One of the ways to assess how well an investment serves you, is to look at the fees. Yet many investors have no idea what they are paying. When teachers ask me to assess their current 403(b) plan investments, many are horrified to learn they are paying over 2%.
How could they be unaware of the fees, you ask?
It’s simple. I’ve come across many an investment statement has a line item that says FEES $0 (or a minimal administrative fee, like $30 for the year).
Clearly, there is no standard when it comes to statements, otherwise fees would need to be transparently disclosed.
Investors paying 2% in fees may not feel this when the market is up 10%, and they are only getting 8% but, but during volatile markets the damage is particularly harsh. If the market is down 20%, an investor paying 2% in fees is down 22%.
Over time, high fees compound and chew a hole in investment returns.
Consider a hypothetical investment of $250/month made over 35 years earning an average annual return of 8%. One investor pays 0.50% versus one paying 2.25%. The investor paying the lower fees ends up with $510,864 – substantially more than the investor with high fees – $336,320.
These hypothetical returns are no indication of past or present returns and are no guarantee of future results. However, the wide disparity in fees is very real. I see it every day.
The prospectus is the best source to uncover fees, but even that becomes confusing. There are numerous types of fees/charges, such as investment costs and sales charges. To tabulate them all requires scouring hundreds of pages of dense, obtuse language.
Working with a professional adds advisor fees for advice, as well.
Investing in an annuity includes insurance fees (M&E) that add 1% to the overall fees. Worse, annuities carry surrender charges that can be quite steep. Many teachers own annuities with rolling surrender fees which means every new dollar invested (i.e., per paycheck contribution) starts a fresh surrender charge on that money. These fees last for years – often six years.
From my experience, investors rarely realize they will be subject to these fees until they call up and decide to exchange/transfer out for a less expensive option. That is when many investors feel blackmailed into staying with an inferior, expensive product.
However, the surrender fee should not be the sole determinant of whether to keep an investment. And, luckily, there is a work-around. Namely, you can always take out 10% per investment calendar year without penalty, provided the funds remain in a retirement account. It’s important to know the anniversary date when you purchased the annuity. For example, if you purchased an annuity September 30th, you are entitled to take out 10% penalty-free before that date and then October 1st, you can take out another 10% penalty free. Furthermore, surrender fees can gradually reduce when an anniversary date passes.
You must find out all the expenses that you pay annually in order to assess if it makes numeric sense to pay a surrender fee. For example, if a $50,000 account carries a 2.25% annual fee (or $1,125), but the surrender fee is a one-time fee of $1,200. It may be worth paying the fee to start clean and to have low expenses going forward (0.50% fee would be an annual fee of $250).
For some, being misled about the fees they are charged is enough to cut bait – regardless of the fees.
When it’s hard to get a straight answer on the fees you are being charged, try emailing your investment professional the following questions. If they are unable or unwilling to answer these questions – it may be time to make a change.
- Do I own an annuity or mutual funds?
- Can you email me a prospectus for the contract and/or funds?
- What is the M&E (insurance) fee on the annuity?
- What is the advisor fee?
- What are the underlying investment fees (or the average underlying investment fees if they can’t be specific to your portfolio)?
- What surrender fees would I pay to exchange out of this annuity to another choice in my plan?
- When will the surrender fees reduce (anniversary date) and how much will they reduce every year? How long before there are no surrender fees?
A wonderful resource to educate teachers about fees and investment optiosn is 403b wise.
We’re here to offer guidance if navigating the maze of fees is too confusing. Email us at firstname.lastname@example.org.
Breaking free of unnecessary high fees takes effort, but once you get out you save year-in and year-out. Let the savings compound in your favor and reach your goals that much faster.
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