What a Difference Two (2) Percent Makes

I’ve been working on a pet project.  The goal of the project is to show the difference in someone’s retirement benefit, depending on the investment fees and charges.  The differences aren’t astounding, but they are illustrative.  Let me show you what I mean.

Illustration 1

One of my illustrations goes like this:

1. Someone deposits $5,000 per year into a 401(k) plan for 20 years.
2. I calculate the account balance at an annual 7 percent return and at an annual 5 percent return.
3. That is a 2 percent difference.

Why a 2 percent difference?  

After researching, I find that a 2 percent wrap-fee is typical for a 401(k) plan that you get from an insurance company.  Insurance companies sell a lot of 401(k) business in the small-plan market.  So, what difference does that 2 percent make?  The difference is over $40,000.

At 7 percent, after 20 years, this person will have over $210,000.  At 5 percent, they will have a little less than $170,000.  That’s almost 25 percent more at the end of 20 years.

Illustration 2

Another illustration explains what might happen with a small-business-owner experience, if they start a plan at age 50.  In this illustration, I assumed the person put in $20,000 for 15 years and, again, I assumed 7 percent and 5 percent. At 7 percent, the owner would have over $520,000; and, at 5 percent, his balance would be $442,000, a difference of $78,000 and 18 percent.

I did the same calculations at 8 percent and 6 percent, and got similar differences.

The Bottom Line

What does all of this tell you?  It tells you that the fees and charges in your 401(k) plan are an important part of what you need to keep track of in your plan.  

How do you know whether you’re paying wrap fees?  If your 401(k) plan is with an insurance company, chances are that you have a wrap fee of some kind.  Ask your agent whether you are paying “contract charges” or “mortality and expense charges” or “insurance charges” or whether there are any “riders and/or options” on your deal with the insurance company.

How to Take Charge

If you don’t have a copy of your contract with the insurance company, then ask to get a copy.  Those wrap fees are in the contract, although they may be buried in the fine print.  Also, take a look at the Schedule A of your plan’s Form 5500.  That’s where commissions have to be reported.  Chances are, you’ll see some amount going to an agent.  Hopefully, you’ll recognize the person’s name.

Once you find out what the wrap fee is:  take that percentage amount, times your total plan assets, and then ask yourself if what you’re getting is worth it.  I looked at a plan recently that had $2 million and what appeared to be a 2 percent wrap fee.  That means that participants were being dinged to the tune of $40,000 per year.  The client did not think that they were getting $40,000 worth of service from the company, especially considering that they were paying another $10,000 to that same insurance company for what was reported as administrative services.

Take a look at what you’re paying, and what you’re getting for what you’re paying.  If the two don’t match, think about finding someone else to put your plan through.  You might be helping someone have a better retirement.  It might even be you.