A 401(k) account is one of the wisest investments most people can make in their working lives. You don’t see the money that goes into a 401(k) account, so you don’t miss the money when it is deducted from your paycheck. In the meantime, you are contributing to your retirement, funding an account that will keep you solvent years down the road. You also choose the type of investments you want to make. However, if you get wind of a good fund deal, beware. You might be charged a redemption fee if you decide to make a change.
TL;DR (Too Long; Didn't Read)
Redemption fees are a type of investment fee incurred on a 401(k). It is charged to an investor who sells out of a fund before a minimum holding period is up.
What Is a Redemption Fee?
Redemption fees are also called exit fees, back-end loads or deferred-sales charges. Redemption fees are limited to 2 percent by the Securities and Exchange Commission, but some redemption fees are as low as 0.01 percent. If you look for a low redemption fee and decide to get out of the investment before the minimum holding period is up, that will make your decision to exit much easier.
You don’t pay this redemption fee out of pocket, so it’s not like you’re losing money that you have in hand. This is deducted as a fee, just like any other 401(k) fees that you are paying. You may have to search in the fine print to get all the information on your redemption fee.
Minimum Holding Period
The minimum holding period is 30 days to one year. Check this information in advance so you know exactly how long you will need to hold your shares. The average holding period has a minimum of 65 days. If you can find shares that are in this holding period, you should be fine, but try to avoid shares that have funds that require a hold that is much longer than 65 days.
Why Pay a Redemption Fee?
Redemption fees may actually help you in the long term if the fund you are in would suffer from excessive liquidity. In other words, if shareowners could pull out quickly, then a high redemption fee may benefit you.
However, for the most part, you don’t want to pay a lot of fees with your 401(k). When being charged high maintenance fees for a 401(k), some people will sell off shares to pay the fees, only to turn around and get hit with a redemption fee. If this happens again and again, those fees will add up, and your 401(k) will not grow the way it should.
The redemption fee falls into the category of investment. Investment fees are likely the single largest of the fees you will pay for your 401(k). There is a cost to managing your investments, and that’s a fair price to pay. However, many mutual fund companies do waive these redemption fees for 401(k) plans, so if yours does not, you should pay close attention to the stocks that are sold in your plan.
Don’t Withdraw From Your 401(k)
Some people consider their 401(k) accounts to be like another bank account. They withdraw the money to pay off bills, to help with a down payment on a house or to pay for education. However, it is best to not consider your 401(k) to be like a savings account. Yes, it’s your money, but it’s not there to fund your living expenses now. It’s there to help pay your retirement expenses later. The penalty for using your 401(k) money for current expenses is often higher than the benefit of putting the money into the 401(k). When you take money out of a 401(k), you may be selling some of your shares and paying some of that redemption fee. So, in this case, your redemption fee is also one of your 401(k) withdrawal fees.
While you can borrow up to 50 percent of your 401(k) up to a maximum of $50,000, it should be a last resort or a way to avoid a financial emergency. Also, when you repay your 401(k) account, your loan payments are considered after tax. So, you are repaying your 401(k) account with money that you are paying tax on now. You’ll also pay tax on it again when you withdraw it for retirement. It may seem like you are just repaying your loan with interest, but you are actually doing more damage.
Cost of Fees
You may be tempted to stop contributing to your 401(k) because you think these 401(k) administration fees are costing you too much. You may think it’s cheaper to just invest in stocks and pay the income tax now instead of later. That’s fine if you have a healthy retirement plan set up, and all your bills are covered. If you want to invest a bit in stocks and see if your nest egg grows, just make sure you do it with money that is left over from your monthly expenses.
A retirement plan, however, will give you a safety net that stocks alone will not. Also, remember that your retirement plan isn’t costing you nearly as much as you stand to gain from it. If your employer has a match, that is in effect free money that you will not pay taxes on until retirement. It’s the money that your company may have once put into a pension plan. Companies rarely do that anymore, so if you are offered a 401(k) match, you should take advantage of it. At the very least, put the minimum amount of the match into your 401(k). Even if your fees amount to 2 percent of your assets, it’s cheaper than if you did this on your own. You would probably on occasion pay a no-load fee, similar to a redemption fee, on stock shares that you bought and sold yourself, and you might not have access to the same quality mutual fund shares because they are often offered to workplaces at lower fees.
A Look at Your Fees
Still, if you are concerned about the fees you are paying to maintain your 401(k), it’s not a bad idea to keep on top of them. In fact, it’s always good to know how much you are paying out in fees. There is a guide put out by the U.S. Department of Labor that offers a checklist of fees and provides a guide for you to determine which fees are necessary.
Fees of 1 percent or less are the best. The best way to determine what you’re paying and whether any redemption fees are involved is to read your 401(k) plan’s summary annual report. You as a participant are required to receive this document. It’s often dry and boring but very necessary if you’re at all concerned about your fees. Ask your plan administrator for the latest report if you didn’t save it. If you feel your administrative fees are too high, some financial advisers say that employees have had success by suggesting their employers shop around for a better 401(k) plan.
Karen Gardner is a former feature editor and writer and is now a freelance writer. She looks forward to doing her family's taxes each year, and likes to write about home finances and money subjects for the rest of us.