In a 2015 study of 4,368 retirement plan participants, the National Association of Retirement Plan Participants (NARPP) found that 89% could not correctly calculate their account fees. Even more disturbing, only 42% knew they were paying fees at all. Most plan participants – 58% - were unaware that fees were being “automatically” deducted from their account.
Given the importance of 401(k) fees, this confusion is a problem, but not at all surprising given the lack of clear fee information available to 401(k) participants today. The Department of Labor (DOL) finalized participant fee disclosure rules in 2012, but they fell short of full disclosure. Most notably, the fees paid to 401(k) providers can be hidden inside investment expense ratios instead of disclosed.
However, all is not lost. If you are a 401(k) participant, you can still uncover all of the fees deducted from your account – even the undisclosed ones. I’ll show you how.
The annual 401(k) fee disclosure notice
Each year, the DOL requires every 401(k) plan to distribute an annual fee notice to eligible employees and beneficiaries with an account balance. This notice consists of two parts:
- An explanation of the plan-level and individual-level fees that might be deducted from a participant’s account and
- A comparative chart that lists each plan investment fund – including past performance information, expense ratio, shareholder fees, and trade restrictions (if applicable).
401(k) provider fees are disclosed in the annual fee notice differently, based on their type - direct or indirect. Direct fees, which are deducted from participant account balances, must be disclosed in the annual fee notice. Due to their transparency, these fees are the most easily understood by 401(k) participants.
Indirect fees, which are deducted from fund returns, are a different story. They are not disclosed in the annual fee notice. Instead, they are lumped into the fund expense ratios listed in the comparative chart. Examples of these fees include revenue sharing paid by mutual funds and/or variable annuity “wrap” fees paid by insurance company variable annuities.
The results of the NARPP study are not surprising when you know the annual fee notice is not required to disclose indirect fees. After all, many 401(k) providers only charge indirect fees today.
401(k) fee confusion can have severe consequences
It’s imperative you understand both the direct and indirect fees applicable to your 401(k) account – since both reduce retirement savings. When you don’t, the consequences can be severe. It’s not uncommon for 401(k) providers to charge 1% or more of a participant’s account balance annually in indirect fees. That may not seem like a lot until you consider a 1% drop in returns can reduce your 401(k) account balance by 28 percent after 35 years!
Uncovering hidden 401(k) fees
Even though indirect fees are not disclosed in annual fee notices, it’s still possible – though not particularly easy - to uncover their amount by using the comparative chart as a starting point. To do so, you’d take the following steps for each fund in your account with a balance:
- Locate a copy of the fund’s prospectus
- Reconcile the expense ratio reported in the prospectus and comparative chart. Please note the following:
- Mutual fund companies often offer a fund in multiple share classes – each with different fees. You need to determine the correct share class (when applicable) for your fund before you look for indirect fees.
- If your 401(k) provider is an insurance company, there is a very good chance each fund expense ratio listed in the comparative chart includes a wrap fee. You’ll need to figure what portion of the expense ratio listed in the comparative chart is attributable to the wrap fee.
- Once you’ve reconciled the expense ratio, look for 12b-1 fees – a type of revenue sharing – in the fund prospectus. When applicable, they’ll be reported in a breakdown of the fund’s expense ratio
If you found indirect fees, you can total all the fees deducted from your 401(k) account using this spreadsheet.
Why not just pick a 401(k) provider with direct fees?
The NARPP study makes it clear that 401(k) participants are confused about their 401(k) fees – even 3 years after the DOL fee disclosure rules were released. I think the #1 source of this confusion is indirect 401(k) provider fees. Because they’re not disclosed in DOL-mandated fee notices, they are easily overlooked.
That said, it’s imperative for 401(k) participants to understand all of their 401(k) fees – because both direct and indirect fees reduce account returns. If your total fees are unclear due to hidden indirect fees, I have a simple solution – ask your employer to replace your current 401(k) provider with one that only charges fully-transparent direct fees.