This Is a Huge Financial Threat to Your Retirement Security

Fees matter. We’ve known for years that even a slight difference in investment costs can amount to big money over a long period. Yet retirement savers are being funneled into high-fee accounts at an alarming rate, new research shows.

Why are investors ending up in costly funds? It's the unfortunate outcome of a broad shift of retirement assets from traditional pension funds to 401(k) plans to IRAs. Back in the '80s, employers started phasing out traditional defined benefit pension plans and replacing them with 401(k)s or similar defined contribution plans. Over the past decade, as boomers continue to retire and younger workers change jobs, those 401(k) savings are being rolled over into IRAs.

Today IRA accounts hold the largest share of retirement assets—some $7.4 trillion compared to $5.4 trillion in 401(k)-type plans and just $3.1 trillion in traditional pension funds. This rotation continues even though investment costs are highest in IRAs and lowest in traditional pension funds, according to a recent report from the Center for Retirement Research at Boston College.

The Center analyzed investment returns from 2000-2012 and found that traditional pension funds grew 4.7% a year, compared with 3.1% for the typical 401(k) account and just 2.2% for IRAs. Some of the lagging IRA performance had to do with asset allocation. The cash portion of IRAs was 11% while pension fund managers held only 4% in money market funds.

But that explains only a small part of the difference. Most of the lag was due to fees, CRR concluded, citing the high expense ratios of many of the mutual funds that individuals choose. The difference between 401(k) plan returns and pension assets was entirely due to the higher fees of funds in a 401(k) plan, CRR found. From 1990-2012, traditional pension assets grew 6.6% a year, on average, while 401(k) assets grew 5.9%.

Pension managers with billions to invest typically pay the lowest fees on the planet, and large companies can use their clout to keep 401(k) plan expenses down and offer institutionally priced fund options to employees. But individuals acting alone in an IRA enjoy none of these cost advantages, and many lack the savvy to choose inexpensive funds.

Many actively managed stock funds, for example, charge more than 1% of assets each year but perform no better than a stock index fund that charges as little as .07%. If you're investing a $100,000 portfolio, that difference in costs could cost you $88,000, assuming you earn 6% annualized returns over 25 years. Whether you're a 20-something struggling to build savings or a retiree relying on Social Security, that's a significant amount to give up in fees.

Many financial advisers specifically target retirees moving their savings from 401(k)s to IRAs, often pushing them into with high-cost investments that pay them commissions. New rules proposed by the U.S. Labor Department may require advisers to put retirement investors' interests first, but the financial services lobby is pushing back.

Individuals have become more aware of fund expenses in recent years and have been moving more of their assets to lower-cost options. Mutual fund fees paid by individual investors dropped 27% over 10 years, according to Morningstar. But the switch from pensions to 401(k) plans and then to IRAs has offset much of those potential benefits, since more retirement assets are being funneled into accounts where investors end up in higher-fee funds.

Still, the good news is that you can do a lot to improve your retirement security by keeping your investment costs low. If you have a 401(k), check out the fees on your fund menu and focus on the cheaper options. And if you roll over your money to an IRA, you have world of low-fee investments available. You can find good candidates on our Money 50 list of recommended funds and ETFs.