One of the most popular retirement accounts utilized by US employees is the 401(k), which was created almost by accident back in 1978 when Congress passed the Revenue Act that included within it a section dubbed—you guessed it—401(k). It allowed employees to defer some compensation from stock options or bonuses.
After the rules went into effect in 1980, the IRS followed suit in 1981 by introducing rules that allowed employees to contribute to their 401(k)’s through salary deductions. And the popularity and availability of these plans have increased ever since.
Despite their noble intent, 401(k)s do have one major drawback that’s often overlooked by account owners, and we’re not talking about early withdrawal penalties.
Your 401(k) and its fees
In 1996, the assets held by 401(k) accounts surpassed $1 trillion. Today that number is around $6.7 trillion and takes up about one-fifth of the nation’s total retirement savings pie. That’s a sizable stash of cash, and much of it is being eaten away by fees that account holders are footing the bill for.
The average fee paid per account comes out to around 0.45% annually, meaning that an account with holdings of $100,000 would end up paying $450 every year in fees alone. That fee schedule ranges greatly though depending on the type of plan and the cost of funds offered —usually from around 0.37% to north of 1.4% per year.
One of the main upsides of a 401(k) plan is its tax benefits, but a 2015 estimate from 3,500 surveyed accounts suggested that in nearly 16% of all 401k plans, the fees incurred are essentially erasing all the tax savings.
Why this happens and how to reduce your fees
If you want to reduce your fees as any aspiring retiree, here are some practical tips.
- First, find out what you’re paying. A surprisingly high number of investors don’t know what their fee schedule is. You may have to make some calls to your plan administrator or ask some questions internally with your employer’s HR department. It’ll be well worth your time.
- Analyze your holdings. If your fund doesn’t allow you to actively make changes, see if there’s an option for a self-directed brokerage window. Certain investments, particularly those that are more actively managed, will have a higher fee than others. Consider passive low-cost index funds if your plan offers them, or diversified target date or target retirement funds that are well-suited for those hands-off investor types.
- Consider rolling it over. By rolling over your entire account to a traditional IRA or something more suitable that allows you to actively control your account, you’ll avoid paying any taxes on this transfer. If, however, you want to go the Roth route, you’ll be paying taxes on the holdings first.
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