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Your 401K is Costing You $155,000!?!?

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Did that catch your attention? Good it should have.

I missed this article last June in NBC News, Your family is probably losing $155K from 401(k) plan, and why new rules won't help. (And I thought I used long titles.)

The $155,000 comes from this study by Demos. The culprit? Investing fees.

As the NBC News article points out, "Doing the math to determine real investing costs from fees is tricky. It involves a long series of assumptions on factors so individualized that no 401(k) projection model is easily generalized. Instead, the Demos study and others like it are merely 'for instance ...' examples." To be fair to Demos, they did their best to create and average couple: people earning average income, contributing the average amount to a 401k, having average growth, over an average 40 year career, etc..

So that's where the "probably" comes from in the NBC article. No one really knows how much the investing fees are going to cost you and everyone is different. However, even conservative estimates from Wall Street sources in that article pin it at $20,000.

This infographic from MoneyNing on 401k fees gives some examples from various companies of the best and the worst. The best 401k plan comes from GE at a price of $45,998, while the worst is Avery Dennison at a whopping $355,057 in fees over a career. That Avery Dennison total covers more than 5 years of the example employee's salary. (Side Note: If you clicked through and wondered why I didn't include the very lowest number in the infographic it is because it incorrectly categorizes the military's Thrift Savings Plan (TSP) as a 401k . It is essentially the same for the participants, but technically it is different. The TSP is one of the better military perks with a miniscule $6,674 fee in the example.)

While there's a huge difference between $355,057, $155,000, and $20,000, none of the numbers should be of consolation to the average person.

Why?

We, Americans on average, don't have that much in our 401k accounts. The NBC article quoted Fidelity as saying that the average person has $75,000 in their 401k and that those close to retirement have an average of $100,000. The Center for Retirement Research two years ago pinned it at $149,400. As I discovered last year even People Making a Lot of Money Still Don’t Have Enough to Retire. That article pointed out that those who make in the 75th percentile only have a median of $52,000 in their retirement accounts (all retirement accounts, not just 401ks)... and those people age 50+ who had time to save .

However you slice and dice the numbers the fees, even at the lowest estimates are very significant compared to the savings.

So what can you do about the investing fees? The answer is not much.

Most 401ks have limited options and people are locked into choosing high fee fund vs. high fee fund. Perhaps I'm being a little too harsh on the fund fees. I should say that the fees are less than optimal. If you had the ability to invest the money however you wanted to, you could choose some very low fee Vanguard funds... often with a cost of 1/10th of a percent a year. In contrast, 401ks can average around 1% in fees. That probably doesn't sound like much, but years of investment compounding make that number mean a lot.

The two actions I recommend are:

  • Look for funds with low expense ratios in your 401k. Typically these are index funds rather than managed ones.
  • When you leave your job, you'll will probably have the opportunity to rollover your 401k into an IRA. Do it, because then you'll be able to choose options with low fees.

If there's one thing I don't recommend, it's waiting to contribute to your 401k. You don't have to be median if you are contributing a big number consistently. My guess is that many people are put off investing in their 401ks because they've got other financial priorities going on (maybe paying off credit card bills) or aren't living within their means. You are also not a "for instance", and do have some ability to limit the impact.

Contributions to my 401k have been one of my most power weapons in my fight for financial freedom.

Posted on February 12, 2013.

This post deals with:

... and focuses on:

Investing, Retirement

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14 Responses to “Your 401K is Costing You $155,000!?!?”

  1. Meghan says:

    Hey there LM,

    TSP is for Federal workers like me as well, so thanks for making me feel warm and fuzzy with the low fees. Second, thanks for reminding me to up my contributions. I HAVE to do that this year.

    • Lazy Man says:

      Hey, I didn’t realize that federal workers get TSP too… Awesome!

      Perhaps I should have mentioned that if you have TSP and switch jobs, it’s may be better to leave your money than take it with you. The expense ratios are better than any I’ve seen anywhere else, even the cheapest Vanguard ETFs. It’s been a few years since I made a thorough comparison though. It may have changed slightly, but at that point we are talking very small percentages.

  2. Hmmm. My new job has the option of a 401K or a Roth. I’m leaning toward the second one. What do people here think?

  3. Kosmo says:

    Or are they offering a choice between a traditional (pre-tax) 401(k) and a Roth (after tax) 401(k)? Some companies offer this now.

    Despite what you might hear, there’s no slam-dunk correct decision on Roth vs. traditional. It’s very situation dependent. The most important variable is whether you expect to be in a higher or lower tax rate when you retire.

    I wrote a pretty length article on the topic a while back. It runs through a bunch of scenarios.

    http://www.thedigeratilife.com/blog/invest-pre-tax-or-after-tax-dollars-retirement-401k-vs-roth-ira/

    • Lazy Man says:

      I didn’t think of the Roth 401k because I’m so trained to think of the Roth as an IRA. The way it was worded with a 401k vs. a Roth is usually a 401k vs. a Roth IRA.

      The military and federal employees (thanks Meghan) now have access to a TSP that works like a 401k and a Roth TSP that works as a Roth 401k. I’ve tried to analyze things a bunch of different ways, but it is almost impossible to figure out which is optimal for us. We don’t know if our income in retirement (due to pension, rental income, and other businesses) is going to be less than now.

  4. Kosmo says:

    And even if you could project your future income, you don’t know what the rates will be in the future. For example, if we completely scrapped income tax for a national sales tax and didn’t any sort of adjustments (very unlikely scenario) Roth investors would be completely screwed, as they’d have paid the income tax on the front end and the national sales tax on the back end.

    Those median numbers are scary. $100K for retirement? Hopefully those folks are planning to die really young – that money won’t last very long.

    I wish we had more saved for retirement (kids are expensive) but compared to the median numbers, we’re doing great. I do also have a defined benefit pension, which is a nice bonus.

    • Lazy Man says:

      A flat rate tax without some sort of adjustment conjures up images from Frankenstein. I’m thinking torches and pitchforks…

      Yeah, the median numbers are extremely scary. I don’t see a scenario where a large portion of the country isn’t screwed.

  5. Meghan says:

    I’m not doing the Roth. I’m doing the Public Service Loan Forgiveness program and need my AGI to be reduced by the TSP pre tax contributions.

  6. Kosmo says:

    @ Lazy Man – can you imagine the debates on exactly what adjustments would be made? It would take forever for congress to hammer out the details of a national sales tax. Oh, subsistence foods should be exempt? Does that include fruits? Is ketchup considered a fruit … etc, etc.

    @ Meghan – That’s smart. Sometimes factors outside of tax and investing can be be factors in a decision.

  7. Thanks, Kosmo and Lazy Man, I will consider. It’s the choice option: pre- vs. after-tax. I doubt I will be in that high of a bracket when I retire, IF I retire, as I am 47 now and have absolutely no savings of any kind anymore. Thank you, unemployment, for sucking my sad little beginning accounts dry!

    I’m making more money now, so I figured it might be a good idea to save while the saving is good. I’ll just pretend I still don’t have any money and the extra will go into the nest egg. :)

  8. I contribute enough to my 401k to get the full match. Then I have the investments allocated to the lowest cost index fund there. It’s not just the 401k fees that I can’t stand, it’s also the fact that my money is locked up for such a long time.

    After my 401k is funded, everything goes to taxable accounts where my focus is investing to build passive income streams. Couple this with a high savings rate and I should be able to retire if I so choose in a bit over a decade.

  9. Some crazy facts for sure. I did a whole series of indepth articles on explaining why the median and average 401k is so low, and we we are screwed if we don’t save more.

  10. Ken says:

    In the military there is a major drawback, in my eyes, to having both TSP types of accounts. When you start making withdrawals you do not get to make the choice of which account the money is being withdrawn from. It is a proportional withdrawal from both accounts, if you have a even 50/50 mix of Traditional and Roth your withdrawal will be evenly split between the 2.

    Since we know the accounts are never going to be a even 50/50 split this will make for some tough decisions on withdrawal rates. Especially if you have multiple investment accounts and are trying to plan withdrawals for the best possible tax gain.

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