The Secret Life of Fees in Your 401K
A few years ago, I mentioned that I used a target-date index fund in my 401K. A reader came out and bashed me pretty hard for that move, saying I was overpaying to save for my retirement. I was frazzled, not because of the comment, but because it was really hard for me to figure out how much I was actually paying in fees and defend my position.
For the next couple of weeks, I went on a mission to discover how much I was actually paying in fees to invest in my 401K. The results were not that bad compared to the other choices in my 401K plan. However, I was disappointed that it was so hard to determine. Thanks to some nice folks in the Get Rich Slowly forums for helping me weed through all the fee details.
If you have a 401K it’s possible that you’ve wondered the same thing: “How much of a cut are these guys taking?” And, “when is it worth stopping my contributions to a 401K to start investing in a Roth IRA with lower fees?”
Now there is a group determined to shed some light on the secret world of 401K fees. They are called BrightScope. I spoke with the co-founder and CEO of BrightScope, Mike Alfred. He shared with me some interesting stats, plus the basics of what BrightScope does.
Is the 401K Match Coming Back?
We first discussed the 401K match, something a lot of companies had done away with temporarily. Mike shared that despite the loss of the match, the savings rate for 401K participant had not dropped. People are still putting money into their 401Ks. We discussed a recent study concerning the return of the 401K, and although Mike agreed with the optimism of the results (the match will be returning for most companies), he found the study to be limited by the small amount of participants.
One place that doesn’t use a small study group is the BrightScope website. They have over 33,000 401K plans included and rated using the BrightScope rating system. This is around 66% coverage of all the 401Ks in the US. What BrightScope does is gather all the data they can get on your company’s 401K plan. This includes things like fees, match, etc. They then compare this plan to a peer group of similarly sized companies. The result is the BrightScope Rating.
The BrightScope Rating is an industry standard quantitative 401k plan rating developed by BrightScope, Inc. with the help of leading academics and independent 401k fiduciaries. The BrightScope rating algorithm calculates a single numerical score for each 401k plan in the country after considering over 200+ individual data points in broad categories such as total plan cost, company generosity and investment menu quality.
How to Use BrightScope
I asked Mike how readers should go about using BrightScope. He suggested the following: (1) visit BrightScope and determine how well your company plan is performing; (2) determine how much in expenses you are paying; (3) share your rating information with your company’s HR department and ask about improving your rating; (4) leave comments on BrightScope.com for others to read. Here’s a snapshot of the BrightScope Rating (I applied it to BOA’s 401K):
Why Fees are So Hard to Find
I asked Mike why 401K fees are so hard to find. He didn’t have a direct answer but he gave me this nugget. Prior to the 80’s, most employers used a defined-benefit pension plan as the main benefit to provide their employees a secure retirement. With a pension, the company controlled all the investment decisions. There was no need for the employee to be aware of the fees, investment choices, etc. The employees would be taken care of. The risk was on the employer to make the right decisions.
Then along comes the 401K, the employee controlled plan, where a benefit is not defined, but the risk is shifted to the employee. Mike says that although employees are now responsible for their own retirement, they didn’t get full control of investment choices and they didn’t get the necessary information to help them make the decisions they need to make.
BrightScope is now helping to create the shift in choice and disclosure that is long needed in the retirement investing world.
What Others Are Saying About BrightScope
What if Your Company’s 401K is Not Yet Rated by BrightScope?
The company I work for has not been rated by BrightScope just yet. Mike assured me that they are getting to it. But he also pointed out that I can help. You can actually submit data to BrightScope. Click on the “Provide Us with Data” link and you’re taken to a page where you can upload specific plan documents. This will help BrightScope provide a rating for your company faster.
You can still find out your 401K plan fees by completing a Personal 401K Fee Report. It’s free to complete and will shed some light on the expenses of the funds in your 401K.
How to Figure Out Your 401K Expenses
Also, I ran across a nice 401K expense calculator in Money magazine this month that I thought I would share.
Step 1: Tally Administrative Costs
- Go to your plan’s summary annual report. Find the “basic financial statement” section.
- Subtract “benefits paid” from “total plan expenses.”
- Divide that number by the total value of the plan.
- This number is your plan’s administrative cost.
Step 2: Calculate Investment Fees
- Multiply your fund expense ratio by your balance in the fund.
- Divide those total fees by your total balance.
- This number is your investment expense.
- *If you have only one fund (i.e. target-date fund), your investment expense ration is the ratio on this one fund.
Step 3: Add Administrative and Investment Fees
So what are your thoughts about 401K fees and the rating system provided by BrightScope? Let me hear from you in the comments below…