A couple of months ago, a friend asked me for help choosing investments in her 401(k). Unfortunately, the investment options were a collection of expensive, actively managed mutual funds, some with sales charges. The only silver lining was her employer’s matching contribution, which is always a fantastic offering.
The price you pay for your investments is very important, yet many people aren’t aware of their retirement account fee structure. Expensive funds can cost a person tens of thousands of dollars (or more!) in fees and expenses over a career. I advised my friend to contribute enough to get the full match, contribute more to an IRA, and ask her employer’s benefits administrator to add some low-cost index funds to her plan.
Tibble v. Edison
Luckily, having low-cost funds at your disposal just got much easier. A recent unanimous Supreme Court decision found that retirement plans that offer expensive investments when cheaper, comparable ones are available are violating Federal law. So what did this mean for you?
The court’s decision was relatively narrow. The plan under scrutiny in this case was offering retail-priced funds when institutional-priced funds were available. In other words, they were forcing employees to buy an expensive product when the exact same product was available at a lower price (kind of like a name brand prescription drug vs. a generic brand.)
That’s illegal, because a 401(k) plan administrator is a fiduciary. A fiduciary means they’re required by law to make decisions in the best financial interests of the employees who keep their retirement savings in the plan. They’re not allowed to use the plan to enrich their employers or themselves. The court didn’t weigh in on how much is too much for a plan to charge, or whether a plan is required to offer index funds. But they offered a glimmer of hope and legal muscle to anyone saddled with a less than ideal 401(k).
How do you know if your 401(k) has lousy investment options? Names and numbers. A good plan will offer a variety of index funds (usually with “index” in the name), with an expense ratio of 0.2% or less. The expense ratio tells you how much the fund charges you per year, as a percentage of the money you keep in that fund. Since the cheapest funds charge under 0.1%, anything over 1% is more than ten times as expensive — and sadly common. The plan is required to disclose the expense ratio of each fund, but it’s not always in the same place. It might be found as a column in the list of investment options on your online benefits site, or you might have to click through to the specific fund.
Even if you find your plan is overpriced, you should still take advantage of your 401(k) to save for the future, especially if there’s an employer match. But it’s worth your time to send a note to the benefits office and ask for index funds. It could make a huge difference to your retirement stash down the road when you’re ready to use your money.