Beware of fees as new pension law takes hold

Tribune staff reporter

Ignorance is bliss.

But if you care about your money, be careful not to take it too far.

During the next few months a newly passed federal pension law will allow your employer to take money out of your paycheck and invest it for you in a 401(k) or 403(b) retirement savings plan at work.

Some employers will do this, and some won't. The new law simply gives employers the green light to do it. Hewitt Associates estimates that about a third of employers may exercise this new authority, while allowing employees to opt out of the plans if they wish.

If you have not participated in a retirement plan at work in the past and are overwhelmed with mutual fund choices, being enrolled automatically in your 401(k) plan could put you on a better course for your future. You might be able to enjoy your ignorance and still build up a modest nest egg.

But if you make a practice of giving your retirement savings a little more attention, you will have to keep an eye on potential changes that could interfere with your investments' earning power in the future. I'm talking about fees.

With the passage of the new law, benefits staffers at employers throughout the country are busy making changes in 401(k) plans. With potentially $1 trillion of new business in the making, brokers, insurance salesmen, financial planners, independent money managers and mutual fund companies all are pitching packages of new 401(k) investment options to these benefits staffers.

Some changes will include investment education for employees and mutual funds that put employees automatically into mixtures of stocks and bonds appropriate for their age. But with some of these plans, fees could be excessive -- stripping investors of some investment returns.

That's where your attention will be warranted.

Fees can seriously erode your hard-earned investing dollars. And often benefits staffers, who make decisions on 401(k) choices, do not fully understand their impact.

Fees are so significant that a young investor could give up close to a half-million dollars, or more, over a lifetime of investing --simply by overpaying 401(k) expenses, said Chicago financial planner Chris Long.

He notes that some expensive 401(k) plans charge investors close to 3 percent a year, while others charge just slightly over 0.25 percent. While those seem like small numbers, Long calculates that a person earning $50,000 could end 30 years of investing with about $870,000 in an expensive 401(k) plan and $1.3 million in an inexpensive plan.

For the calculation he assumed the person would save 10 percent of pay at first; then increase saving 1 percent with each annual raise. Once their contribution hits the per-year ceiling of $15,000, that contribution total would stay constant in subsequent years. The investments in the account would average a 9 percent average annual return, prior to extracting the fees.

Investors often fail to consider fees -- especially in 401(k) plans, where fees are not obvious. Money simply slips away without an employee ever getting billed or writing a check. It comes out of your investment returns.

In a study of benefits decision-makers in 2004, Hewitt Associates found that only 5 of 10 large employers had attempted to calculate the fees.

With the Department of Labor urging employers to insulate employees from excessive fees, more employers have been asking questions, says Pamela Hess, a Hewitt defined-contribution plan consultant.

The effort remains difficult, Hess says, because there are layers of fees that are often interwoven.

They include administrative fees related to paperwork and record-keeping, investment management fees for the investments, and trustee fees.

Since many employers simply pass the entire package on to employees, there is sometimes little incentive to scrutinize it.

Small firms struggle

Small and medium-size employers, in particular, may struggle because of a lack of expertise, but also because they have fewer low-cost investment options available compared with larger employers, Hess said.

Instead of dissecting fees, a small employer might be prone to give a contract to the boss' golfing buddy or to the same agent who provides the company with liability insurance.

Consequently, it's critical that employees ask questions.

As a rule of thumb, Hess suggests that employees should pay no more than a 1 percent fee.

She said employees should ask their employee benefits staff: "What are our total fees?" and "How much am I paying?"Since the employer has a legal responsibility to handle 401(k) and 403(b) money wisely, the staff will be bound to take the questions seriously, and get an answer if one is not immediately available.

Long says employees should be aware of two numbers: "the expense ratio," which usually incorporates all fees -- but may not --and a potential extra charge called a "wrap fee."

The wrap fee might apply when a broker or some other adviser is providing investment advice. Hess says so-called "separately managed accounts" can be expensive. With these, an investment consultant may custom-make investment solutions for particular employees -- adding a fee of about 0.30 percent on top of the expenses charged for mutual funds.

"Paying 0.30 percent every year is a lot of money over all the years leading up to retirement," Hess said.

Employees should also watch out for annuities, which tend to be the most expensive of all options -- perhaps charging 2.3 percent, or even 3 percent once all costs are included, Long said.

Target-date funds

Also, with the new law, many employers will be providing what are called "target-date funds."

These are outstanding no-brainer funds for people who find investing overwhelming. A fund manager mixes stocks and bonds together based on a person's age -- with younger investors taking on greater investing risks than older investors.

While the new funds give investors a simple investing solution, employees should also make sure they are not becoming excessively expensive. Some are pricey from the start -- charging over 1 percent. And some employers add 0.50 percent "wrap fees" on top of that --stripping savers of a potential 1.5 percent, or more, of their earnings.

Hess says employers are debating how to communicate with employees about fees. "They don't want to inflame them."So if you care, ask questions now.

Contact Gail MarksJarvis at or leave a message at 312-222-4264.

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