Saving for retirement using an Individual Retirement Account should be part of your long-term strategy, even if your employer offers a 401(k) plan.
Here's why: fees!
Many of us see an employer-sponsored 401(k) savings plan at work as the best and easiest way to accumulate retirement money. Few of us, however, do the homework to make sure we are getting the most bang for the buck.
Lately, experts recommend that savers put enough money into their 401(k) to receive any matching money available from their employer, but then use a self-managed tax-deferred Individual Retirement Account or a tax-free Roth IRA for the rest of their long-term savings strategy.
That's because cost matters. Management fees levied on a 401(k) can cost you hundreds of thousands of dollars over a lifetime of work.
Higher fees undermine portfolio returns because "every dollar taken out to cover management costs is one less dollar left to invest in the portfolio to compound and grow," say researchers at nerdwallet.com
For example: You save $10,000 a year over 30 years in your nest egg. You average a 7 percent annual return and pay 0.5 percent in annual management expenses.
According to USA Today, you will finish up with about $920,000 in your retirement account. If the management fee was 1 percent (one-half percent higher) you will have $840,000. A 2 percent annual fee results in a "finishing total" of just $700,000.
For those planning to live on this nest egg for the next 25 years, the lower amount saved will have a significant impact on their retirement lifestyle.
Despite attempts to require more transparency, the retirement fund management industry does not make it easy to find out what administrative and asset management fees are being charged to your account. And many of us are too busy to investigate those fees.
Recently, a 40-something friend of mine admitted that she didn't even know how to sign into her 401(k) web site and had not evaluated the performance of the funds where her money is invested since signing up for the program 10 years ago. Needless-to-say, she had no idea what fees were being charged by her 401(k) fund managers.
"I know I need to do this…but I just never find the time," she lamented.
According to an AARP survey, seven out of 10 participants in 401(k) plans thought they didn't pay any fees and had no clear understanding of the impact of fees on long-term savings.
Meanwhile, the typical American worker, earning a median salary starting at age 25, will pay an estimated $138,336 in 401(k) fees over their lifetime, reports the Motley Fool. "The corrosive effect of high fees in many...retirement accounts force many Americans to work years longer than necessary or than planned," Fool researchers said.
Higher fees, according to USA Today, are likely to stay around after a judge this year dismissed two cases brought against Putnam and Wells Fargo investment managers. Putnam had been accused of "loading" its employee retirement plans with its own funds instead of external (less expensive) ones. A similar case was dropped against Wells Fargo. The judge ruled that "fiduciaries (fund managers) are not required to find the cheapest available funds" for the 401(k) investments that they manage, the report said.
There is a do-it-yourself alternative.
If you are uneasy about management fees being charged against your 401(k) funds, set up your own self-managed Individual Retirement Account or a Roth IRA through an online brokerage firm. Stick your money inside the account in a low-cost S&P 500 index stock fund and reinvest the dividends. Leave it alone.
You don't pay taxes on money in a traditional IRA until you begin withdrawing it in retirement. Withdrawals are mandated at age 70 and a half. A Roth IRA uses money that you already have paid taxes on. When you retire, money withdrawn from a Roth IRA comes out tax-free with no withdrawal deadline.
Check with your tax accountant on further details related to this strategy to make sure it is right for you.
Meanwhile, self-directed IRAs will offer two advantages — transparency with investment performance and clarity with fees. Your 401(k) may not offer either.
Julia Anderson writes for women about money and retirement at: sixtyandsingle.com. She is a business news commentator on KXL 101.1 FM in Portland.