I am 20 and have a 401(K) contributing 4% for the last 3 yrs. In reading about the amount of fees charged to manage these accounts that would eat up my savings, would it be a better choice to have an IRA or Roth account at my age? My plan is to grow with this company as far as I can.
Good question. It is important to consider fees when you invest, especially at your age. Hopefully you have another 80 years of investing ahead of you. Over time fees can make a big difference. Paying an extra 1% over 20 years can deplete your account balance by 17%. But fees are necessary. No one will create and manage a mutual fund for free. And your 401(k) requires a multitude of service providers to deliver the plan who also want to get paid. The trick is to pay a fair, reasonable fee and not overpay.
To determine what you fees are locate your annual plan disclosure which is may have the term 404(a)(5) somewhere in the title. Back in August of 2012 the Department of Labor started requiring all plan sponsors (employers) to provide this notice to their plan participants annually. In the disclosure, among other things, you will find all of the fees you have in your plan. You will want to find the section regarding “administration” fees and also the fees associated with the investments in your plan.
Don’t be surprised if the administration fees are $0. Unfortunately the service providers in the industry have adopted a common practice of “revenue sharing” from the mutual fund expenses. So instead of charging transparent fees for each service they provide they instead build their fees into the mutual funds. Then the mutual fund company pays the 401k platform provider (any household name financial service firm) who in turn pays the recordkeeper, administrator, custodian, corporate trustee, auditor, and financial advisor (this is just an example). When the platform uses revenue sharing it can be very difficult to really understand the fees. At a bare minimum the service provider must break out the total fund expense ratio and any contract fees in the 404(a)(5) disclosure. This is really all you care about. I doubt you care about how the fees are split among the service providers. Your plan sponsor should care however because they have a legal obligation to know what these fees are and to document that they are reasonable.
Assuming the fees are reasonable you aren’t overpaying. You may be able to get a lower fee in an IRA (ROTH or otherwise) but if you aren’t careful you could pay more (because the same household names that are good at hiding fees in the 401k are just as good at hiding them in the IRA).
At a minimum contribute enough to the plan to capture the employer Match, if any. And make sure you take full advantage of any service the 401k offers such as access to a financial professional or managed model portfolios. If the plan offers no education service to you and the funds are very expensive then the IRA may be better. Remember that you can’t put as much into an IRA as you can your 401k.
I want to congratulate you for saving at such a young age. Please keep it up. With faith, patience and discipline you’ll have a very large retirement account one day. Just one suggestion, try to work your 401k deferral up from 4% to 10% over time. 4% won’t get many people to the place they want to be in retirement. This is just a general statement.
Hope this helps.
Costs do matter in investing. New regulations require fee disclosure for employer sponsored 401(k) plans. This disclosure can be found on-line and/or is available through your employer's HR department. Participant fees exceeding 1% are considered high, but you should stay in the plan (even if it is expensive) when your employer offers matching contributions.
Consider adding a Roth IRA to your overall savings/investment strategy if you are eligible (there are income limits). Funding an IRA is completely separate from your 401(k), so the answer is not either/or. It is both, if you can afford it. After all, good financial planning requires you to strike a balance between taking good care of your present day self, as well as your future self.
It is very wise of you to consider your savings options. I meet with too many who have “done the right thing” and saved to their 401(k), and not only paid high fees, but also had reduced control and diversification options. Consider if you may be able to earn 1-2% more by diversifying on your own, that alone beats the high fees you may be paying!
I agree, a match is generally worthwhile. But, if you pay high fees, if you are young, if the match is not significant (greater than 50%) then you may not benefit as much as you think. If you’re unsure, absolutely, get the match. However, I know many who have too few investment areas to invest in, no matter the low fees that they pay, whose accounts would have grown higher if they had additional diversification options.
Your long-term target for retirement savings should be at least 15%. Yes, that’s a target, but if your match is met on 4%, it makes sense to look at other options prior to increasing the 401(k). I would advise spending time with an independent and maybe hourly financial advisor to make sure you are saving in the right place today where it benefits you the most.
Generally you should contribute to the maximum of the company match and contribute additional monies to self-directed qualified plans (either a ROTH or Traditional IRA, depending on your income level and potential tax savings). If you work with a CPA or qualified tax advisor, they should be able to direct you and suggest the best course of action. With regard to fees, I wrote extensively on the matter at this link (http://www.jasongilbertcpa.com/jason-gilberts-blog/why-fee-only-matters). Please let me know if I can be of more specific help. Best of luck.