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Over time, high fees can take big bite out of retirement accounts

WASHINGTON — It's the silent enemy in our retirement accounts: high fees.

And now a new study finds that typical 401(k) fees — adding up to a modest-sounding 1 percent a year — would erase $70,000 from an average worker's account over a four-decade career compared with lower-cost options. To compensate for the higher fees, someone would have to work an extra three years before retiring.

The study comes from the Center for American Progress, a liberal think tank. Its analysis, backed by industry and government data, suggests that U.S. workers, already struggling to save enough for retirement, are being further held back by fund costs.

"The corrosive effect of high fees in many of these retirement accounts forces many Americans to work years longer than necessary or than planned," the report concludes.

Most savers have only a vague idea how much they're paying in 401(k) fees or what alternatives exist, though the information is provided in often dense and complex fund statements. High fees seldom lead to high returns. And critics say they hurt ordinary investors — much more so than, say, Wall Street's high-speed trading systems.

The higher fees often accompany funds that try to beat market indexes by actively buying and selling securities. Index funds, which track benchmarks such as the Standard & Poor's 500, don't require active management and typically charge lower fees.

For one of its stock index funds, Vanguard lists an expense ratio of 0.05 percent. State Farm lists it at 0.76 percent for a similar fund. The ratio jumps to 1.73 percent for a Nasdaq-based investment managed by ProFunds.

Average fees also tend to vary based on the size of an employer's 401(k) plan. The total management costs for individual companies with plans with more than $1 billion in assets has averaged 0.35 percent a year, according to BrightScope, a firm that rates retirement plans. By contrast, corporate plans with less than $50 million in assets have total fees approaching 1 percent.

The Investment Company Institute, a trade group, said 401(k) fees for stock funds averaged 0.63 percent in 2012 (lower than the 1 percent average figure the Center for American Progress uses), down from 0.83 percent a decade earlier. The costs fell as more investors shifted into lower-cost index funds. They've also declined because funds that manage increasing sums of money have benefited from economies of scale.

"Information that helps people make decisions is useful," said Sean Collins, the institute's senior director of industry and financial analysis. "Generally, people pay attention to cost. That shows up as investors tend to choose — including in 401(k) funds — investments that are in lower-than-average-cost funds."

The Center for American Progress is calling for a prominent label to identify how a plan's fees compare with low-cost options. That information, now found deep inside documents, shows the annual fees on investing $1,000 in a plan. Yet that figure, usually only a few dollars, doesn't reflect how the fees rise into tens of thousands of dollars as the account grows over decades. The researchers say the Labor Department could require more explicit disclosure without going through Congress.

Over time, a little means a lot

Retirement fund scenarios for a 25-year-old worker, earning the U.S. median income of $30,500, who puts 5 percent of his or her pay in a 401(k) account and whose employer chips in another 5 percent, over the course of 42 years of investing:

If the plan charged 0.25 percent in annual fees, a widely available low-cost option, and the investment return averaged 6.8 percent a year, the account would equal $476,745 when the worker turned 67 (the age he or she could retire with full Social Security benefits).

If the plan charged the typical 1 percent the account would reach only $405,454 — a more than $71,000 shortfall.

If the plan charged 1.3 percent, common for 401(k) plans at small companies, the account would reach $380,649, a more than $96,000 shortfall. The worker would have to work four more years to make up the gap. (Assumes the worker's pay rises 3.6 percent a year.)

Over time, high fees can take big bite out of retirement accounts 04/15/14 [Last modified: Tuesday, April 15, 2014 9:45pm]
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