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I was looking over my end-of-the-year finances and noticed some really disheartening details about my company's 401k. The company holds a plan through Principal, and the managed 'target date style' fund charges 1.20%. Yikes. I was under the impression that anything below 1% was 'reasonable', but anything above was... not.

Looking around at the other options inside the plan, it doesn't get much better. There are only 12 other funds to choose from, and 6 of those have fee structures even higher than 1.20%.

The dangers of a high-fee plan are obvious, but in this case I just don't feel like I have any choice. It seems like a very poor investment to distribute income into only those funds charging the lowest fees. It's probably the case that fee structures are directly tied to past performance.

Did my plan administrator get duped? Is Principal just a bad company with which to retire? Is there anything I can do?

Addition: For those interested, I spoke with HR responsible for picking the plan. It seems they did due diligence in evaluating a large number of different plans. The problem was the age/size of the company... fewer employees dictated higher fees. On the plus side, as the 401k grows (as a company) the fee % will lower slightly (to around .8%).

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    Is there any company match? – JoeTaxpayer Dec 30 '14 at 21:46
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    You refer to a "managed 'target date style' fund". Is the fund actively managed or is it comprised of underlying passively-managed index funds? Also, what state do you live in / what is your state income tax? That's another factor - the tax deferral is a bigger advantage if you live in a high-tax state and could plausibly move to a lower-tax state in the future. – wrschneider Jan 1 '15 at 20:39
  • Also what are the actual investments offered in the fund? Is there an S&P 500 index or total stock market index? – wrschneider Jan 1 '15 at 20:50
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In my opinion, the fee is criminal. There are ETFs available to the public that have expenses as low as .05%. The index fund VIIIX an institution level fund available to large 401(k) plans charges .02%. I'll pay a total of under 1% over the next 50 years,

Consider that at retirement, the safe withdrawal rate has been thought to be 4%, and today this is considered risky, perhaps too high. Do you think it's fair, in any sense of the word to lose 30% of that withdrawal?

Another angle for you - In my working years, I spent most of those years at either the 25% or 28% federal bracket taxable income. I should spend my retirement at 15% marginal rate. On average, the purpose of my 401(k) was to save me (and my wife) 10-13% in tax from deposit to withdrawal. How long does it take for an annual 1.1% excess fee to negate that 10% savings? If one spends their working life paying that rate, they will lose half their wealth to those managing their money.

PBS aired a show in its Frontline series titled The Retirement Gamble, it offers a sobering look at how such fees are a killer to your wealth.

  • Thanks for the link. So what do you do to combat this? I have a RothIRA, but of course the limit for contributions is too small to be meaningful. Is it better to run my own brokerage account and take the tax penalties? – Clever Dec 19 '14 at 14:41
  • I agree the limit is low for IRAs. Paying the tax, investing in a brokerage account, and enjoying long term cap gain treatment will win the race. Consider, if I saved my way to a 401(k) that put me at 25% on withdrawal, I'd be even worse off, as cap gains are currently 15% maximum, for most of us. – JoeTaxpayer Dec 19 '14 at 16:07
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    Probably worth a line of "Don't forget, if there is an employer match, make sure you get that no matter how horrid the fees are." – Joe Dec 19 '14 at 19:07
  • @Joe - D'oh! Yes, how in the world did I forget that line? – JoeTaxpayer Dec 19 '14 at 19:50
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When you look at managed funds the expense ratios are always high. They have the expense of analyzing the market, deciding where to invest, and then tracking the new investments. The lowest expenses are with the passive investments. What you have noticed is exactly what you expect.

Now if you want to invest in active funds that throw off dividends and capital gains, the 401K is the perfect place to do it, because that income will not be immediately taxable. If the money is in a Roth 401K it is even better because that income will never be taxed.

  • Thanks for the response, but what are some real alternatives (if any) to a "responsible" 401k retirement plan? – Clever Dec 19 '14 at 14:44
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I would even say 1% is not even reasonable in this age. The short answer is there probably isn't much you can do directly. However, there are a few things to consider:

  • As Rocky mentioned get HR to change the plan. Worth a shot but is at best a longer term solution.
  • Carefully read the 401(k) rules and talk to HR. Some 401(k) plans will have ways you can roll out the money but most require you to be over 59 years old.
  • At the same time talk to HR about what happens to the 401(k) if you take a sabbatical. Under some instances you may be able to roll out.
  • As JoeTaxpayer mentioned you can not put money into the 401(k) in the first place. However, this is generally a bad option as even with these shocking 1% fees it would take more years to break, even with the 15% tax rate, than most people stay at a job.
  • Consider changing jobs or taking a year off. As you mention Roth limits are negligible you clearly make a significant amount of money. As Ben mentions if you have a lot of money in this 401(k) you may get a significant effective pay boost from switching jobs.
  • +1 nice summary. Your 3rd point is worth noting. It's tough, in my opinion, to have these fees accumulate even though the statistics say the time is limited. – JoeTaxpayer Dec 19 '14 at 20:11
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Would anything happen if you bring this issue to the attention of the HR department? Everyone in the company who participates in the 401(k) is affected, so you'd think they'd all be interested in switching to a another 401k provider that will make them more money.

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    It's worth pointing out to HR that this directly works against retention. Changing jobs is often the only way to regain control over 401(k) and re-invest it with a management firm of the employee's own choosing, and when the benefit of doing that starts running into tens of thousands of dollars... that's like a significant signing bonus that the new employer doesn't even have to pay for, but HR at the current company has to bid against. – Ben Voigt Dec 19 '14 at 17:40
  • +1, but HR or whoever chose this administrator has already proven their incompetence. They'd be admitting a mistake by changing. – JoeTaxpayer Dec 19 '14 at 18:09
  • agreed, it would have to be approached diplomatically. "we'll all make more money, this is a solution for all of us." Make Principal the bad guy and HR the good guys. – Rocky Dec 19 '14 at 18:20
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Your employer could consider procuring benefits via a third party administrator, which provides benefits to and bargains collectively on behalf of multiple small companies. I used to work for a small start-up that did exactly that to improve their benefits across the board, including the 401k. The fees were still higher than buying a Vanguard index or ETF directly, but much better than the 1% you're talking about.

In the meantime, here's my non-professional advice from personal experience and hindsight: If you're in a low/medium tax bracket and your 401k sucks, you might be better off to pay the tax up front and invest in a taxable account for the flexibility (assuming you're disciplined enough that you don't need the 401k to protect you from yourself). If you max out a crappy 401k today, you might miss a better opportunity to contribute to a 401k in the future. Big expenses could pop up at exactly the same time you get better investment options.

Side note: if not enough employees participate in the 401k, the principals won't be able to take full advantage of it themselves. I think it's called a "nondiscrimination test" to ensure that the plan benefits all employees, not just the owners and management. So voting with your feet might be the best way to spark improvement with your employer. Good luck!

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The expense fees are high, and unfortunate. I would stop short of calling it criminal, however.

What you are paying for with your expenses is the management of the holdings in the fund. The managers of the fund are actively, continuously watching the performance of the holdings, buying and selling inside the fund in an attempt to beat the stock market indexes. Whether or not this is worth the expenses is debatable, but it is indeed possible for a managed fund to beat an index.

Despite the relatively high expenses of these funds, the 401K is still likely your best investment vehicle for retirement. The money you put in is tax deductible immediately, your account grows tax deferred, and anything that your employer kicks in is free money.

Since, in the short term, you have little choice, don't lose a lot of sleep over it. Just pick the best option you have, and occasionally suggest to your employer that you would appreciate different options in the future. If things don't change, and you have the option in the future to rollover into a cheaper IRA, feel free to take it.

  • Please provide a link to any study showing a positive correlation between such a fee and the excess return (i.e. as compared to a broad index) the fund would see. – JoeTaxpayer Jan 1 '15 at 15:14
  • @JoeTaxpayer I'm not arguing that managed funds always, or even usually, perform better. Just that it is possible for one to perform better. (If you don't trust the skills of the manager, you might call it short term luck, if nothing else.) I agree with you that the expenses are high, but I wouldn't stay out of the 401K altogether as a result. – Ben Miller Jan 1 '15 at 15:22
  • To @JoeTaxpayer 's point, there was a good article in the New York Times this summer showing how incredibly rare it is for a managed fund to consistently beat the index for any length of time. – Ben Miller Jan 11 '15 at 1:53

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