The Costs of Opening a Retirement Fund

If you are interested in opening a retirement account, you probably want to know what it will cost you.

The components you need and will be paying for are as follows: a bucket, and a few interesting things to throw into it.

Did I lose you with all that financial lingo? Let me break it down for you. There are two components to your retirement account:

1. The Bucket is the retirement account itself.  Usually in the form of an IRA, a 401(k), or a 403(b). Any type of retirement account can be considered a bucket. These can be simple or complex, depending on what you need, and that’s where the costs vary. But we will get to that later.

2. The Interesting Things are investments you put in the bucket. Mutual Funds, Exchange Traded Funds, Managed Portfolios, Certificates of Deposit and other investments can be considered the interesting things.

Now let’s get to the important part: The costs.

Bucket (aka Retirement Account) Fees

There are many types of retirements accounts: There’s your IRA at the local bank, the IRA with an online provider, an old 403(b) from when you were a substitute teacher, a 401(k), SEP-IRA, or SIMPLE IRA. There are costs to own any type of account. The fee could be in the form of a direct annual bill, an annual debit from the account, or it could be embedded into the cost of the investment purchased in the account. If you set up this account independent of your employer, you will have to pay this. Usually if the employer is responsible for the account, they will pay. The fees for the bucket can be charged as an actual dollar amount or a percentage of assets.

An IRA is an easier account to maintain and will have a lower fee than a 401(k). If your IRA has a higher annual fee, it is usually because it receives no compensation from investments inside the account. IRA accounts with very low fees are usually subsidized by the investment firm managing the account and the investments inside the account. They may receive money when you make an investment, annually as a small percentage of the investment, or even by selling your data.

An account can be much larger and more complex than an IRA, like a 401(k) with multiple employees in the plan set up by your employer. Here everyone’s assets are all in one big bucket, or 401(k). Don’t worry, yours won’t get lost in the bucket. Your employer hires a record keeper to keep the details of the bucket and of all the accounts and values inside it sorted. They also need a third party administrator to do the work of maintaining the plan document and filing annual plan reports. Of course, this work doesn’t come for free. The fees for this work can be in the form of a direct bill to the employer, a direct fee to participants (i.e., you), an added percentage to plan assets, or as payment from asset managers. An example of “hard” dollar costs is the annual bill the record keeper will send for $1,000, plus $40 per participant, to do the work of tracking the value of the accounts. Other ways to collect fees are “soft” dollar costs, when the expense ratio of the investment fund is raised to accommodate other fees. Mutual Fund ABC might charge 1 percent to operate, but a record keeper could add 0.25 percent, for a total of 1.25 percent cost against investment returns.

Fees for the Interesting Things (aka Investments)

The typical investments in retirement accounts are Mutual Funds and Exchange Traded Funds. These have expense ratios — the amount each investment manager charges to manage your money, given as a percentage of assets under their control. For example, you may be told the annual fee to manage a specific fund is 1 percent. Keep in mind the percentage depends on underlying cost structure and asset base under management. If cost is fixed at $1,000,000 annually, a smaller fund pays a higher percentage than a larger fund. A small fund might charge 1.5 percent annually, while a large one might charge 0.5 percent and bring in the same dollar amount. Compare the expense ratios of these funds to that of their peer groups. Some investments cost less, some more. Performance is shown after the fund expense ratio is applied; for example, you may see that the fund made 10 percent last year but you only saw 9 percent. The fund kept 1 percent for the work. Obviously, a lower fee for the work is better, but overall performance against peers is also important.

Before investing, you need to consider how much they are charging you to buy the investment, and how much they are charging to manage the investment annually. Sometimes these two numbers are related, like points at a mortgage closing and the rate. More points, lower rate.

I know this is a lot of information to take in, but once you understand what you will be paying for your bucket and what’s in it, it will become easier to shop around and find the perfect bucket for whatever you plan on filling it with.

Robert Thomas is a member of the DailyWorth Connect program. Read more about the program here.

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