Most employers sponsor a retirement plan for their employees. The most common option is the 401(k) plan. Most people prefer to use their employer’s sponsored plan to save for retirement as it is a lot easier than having to go through the steps to open up an IRA on their own. Many employers go as far as to automatically enroll their new employees to contribute to their 401k at a low percentage such as 3% just to get started. (It’s also easy to miss 3% coming out of your check, but that small percentage can lead to thousands saved for retirement.)
As great as using a 401(k) is, there is one big problem to be aware of: your 401(k) options were not selected by financial experts.
The Business of Selling 401(k)s
Your employer’s human resources or benefits department likely selected the company that provides the accounts and options for your 401(k). Some companies have just one person make the selection while others use a selection committee. The decision is usually passed up the chain to be approved by the CEO, President, or Board of Directors.
To make the selection, most companies receive presentations from financial firms competing for the opportunity to run the retirement plan. In this scenario, the financial experts are not on your side of the table. They are the ones making the presentation. This is a huge risk to your retirement.
The firms presenting to your organization know exactly how much money stands to be made by running the plan. They know the company wants to pay as little as possible to run the plan, and they can sneak in hidden administrative fees that employees pay to run the program. This makes the 401(k) seem very inexpensive for the employer while secretly costing employees a lot of collective money.
Two Ways Your 401(k) is Costing You Too Much
Here are some of the ways the plan that was sold to your human resources department can cost you as you try to build up a nest egg for retirement. Consider these potential costs as you decide where to invest your retirement dollars. While your employer’s plan may be the easiest option, you may be paying hidden fees that eat away at your retirement. If you research an IRA or Roth IRA, you have the ability to completely control your investment costs with no hidden fees.
Hidden Administrative Fees
If you carefully inspect your transaction logs for your 401(k) plan at work, you will see administrative fees deducted from every investment. The charges are small – pennies on the dollar – but over time they can add up to a significant amount of money taken out of your retirement. With a firm running millions of dollars of investments for many companies, just a few pennies every year from every account can really add up.
Above Industry Average Expense Ratios
A more obvious cost that can hurt your retirement is the expense ratio associated with your mutual fund investment options. Since most people just stick money into their 401(k) and don’t know much about the investment options, a firm can sneak in higher cost funds into the investment mix. The industry average is 1% for mutual funds, but index funds can be as cheap as 0.10% or 0.20% per year. That’s a discount of 80% to 90% off of the cost of investing. Your plan may only have one inexpensive index fund to choose from, but the low costs will serve you well into the future.