The feds are making it easier to check 401(k) fees

Sometime this summer, the U.S. Department of Labor is expected to announce new rules requiring companies to give employees more information about the fees they pay in their 401(k) plans.

This is no small matter, because just one of the fees - the biggest and most common, known as the expense ratio - averages more than 0.5 percent of assets each year, according to the Investment Company Institute, the main trade group for mutual funds. Depending on the size of the company's plan and the types of investments selected, total fees can easily top 2 percent.

In other words, if a participant in a 401(k) thinks he or she has put away $100,000 for retirement, it may really be only $99,500 or $98,000 - regardless of what happens in the markets. Next year, that will drop another $500, $2,000, or whatever the fees are.

The Labor Department has already given some strong hints of what the new rules will say. For instance, employers would have to provide the fee information in annual reports, rather than expecting employees to dig it out from long legal documents (see related story).

No one disputes that people should know how much they're paying for their retirement investments. "You should always be aware of the fees when you're using your own money," said Alan Kahn, president of the AJK Financial Group, a financial advisory firm in Syosset. "When companies provide transparent information, it helps people make the right decisions."

There are three main types of 401(k) charges: administrative fees, investment management fees, and fees for special services like loans and investment advice. Only the last category is specified in typical employee documents.

The administrative fee is for the employer's bureaucratic costs of running a 401(k) - regulatory filings, accounting, record-keeping, and the like - usually from hiring an outside administrator. Companies used to pay this out of profits, but today 59 percent take it out of their employees' 401(k) assets, according to the benefits consulting firm Hewitt Associates.

The service fees are levied only when someone uses a particular service. For instance, there may be a charge of $5 or $10 to take a loan (in addition to interest payments), said Joseph De Sena, a senior adviser at Ameriprise, a financial services company in Melville.

The investment fee - by far the most important - pays for the managers who actually oversee the money. (This is the same thing as a mutual fund's expense ratio.) Essentially, this covers a portion of the management company's overhead, including brokerage commissions and advertising.

Investment charges can cost each person from 0.2 percent of assets to more than 2.5 percent, largely because the types of investments vary tremendously. Index funds that try to mimic the broad market are the least expensive, while exotic investments that require a lot of research, such as emerging markets stocks, are at the high end. Extra protection or help might also cost more, such as insurance "wraps" that guarantee a minimum return and managed funds where professionals make the decisions. As with the administrative fee, larger plans can negotiate lower rates because of economies of scale.

Another reason for the cost variation is that some investments have fees that others don't. Among the ones to look out for: "front-end loads" for buying into a mutual fund and "redemption charges" or "surrender fees" for early withdrawal from mutual funds and insurance contracts, respectively.

Retirement plan participants "want their fees to be low and disclosed," summed up Michael Goodman, president of the financial planning firm Wealthstream Advisors in Woodbury. "Unfortunately, there's no standard format for disclosing those fees."

That's why the Labor Department will probably ask employers to provide a chart. Financial experts say it would be relatively simple to compare mutual funds in the same asset class, like bond funds or large-company U.S. stock funds. But it gets stickier when trying to compare offerings from a mutual fund, a bank, and an insurance company, which charge different types of fees and report to different regulators in different formats.

What can employees do if their 401(k) carries, say, only an expensive large-company U.S. stock fund and no other large-stock alternatives?

"You could ask your employer: 'Why are you limited to that fund?' Your employer might be open to adding funds," Kahn of AJK suggested. However, he added, "That's usually not that easy to do."

Katherine Agrillo, owner of the East Meadow-based financial planning firm Agrillo Financial Group, is more optimistic. Because plan officials are fiduciaries, legally required to act in the best interests of plan participants, she said, they're often willing to switch funds as part of their annual review.

As a last resort, "participants can sue them for not acting in a prudent manner," said Jeffrey O'Connor, director of operations at Hauppauge-based Long Island Benefits Group, which administers 401(k) plans for more than 400 small and medium-size businesses.

If the 401(k) choices really don't make sense, investors can open an individual retirement account, where they select the investments. The catch is that virtually all experts say people should first save in their 401(k)s to take advantage of matching funds from companies that offer them.

In any case, fees are only one of several factors to consider when choosing investments.

"If you're getting a much better return, you understand why you're paying a higher fee," Agrillo said.

Most advisers consider fees, risk level, and historical returns compared among similar funds the three most important issues, followed by the investment's stability. They ask questions like: Does it keep to its avowed style? How long has the fund been in existence, and with the same managers? (A five-year track record is standard.) Is it too heavily weighted in a few stocks?

Certainly, a high-fee investment may be worth the extra cost, perhaps because of a long history of outstanding profits. And investors who don't want to spend time studying the markets may be willing to pay more for target-date funds that preselect the asset mix according to their age.

However, Goodman warned that fees can eat away at what might seem like an advantage. "Anybody can have some good returns for a couple of years," he pointed out. "But in the long run, if they have one hand tied behind their back because of a high expense ratio, it's unlikely they're going to outperform most of their competitors."

While awaiting the new rulles...

Investors with 401(k) plans don't have to sit in the dark waiting for the Labor Department's new rules. Plenty of information is available on the Internet, but it may take some digging.

When money is first invested, investors must get a formal prospectus listing the fees. In addition, the information is probably available on the investment company's website by looking up each particular fund.

Every 401(k) plan must provide a summary plan description, which explains how the administrative fees are paid.

Many companies have written investment policy statements, which may spell out some fees.

Retirement experts say that more and more large money management companies are listing their fees on customers' regular quarterly statements. "A lot of the larger houses are gearing up toward the upcoming legislation," said Jeffrey O'Connor of Long Island Benefits Group.