Little Differences Mean A Lot

When times were good, and returns high, it was tough to get excited about the hidden costs of 401(k) plans. With account balances rising steadily, what did it matter that charges for plan administration and trustee costs, added to investment expenses, could subtract a percentage point or more each year from the growth of employee assets in these self-directed retirement plans?

Now, of course, most retirement investments aren’t growing, and a new warning from benefits consultant Hewitt Associates shows just how costly high plan expenses can be. Hewitt calculated the growth of a tax-deferred account balance with three different total expense ratios: 0.5%, 1%, and 1.5%. For the purposes of this illustration, three hypothetical employees begin with 401(k)s worth $50,000. The model assumes they make no further contributions, and that they earn identical 8% average annual returns for 30 years. At the end of that time, the assets in the plan with 1.5% yearly expenses are worth $330,718. The other two scenarios—with annual charges of 1% and 0.5%—result in final balances of $380,718 and $437,748, respectively. The bottom line is that an employee in the least expensive plan will end up with $107,030 more than someone in the costliest plan—a bonus of almost 33%.

Hewitt’s point is that employers may not understand just how much they’re paying for their retirement plans, because providers often bundle administrative and trustee costs with investment management expenses and may not fully disclose total charges. Meanwhile, it’s the employees who bear the brunt of those fees. But this illustration also underlines a fact of investment life that is just as true outside company-sponsored retirement plans as it is within them. Seemingly small differences in expenses for mutual funds and other investment vehicles can compound into enormous discrepancies over time, rewarding those who keep an eye on costs.