The Markets October 19, 2007

Study Says 401(k) Fees Can Take Huge Bite Out of Plan Balance

Hefty 401(k) plan fees can take a big bite out of a participant’s balance – a 26% chunk, according to a new study by the Congressional Research Service (CRS).
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The CRS report, “Retirement Savings Accounts: Fees, Expenses, and Account Balances,’ found that the difference in ending balances between scenarios where fees were 2% of plan assets and where they were 0.4% of assets was $92,771 – $356,434 with lower fees and $263,663 with heftier charges.

CRS researcher Patrick Purcell, Specialist in Income Security in the CRS Domestic Social Policy Division, explained in the report the scenarios studied involve a median-earning married couple saving 6% of family earnings yearly for 30 years with two-thirds of the account invested in equities and the rest in fixed income.

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Purcell cited Investment Company Institute (ICI) data showing the average asset-weighted 401(k) stock fund expense ratio was 0.76% in 2006.

The calculations also used the distribution of rates of return in U.S. stock and bond markets over the 80-year period from 1926 through 2005, the researcher explained.

Meanwhile, according to the CRS, a median-earning single person who contributes 6% of earnings each year for 30 years to a retirement account that is invested two-thirds in stocks and one-third in bonds could expect to accumulate $187,738 in constant 2004 dollars if investment rates of return are at the historical median over the investment period and annual expenses are equal to 0.4% of plan assets.

Purcell said that same person in a plan where annual expenses were 2% of plan assets, could expect to accumulate $138,344, or 26.3% less than under the low-cost program.

For this report, CRS estimated the effect of expenses ranging from 0.4% to 2% of assets on the amounts accumulated in retirement accounts over a thirty-year period by married couples and single persons with high, median, and low earnings who contribute 6%, 8%, or 10% of earnings each year to a retirement account invested in a mix of stocks and bonds.

The study compared annual expenses of 0.8%, 1.2%, 1.6%, and 2% of plan assets to a low-cost “base case” in which annual expenses were equal to 0.4% of assets in the account.

Compliance October 19, 2007

Maximum Benefit and Contributions Limits for 2000-2008

As published by the Internal Revenue Service.
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2008

2007

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2006

2005

2004

2003
2002
2001
2000
Elective Deferrals (401k & 403b plans)$15,500$15,500$15,000$14,000$13,000$12,000$11,000$10,500$10,500
Annual Benefit Limit$185,000$180,000$175,000$170,000$165,000$160,000$160,000$140,000$135,000
Annual Contribution Limit$46,000$45,000$44,000$42,000$41,000$40,000$40,000$35,000$30,000
Annual Compensation Limit$230,000$225,000$220,000$210,000$205,000$200,000$200,000$170,000$170,000
457 Deferral Limit$15,500$15,500$15,000$14,000$13,000$12,000$11,000$8,500$8,000
Highly Compensated Threshold$105,000$100,000$100,000$95,000$90,000$90,000$90,000$85,000$85,000
SIMPLE Contribution Limit$10,500$10,500$10,000$10,000$9,000$8,000$7,000$6,500$6,000
SEP Coverage$500$500$450$450$450$450$450$450$450
SEP Compensation Limit$230,000$225,000$220,000$210,000$205,000$200,000$200,000$170,000$170,000
Income Subject to Social Security$102,000$97,500$94,200$90,000$87,900$87,000$84,900$80,400$76,200
Top-Heavy Plan Key Employee Comp$150,000$145,000$140,000$135,000$130,000$130,000$130,000n/an/a
Catch-Up Contributions$5,000$5,000$5,000$4,000$3,000$2,000$1,000n/an/a
SIMPLE Catch-Up Contributions$2,500$2,500$2,500$2,000$1,500$1,000$500n/an/a

The Elective Deferral Limit is the maximum contribution that can be made on a pre-tax basis to a 401(k) or 403(b) plan (Internal Revenue Code section 402(g)(1)). Some still refer to this as the $7,000 limit (its original setting in 1987).

The 457 Deferral Limit is a similar restriction, applied to certain government plans (457 plans).

The Annual Benefit Limit is the maximum annual benefit that can be paid to a participant (IRC section 415). The limit applied is actually the lessor of the dollar limit above or 100% of the participant’s average compensation (generally the high three consecutive years of service). The participant compensation level is also subjected to the Annual Compensation Limit noted above.

The Annual Contribution Limit is the maximum annual contribution amount that can be made to a participant’s account (IRC section 415). This limit is actually expressed as the lessor of the dollar limit or 100% of the participant’s compensation, applied to the combination of employee contributions, employer contributions and forfeitures allocated to a participant’s account. This limit was increased for the first time since its inception last year.

In calculating contribution allocations, a plan cannot consider any employee compensation in excess of the Annual Compensation Limit (401(a)(17)). This limit is also imposed in determining the Annual Benefit Limit (above). In calculating certain nondiscrimination tests (such as the Actual Deferral Percentage), all participant compensation is limited to this amount, for purposes of the calculation.

The Highly Compensated Threshold (section 414(q)(1)(B)) is the minimum compensation level established to determine highly compensated employees for purposes of nondiscrimination testing.

The SIMPLE Contribution Limit is the maximum annual contribution that can be made to a SIMPLE (Savings Incentive Match Plan for Employees) plan. SIMPLE plans are simplified retirement plans for small businesses that allow employees to make elective contributions, while requiring employers to make matching or nonelective contributions.

SEP Coverage Limit is the minimum earnings level for a self-employed individual to qualify for coverage by a Simplified Employee Pension plan (a special individual retirement account to which the employer makes direct tax-deductible contributions.

The SEP Compensation Limit is applied in determining the maximum contributions made to the plan.

Catch up Contributions, SIMPLE “Catch up” deferral: Under the Economic Growth and Tax Relief Act of 2001 (EGTRRA), certain individuals aged 50 or over can now make so-called ‘catch up’ contributions, in addition to the above limits.

EGTRRA also added the Top-heavy plan key employee compensation limit.

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