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2005: Where to Invest

Fees Take a Bite From 401(k)s

By Brooke A. Masters
Washington Post Staff Writer
Sunday, January 2, 2005; Page F01

Employees fortunate enough to have an employer-sponsored retirement savings plan now know (or should know) not to fill it up with too much stock in the company they work for. Many have also learned, some the hard way, about the benefits of diversifying where they stow their money. But the investing industry has one more curveball to throw at workers : the fees they pay for their retirement plans.

Named for a section of the tax code, 401(k) plans allow workers to set aside and invest a portion of their pretax income -- up to $14,000 in 2005 for those under 50 -- in mutual funds or other group investment vehicles. Some employers also match a portion of their employees' savings, and then all the money grows on a tax-deferred basis.

401(k) plans that require that some employee contributions be invested in company stock carry an extra element of risk. Workers at Enron, WorldCom and Marsh & McLennan lost significant savings when their employers were entangled in investigations. (Brett Coomer -- AP)

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These arrangements, called defined-contribution plans, are supposed to provide workers with the fiscal discipline and tax advantages they need to provide for their old age, but recent scandals and federal investigations suggest that some investors need to be wary.

That's because 401(k) plans, like the mutual fund investment options they offer, charge management fees, and the higher those fees are, the more they cut into long-term returns. "In many cases, if you are not getting matched [with money from your employer], you're better off not investing in a 401(k) at all because the higher fees offset the tax advantage," said University of Mississippi law professor Mercer Bullard, who has testified about fees to the part of the Labor Department that regulates these plans.

For example, an investor who puts the maximum $14,000 a year in for 30 years into a plan with a 2 percent annual fee and gets 8 percent returns (before fees) will retire with $984,000 in his or her plan. The same amount of money over the same period of time in a plan with a 0.25 percent fee will grow to almost $1,394,000, a difference of $410,000, far more than the possible tax savings.

Some plans also make employees doubly vulnerable to their employers' problems by requiring employees to put the matching contributions into company stock. Workers at WorldCom Inc., Enron Corp. and more recently Marsh & McLennan Cos. all saw much of their retirement savings evaporate when their companies were caught up in financial scandal.

But here's the rub: Investors have very little control over their 401(k) options. When investing on their own, they can pick and choose among 8,000 mutual funds, using standardized charts on fees and returns to pick the best. No such luck when they turn to their retirement plans. Employers select the investment options for 401(k) plans, including the fees that their employees will pay, and to make those decisions, many employers rely on consultants and financial services firms that sometimes have an incentive to push high-fee plans.

An estimated 42 million American workers had $1.9 trillion in 401(k) accounts by the end of 2003, the most recent figures available from the Employee Benefit Research Institute. About 45 percent of the assets were in equity mutual funds, 16 percent were in company stock and 9 percent were in balanced funds, which mix stocks and bonds. The rest were in bond funds, money market funds and stable-value funds such as guaranteed investment contracts.

There are no comprehensive data on the fees that plan administrators and mutual fund companies made from these plans, but critics say the profits are enormous.

Part of the problem is that while the Securities and Exchange Commission requires ordinary mutual funds to disclose their costs in a standardized fashion that makes comparisons easier, 401(k) plans do not have to.

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