retirement lieYou've been advised to save for retirement using your company's 401(k) plan.

The benefits, after all, are significant:

  1. Contributions are made with pre-tax dollars, lowering your taxable income each year you contribute.
  2. The money you contribute, along with earnings, continues to grow tax-free until you begin to withdraw.
  3. Most plans include a matching contribution from your employer, handing you free money as an incentive to save.

Yet despite all these perks, a new study by Demos, a nonpartisan public policy research and advocacy organization, alleges that your 401(k) plan may be ripping you off in ways you don't even recognize.

What's worse, the typical 401(k) will steal an average of nearly $155,000 from each worker over a lifetime of saving.

'Secret' Fees Savers Don't Know They're Paying

The reason for this massive loss of wealth over a lifetime of saving comes down to fees. And those fees are usually expressed in a way that disguises the true cost.

Most investors who purchase mutual funds have heard of fees like the "expense ratio," which averages more than 1% annually. Funds in 401(k)s are not exempt from such fees, which cover the cost of record keeping and compliance, the fund manager's salary, and (sometimes) marketing fees.

While the expense ratio is publicly shared, there are other fees that, Demos found, "are nearly completely hidden from retirement savers." We're talking about "trading fees."

Trading fees are costs incurred when a mutual fund buys or sells an investment, in the form of commissions and bid/ask spreads (the difference between the price the fund actually buys or sells it for versus its market value). And they vary based on how actively a mutual fund is trading.

But good luck trying to figure out how much you're actually paying for trading fees.

Obscure Reporting at Its Finest

The biggest problem facing 401(k) sleuths is that "reporting fees as a percentage of assets actually disguises their true cost," according to the Demos report.

Demos compares it to receiving a surcharge on a concert ticket purchase. Let's say you buy a ticket to a show. The ticket company bases its fee on the price of the ticket. So, for example, if the fee is 5%, you pay 5% of the price of the value of the good they're selling you.

Mutual funds, on the other hand, charge customers a fixed amount based on your account balance, not a percentage of the returns they earned on your money (which is the value they actually provided). It's akin to paying 5% of your bank account balance to the ticket seller in order to buy admission to the show.

In other words, mutual funds that employ this practice are paid even if they just hold onto your money. They don't have nearly as much incentive to actually earn returns on your money because they get paid no matter what.

You Only Think You're Paying 1.23% in Fees...

The study shares an example fund in which a $50,000 investment earned 4.65% net. Meaning after one year, the account was worth $52,325.

In reality, of course, the fund earned more on that initial $50,000. The stated expense ratio was 1.23%, so $615 in fees came out prior to that return. That means the fund actually made $2,930 gross, or 5.88% of the initial $50,000.

However, the study encourages us to look at this in another way -- by expressing fees as a percentage of the gross return. To do this, take the $615 in fees, and divide it by the gross return of $2,930. This equates to a startling 20.9% of its return in fees -- meaning an investor paid 20.9% for the value the fund added.

But this still doesn't take into consideration those obscure "trading fees" mentioned above. According to Demos, trading fees "often cost savers as much as or more than the explicit expense ratio," meaning this example fund probably had a "real expense ratio" of 2.46%.

Since trading fees come out of the gross returns, we can adjust the fund's gross (pre-fee) return to 7.11%. Meaning the fund actually earned $3,555 before fees. It gets worse.

... You're Actually Shelling Out More Than 30%

Combining the expense ratio and trading fees, this fund withdrew $1,230 in fees ($615 + $615). Dividing this by the gross return of $3,555, an investor in this fund paid a startling 34.6% in "true fees."

In other words, an investor paid a whopping $1,230 for $2,325 to be made on his money.

Add this up over a lifetime of saving and investing in a 401(k) plan and the average worker loses as much as $154,794, according to Demos. A higher-income household can expect to lose even more -- as much as $277,969.

As Demos' study sums up, "Considering that a significant portion of these fees goes to paying the high salaries and expenses of the investment professionals managing these funds, asking struggling American households to pay these prices to save for retirement is more than patently unfair, it's immoral."

Unfortunately, the options for investors who want to avoid the fee frenzy are limited.

Stuck With a Rigged System?

One way around the fee issue is to take charge of your saving yourself, investing in a self-directed brokerage account through your company's 401(k) plan. Or you could make use of IRAs or taxable accounts.

The trade-off is that you lose some of the biggest perks of a 401(k) -- either a company match, or tax-free growth. After all, it's necessary to save for your own retirement. And a 401(k) is still the most tax-efficient way to save for retirement.

But the system is clearly broken. So until the 401(k) system gets fixed, it's a lose-lose situation for all too many investors.

This article was written by Motley Fool analyst Adam J. Wiederman. Click here for Adam's free report on how to ensure a wealthy retirement.

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September 15 2013 at 3:26 PM Report abuse rate up rate down Reply

this is the worst advice ever an ira instead of your employer 401k to save a 1% fee.what fool would give up the huge tax dedcution and employer match (like even 3%) to save 1% since your employer isnt going to match your 6k IRA and you can put 16k in to 401k plus his match you get 20k into the plan at a cost of 200.00 (1%) so to save 200 you lose a 14,000 deductiion and pay 5k in taxes .brilliant.

June 15 2012 at 7:33 AM Report abuse rate up rate down Reply

Is there an HR person anywhere in america amongst the many thousands who know anything about investing?
Because while it is not their job to TELL an employee what they should invest in, it is their job to know what an investment can do for or TOO an employee!
They are supposed to know about diversification, reinvesting dividends, costs such as opening or closing an account or nuying or selling a fund, expense ratios and frankly ALL FEEs!
Very, very, very FEW have a clue and this is the guidance our work force is getting? meanwhile Congress just finally got caught insider trading which seems to have been a century old freedom our elected officials enjoyed over we peasants, we tax payers.
Is it any wonder there is so little confidence in our markets except for foreign investors running for supposed quality?
Back to employees. I found a mutual fund group that had comments on their online site for 401k participants that were 3 YEARS OLD!
I reported same to the SEC and confronted the company and all was changed and, I got an apology.
WHO IS GUARDING THE HEN HOUSE so to speak? Is it the SEC? NO. Is it the NASD? NO. Do HR benefit personnel KNOW anything about investing? I have yet to meet one and while I'm sure they are out there, i am also sure they represent less than 1% of the HR types responsible for helping employees understand whats going on.

June 11 2012 at 10:06 PM Report abuse rate up rate down Reply

Fees should be outlawed, with a penalty of "death" to the person who imposes same. There are costs of doing business, which i do not object to. But, let same be properly spelled and properly identified out rather than be classified as, "fees" whereby the average guy simply gets screwed.

June 11 2012 at 8:22 PM Report abuse rate up rate down Reply

See this for a rebuttal of Demos:

Anybody that believes Demos' "information" deserves to be broke. Both financially and intellectually. Simply stupid.

June 10 2012 at 8:44 AM Report abuse rate up rate down Reply

I don't believe in "Fund managers" I'll manage my own money. Thank you very much.

June 09 2012 at 4:51 AM Report abuse rate up rate down Reply

If you have a self directed account you still have to pay trading fees and the rates of commissions for small retail investors tend to be much higher than those of large institutions who get a volume discount.

This article is so misleading it is sickening. If you applied these standards to, say, a CD the amount the bank made in gross returns on that money would very likely be over this phantom 20%. The bank loans out that money and they have to pay commissions to the mortgage broker and pay all that overhead that goes in to the bank. Listen, if you are making 5% like the example in the article and you are crying because the people running the fund have to pay their employees and pay for a company to price and audit the fund to prevent fraud then go ahead and stick your money under your mattress. Sure you will earn nothing but neither will anyone else.

June 08 2012 at 9:16 PM Report abuse rate up rate down Reply

I don't understand 401(k) and I didn't understand anything in this article. What's a "self-directed brokerage account through your company's 401(k) plan" and the last time I opened an IRA with $2000 which slowly went down to $1500 and when I got sick of the lack of growth while my 401(k) doubled in value I and closed the IRA I was then told I needed to declare an additional income of $1500 on my Federal taxes which is ridiculous and I refused to do.

June 08 2012 at 7:49 PM Report abuse rate up rate down Reply

This article seems to be an attack on mutual funds...not 401ks. So basically a re-hashed article where Adam sings the same song. We get it already. What's your job again? Oh yeah, you scam people into paying for stock advice when it is freely available.

June 08 2012 at 4:49 PM Report abuse rate up rate down Reply

This article should be common knowledge for any investor. 401Ks are a ripoff for the investor, unless employer matching is taken into account. Why do you think Wall St. lobbied so hard to get 401Ks to replace pension plans throughout the 80s? Piles of money fed into the system by unsophisticated investors.

June 08 2012 at 1:41 PM Report abuse rate up rate down Reply
2 replies to Aaron's comment

The problem is (in most cases) that the employer match money is real. I effectively make 60% on my contributions the minute I put them into my 401(k). I'm not paying anywhere near enough in fees to offset that, no matter how you slice it.

Additionally, since my 401(k) is held at a major brokerage (right next to my other stocks) I can see on a regular basis how I am performing compared to the major indices. So far, so good.

I'm all for suggesting that investors do their due diligence and understand how their money is being managed, but articles like this that discourage employees from participating in their 401(k) plans are, on balance, doing a disservice to your readers.

June 08 2012 at 4:28 PM Report abuse rate up rate down Reply
1 reply to David's comment

Bingo! For some unknown reason, there appear to be a lot of people out there that can't do math. Let them fend for themselves. I wish I could have sympathy for them, but I cannot. Stupid and hopeless is simply a way of life (if you can call it that) these days. Too bad.

June 09 2012 at 2:15 AM Report abuse rate up rate down

My employer offered both a pension plan and a 401(k) plan. After 30 years my 401(k) has the higher value. Unsophisticated investors can also be called idiots. They help the rest of us make a living in the market. They are much appreciated.

June 09 2012 at 9:25 AM Report abuse rate up rate down Reply