Want to save more money for retirement? Check the fees on your 401(k)

GAINESVILLE, Fla. – What do you dream of doing after you retire? Maybe you’d like to travel the world, buy a vacation home on the beach or, perhaps, get back to work by starting the business you’ve always been passionate about. Whatever it is you choose to do, you’re going to need some extra cash to help make your retirement dreams a reality, on top of the expenses you’ll need day-to-day.

You might be able to save some of that extra money now thanks to fee disclosure requirements on your 401(k) or 403(b) retirement plan, according to new research from the University of Florida Warrington College of Business.

“Fees have an important impact on your ability to save for retirement,” said Dr. Christopher James, William H. Dial/SunTrust Eminent Scholar at Warrington. “[The fee] might seem like a small amount, but if you think about that amount over a savings timeframe of 20 or 25 years, your retirement fund could end up earning 10 percent less by the time you retire.”

In a paper forthcoming in the Journal of Financial Economics, James and Warrington alumni Dominique C. Badoer (Ph.D. ’14) and Charles P. Costello (Ph.D. ’18), study the impact of a 2012 Department of Labor rule that required retirement plan service providers to disclose the indirect fees they earn through revenue sharing agreements with mutual funds.

Prior to the implementation of this rule, a concern was that these fees were not prominently disclosed to the 401(k) and 403(b) plans that employers offer to their employees, and that plan service providers were recommending certain investment products that they could financially benefit from, rather than suggesting investment products that would be most valuable to employees.

“How fees are disclosed have an important impact on the level of fees that people pay,” James said. “Typically, you pay more when fees are not clearly disclosed, or salient. For example, toll bridges are set up in two ways – electronic or with a person in a booth collecting money. Electronic toll fees are not salient, so people don’t notice what they’re paying when they drive through electronic tolls versus paying cash to a person in a toll booth.

“Similarly with mutual funds, people pay more when the fees associated with a plan are not prominently disclosed.”

In their paper, “I Can See Clearly Now: The Impact of Disclosure Requirements on 401(k) Fees,” Badoer of the University of Illinois at Chicago, Costello of Cornerstone Research and James find that when fees are required to be disclosed, there is a significant decline in the use of indirect fees, an increase in the number of new retirement share classes with low 12b-1 fees and an increase in the low-cost mutual fund options available to employees.

Specifically, using data on direct and indirect compensation from about 39,500 401(k) plans, the authors find that indirect compensation relative to total assets dropped by 36 percent after 2012 and the introduction of new retirement share classes with low 12b-1 fees almost tripled between 2011 and 2012. They also hand-collected a sample of mutual funds offered by 400 plans to determine that new funds added to plan menus after 2012 have 12b-1 fees that are about 5.6 basis points lower than existing mutual funds.

Based on their findings, Badoer, Costello and James conclude that the disclosure of fees leads to greater transparency in service provider compensation and greater competition among plan providers. The results of increased transparency and competition mean lower fees and higher returns on the investments employees like you make through their retirement plans, both of which could provide extra cash to help make your retirement dreams come true.