-tax and $10,000 post-tax is more money than $16,000 pre-tax.

The big benefit of a retirement plan is not being taxed on the gains and dividends while it is growing.

Let's say you have $10,000 and you can make 11%/yr in the stock market. Your normal investment takes an expense ratio of 0.25% off that amount but most costly funds take another 0.5% in addition (silimar to what Wode is seeing).

10.75% for 10 yrs: $27,761
10.25% for 10 yrs: $26,533

Edited to add: I just read the part where Wode talks about making too much $$$ to contribute in which he almost certainly isn't likely in the 15% tax bracket. The question might come down to whether the deferred taxes on growth and dividends outweighs the higher expense ratio.

[runewell]

Mar 1, 2011 9:34:24 GMT -5 Savoir Faire-Demogague in NJ said:

The tax benefits of putting in deferred contributions, yields you a guaranteed 25% return.

I also agree this was a poor choice of words. You aren't making any money here so it's not a return, you are just choosing to pay it later.

[wodehouse]

Runewell, I think your plan is good, and it's what I've been doing for some years now. The benefit to the Roth is that withdrawals (including earnings, capital gains, etc) are not taxed at all, versus 401k and IRA accounts being taxed as regular income (rather than at capital gain rates). Of course, the tax laws can easily change and there may be some sort of tax, excise or otherwise, imposed on Roths in later years, but I think that "tax diversification" is a good plan.