Skip to main content

Hidden fees are eating up your 401(k)s

By Robert Hiltonsmith, Special to CNN
June 28, 2012 -- Updated 0615 GMT (1415 HKT)
Fees can, on average, reduce your 401(k) balance by up to 30%, says Robert Hiltonsmith.
Fees can, on average, reduce your 401(k) balance by up to 30%, says Robert Hiltonsmith.
STORY HIGHLIGHTS
  • Survey: 70% of people with 401(k)s don't know they paid fees for retirement accounts
  • Robert Hiltonsmith: Fees can, on average, reduce your 401(k) balance by up to 30%
  • He says far too many Americans are paying unnecessary high fees, even when market is up
  • Hiltonsmith: The mutual fund system we have can't be fixed and must be replaced

Editor's note: Robert Hiltonsmith is a policy analyst at Demos.

(CNN) -- Most of us with 401(k) plans watched in horror, as our retirement savings plummeted in the stock market crash of 2008. That year, the average 401(k) balance dropped by a third, forcing older Americans to delay retirement or cut back on spending. Since then, as the market rebounded, some of our savings have recovered in fits and starts.

The crash showed one serious downside to 401(k)s: their complete exposure to the wild swings of the market. But what you may not realize is that even when the stock market is zooming ahead, hidden fees take an unacceptably high share of your investment return.

If your immediate response is, "Oh, I know how much my 401(k) is costing me," then you're one of small numbers of Americans who's in the know.

Robert Hiltonsmith
Robert Hiltonsmith

According to a recent AARP survey, 71% of people with 401(k)s didn't even know they were paying fees for their retirement accounts.

So how much do these fees really cost you?

The answer may shock you. Fees can, on average, reduce your 401(k) balance by up to 30%, regardless of whether you have $1 or $1 million in your retirement account.

You may wonder -- is 30% a big deal? Yes.

Let's look at a hypothetical model of say, an average two-earner household where the combined earnings is between $50,000 and $70,000 a year over the course of 40 years (from ages 25 to 65).

This couple, unlike most Americans, consistently saves between 5% to 9% of their salaries each year and puts that money into a 401(k) account, gradually increasing their yearly contribution over time. And atypically, they never have to withdraw from this account. They invest their 401(k) account equally in a stock mutual fund and a bond mutual fund, each of which charges average market fees.

For such a household, 401(k) fees will cost $155,000 over a lifetime, which leaves the couple with about $350,000 in 401(k) income at retirement. This may sound like a large amount, but if the couple spends this nest egg at the 4% annual rate recommended by financial advisers, they will have a mere $14,000 yearly supplement to their Social Security benefits -- not exactly a king's ransom.

However, $350,000 is by far more than what most Americans save. According to the Federal Reserve's Survey of Consumer Finances, the average household approaching retirement has only $100,000 in total retirement savings among all of their accounts.

What are these fees, then, that are taking such a big bite out of your retirement account? There are four kinds: administrative fees, marketing fees (sometimes called 12-b1 fees), investment management fees and trading costs.

The first three types of fees are shown, as an aggregate total, in each mutual fund's expense ratio, and are generally reported in your 401(k)'s "summary documents" as a percentage of assets.

For example, if you had $50,000 invested in a mutual fund that has an expense ratio of 1%, it means that you pay 1%, or $500, of the total balance you have invested in the fund in fees. This 1% is charged each year regardless of the mutual fund's performance.

However, the expense ratio does not include the last type of fee -- trading costs. Despite this omission, rest assured that you are indeed paying this fee as well. Trading costs are pretty complex, but the best way to understand them is to know simply that they rise the more often a mutual fund buys and sells its assets, i.e., the more it is being "actively managed."

If you knew that 30% of your retirement savings are chipped off, you would probably be outraged. It seems like a steep price to pay for investment management, doesn't it?

But the investment industry disagrees, arguing that such costs are justified because mutual fund expenses are regulated by the competition of the free market, and what consumers are paying is simply the cost of doing business.

The problem with this argument is that it's not true.

Index funds, for example, have often outperformed actively managed mutual funds while charging a small fraction of the fees. But investing more in index funds will not come close to fixing the broken, expensive 401(k) system.

There's no way around it: the mutual fund system we have can't be fixed, and must be replaced. Why?

Because everything about the 401(k) is too individualized: investment management, risk and fees. We need a new type of retirement account that is somewhere between a traditional pension and a 401(k) that combines some of the best features of each.

To minimize the excessive risks of the stock market and keep down investment management costs, we can invest the funds from all the individual retirement accounts as a pool, mirroring the way that the assets of a traditional pension fund are invested. Pooling maximizes returns for all participants by allowing managers to invest in a more diversified portfolio and over a longer investment horizon.

The government should administer these retirement accounts, making sure that everyone can participate and the pools are as large as possible. However, investment management can and should be bid out to private companies to foster competition.

This is one proposal. It's worth exploring. Far too many Americans are paying unnecessary high fees for precious savings meant for retirement. We can't let that continue.

Follow us on Twitter @CNNOpinion

Join us on Facebook/CNNOpinion

The opinions expressed in this commentary are solely those of Robert Hiltonsmith.

ADVERTISEMENT
Part of complete coverage on
July 28, 2014 -- Updated 2245 GMT (0645 HKT)
LZ Granderson says the cyber-standing ovation given to Robyn Lawley, an Australian plus-size model who posted unretouched photos, shows how crazy Americans' notions of beauty have become
July 28, 2014 -- Updated 1156 GMT (1956 HKT)
A crisis like the Gaza conflict or the surge of immigrants can be an opportunity for a lame duck president, writes Julian Zelizer
July 26, 2014 -- Updated 1822 GMT (0222 HKT)
Carol Costello says the league's light punishment sent the message that it didn't consider domestic violence a serious offense
July 28, 2014 -- Updated 1251 GMT (2051 HKT)
Danny Cevallos says saggy pants aren't the kind of fashion statement protected by the First Amendment.
July 28, 2014 -- Updated 1852 GMT (0252 HKT)
Margaret Hoover says some GOP legislators support a state's right to allow same-sex marriage and the right of churches, synagogues and mosques not to perform the sacrament
July 28, 2014 -- Updated 1831 GMT (0231 HKT)
Megan McCracken and Jennifer Moreno say it's unacceptable for states to experiment with new execution procedures without full disclosure
July 28, 2014 -- Updated 1850 GMT (0250 HKT)
Priya Satia says today's drones for bombardment and surveillance have their roots in the deadly history of Western aerial control of the Middle East that began in World War One
July 28, 2014 -- Updated 1635 GMT (0035 HKT)
Jeff Yang says it's great to see the comics make an effort at diversifying the halls of justice
July 26, 2014 -- Updated 1555 GMT (2355 HKT)
Rick Francona says the reported artillery firing from Russian territory is a sign Vladimir Putin has escalated the Ukraine battle
July 27, 2014 -- Updated 1822 GMT (0222 HKT)
Paul Callan says the fact that appeals delay the death penalty doesn't make it an unconstitutional punishment, as one judge ruled
July 24, 2014 -- Updated 2225 GMT (0625 HKT)
Pilot Robert Mark says it's been tough for the airline industry after the plane crashes in Ukraine and Taiwan.
July 25, 2014 -- Updated 1510 GMT (2310 HKT)
Jennifer DeVoe laments efforts to end subsidies that allow working Americans to finally afford health insurance.
July 26, 2014 -- Updated 1533 GMT (2333 HKT)
Ruti Teitel says assigning a costly and humiliating "collective guilt" to Germany after WWI would end up teaching the global community hard lessons about who to blame for war crimes
July 25, 2014 -- Updated 1245 GMT (2045 HKT)
John Sutter responds to criticism of his column on the ethics of eating dog.
July 25, 2014 -- Updated 1302 GMT (2102 HKT)
Frida Ghitis says it's tempting to ignore North Korea's antics as bluster but the cruel regime is dangerous.
July 25, 2014 -- Updated 1850 GMT (0250 HKT)
To the question "Is Putin evil?" Alexander Motyl says he is evil enough for condemnation by people of good will.
July 24, 2014 -- Updated 1803 GMT (0203 HKT)
Laurie Garrett: Poor governance, ignorance, hysteria worsen the Ebola epidemic in Sierra Leone, Guinea, Liberia.
July 24, 2014 -- Updated 1349 GMT (2149 HKT)
Patrick Cronin and Kelley Sayler say the world is seeing nonstate groups such as Ukraine's rebels wielding more power to do harm than ever before
July 23, 2014 -- Updated 2205 GMT (0605 HKT)
Ukraine ambassador Olexander Motsyk places blame for the MH17 tragedy squarely at the door of Russia
July 24, 2014 -- Updated 1142 GMT (1942 HKT)
Mark Kramer says Russia and its proxies have a history of shooting down civilian aircraft, often with few repercussions
July 24, 2014 -- Updated 1853 GMT (0253 HKT)
Les Abend says, with rockets flying over Tel Aviv and missiles shooting down MH17 over Ukraine, a commercial pilot's pre-flight checklist just got much more complicated
July 24, 2014 -- Updated 1317 GMT (2117 HKT)
Mark Kramer says Russia and its proxies have a history of shooting down civilian aircraft, often with few repercussions
July 24, 2014 -- Updated 1637 GMT (0037 HKT)
Gerard Jacobs says grieving families and nations need the comfort of traditional rituals to honor the remains of loved ones, particularly in a mass disaster
July 24, 2014 -- Updated 1413 GMT (2213 HKT)
The idea is difficult to stomach, but John Sutter writes that eating dog is morally equivalent to eating pig, another intelligent animal. If Americans oppose it, they should question their own eating habits as well.
July 23, 2014 -- Updated 1630 GMT (0030 HKT)
Bill van Esveld says under the laws of war, civilians who do not join in the fight are always to be protected. An International Criminal Court could rule on whether Israeli airstrikes and Hamas rocketing are war crimes.
July 23, 2014 -- Updated 1408 GMT (2208 HKT)
Gordon Brown says the kidnapped Nigerian girls have been in captivity for 100 days, but the world has not forgotten them.
ADVERTISEMENT