I was in a tricky situation. A company asked me to speak to its employees about investing. They offer a Roth 401(k) plan. But when I studied the plan, it wasn’t a good deal. Yes, it offers tax-free growth. But it charges high fees. I figured employees would make more money in a taxable account that charged lower fees.

That might sound crazy. But it isn’t. In 2014, Yale Law School’s Ian Ayres and the University of Virginia School of Law’s Quinn Curtis published, “Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’ in 401(k) Plans.”

They studied more than 3,500 401(k) plans. Sixteen percent of the plans charged fees that were high enough to wipe out the benefit of their tax-free status. In these cases, young investors would have made more money in taxable portfolios of low-cost index funds.

Ayres and Curtis wrote, “A lengthy menu of varied funds all charging management fees of 1.5 percent [which is] well above the industry average, would not lead to good outcomes for the investors who must hold these funds.”

The employees at the company where I was invited to speak pay total annual investment fees of about 1.65 percent. That includes fees to the fund management companies and a much larger platform fee to the 401(k) administrators. That might not sound like much. But there’s a reason Ayres and Curtis say such fees can wipe out the benefits of the tax-free status.

Vanguard’s Target Retirement 2030 Fund is a fabulous low-fee product. It’s a complete portfolio wrapped up in a single fund. It includes U.S. and international stocks and bonds. And Vanguard charges just 0.14 percent per year. But if a 401(k) provider offered this fund, and if they tagged an additional 1.4 percent annual charge for administrative and platform fees, the employee would pay total annual fees of 1.54 percent.

Fees can be worse than taxes. Consider this:

Over the past 12 months ending September 30, 2019, Vanguard’s Target Retirement 2030 fund gained 4.14 percent after Vanguard’s fee. But if a 401(k) plan administrator took an additional 1.4 percent in fees, the investor’s return would be 2.74 percent. In other words, that 1.4 percent extra fee would take 31.2 percent of the profits. As a result, that extra 1.4 percent fee is equal to a 31.2 percent tax over that 12-month period. That “tax” is far more than investors would pay in a taxable account.

Vanguard’s Target Retirement 2030 Fund
One-Year Performance Ending September 30, 2019

Fund’s Return After Vanguard’s Fee 401(k) Plan Administrative Costs Percentage of the profits paid in fees 401(k) Fees Equate To A Tax Of…
4.14% 1.4% 31.2% (1.4 divided by 4.14) 31.2%

If the stock market doesn’t soar, fees in a high-cost plan take an even bigger bite. Consider the 10-year period ending January 2011. A low-cost diversified portfolio of index funds (50% U.S. stocks, 30% International stocks, 20% U.S. bonds) would have gained a compound annual return of 3.8 percent per year.

How $10,000 Would Have Grown In A Diversified Portfolio of Low-Cost Index Funds
January 2001 – January 2011
Compound Annual Return: 3.8%

If a 401(k) plan charged additional fees of 1.4 percent per year, this would be equal to paying 36.8 percent tax on the profits every year.

Diversified Portfolio Of Low-Cost Index Funds*
Ten-Year Performance Ending January 2011

**Portfolio’s Return After Vanguard’s Fee 401(k) Plan Administrative Costs Percentage of the profits paid in fees 401(k) Fees Equate To A Tax Of…
3.8% 1.4% 36.8% (1.4 divided by 3.8) 36.8% per year

By comparison, a taxable account would cost investors long-term capital gain tax of just 15 percent. Index funds are already tax-efficient. Investors would pay the bulk of their capital gains taxes on their profits after they sold.

Dividend taxes, along the way, impact the taxable account a bit further. But such taxes don’t swing the argument in favor of a high-cost 401(k).

Let’s take a longer-term view. Over the 20 years ending August 31, 2019, a diversified portfolio of index funds (50% U.S. stocks, 30% International stocks, 20% U.S. bonds) would have earned a compound annual return of 5.93 percent.

Imagine a 401(k) plan charges an extra 1.4 percent per year. That would have the same effect as an annual tax of 23.6 percent. Once again, a low-cost taxable portfolio would have won over this 20-year duration.

How $10,000 Would Have Grown In A Diversified Portfolio of Low-Cost Index Funds
September 1999 – September 2019
Compound Annual Return: 5.93%

Diversified Portfolio Of Low-Cost Index Funds* Twenty-Year Performance Ending September 2019

**Portfolio’s Return After Vanguard’s Fee 401(k) Plan Administrative Costs Percentage of the profits paid in fees 401(k) Fees Equate To A Tax Of…
5.93% 1.4% 23.6% (1.4 divided by 5.93) 23.6% per year

Plenty of employers, however, offer matching incentives to invest in a 401(k). For example, imagine earning an annual income of $50,000. Your employer might offer to match up to 5 percent of your salary. In other words, if you contribute $2,500 into your company’s 401(k), your employer might contribute an additional $2,500 on your behalf. According to Plan Council Plan of America’s 61st Annual Survey of Profit Sharing and 401(k) Plans, most employers with 401(k) plans offer matching contributions. They offer to match (on average) 5.1 percent of their employees’ salaries.

Don’t say no to free money. If your company has a high-cost 401(k) plan, invest the minimum amount required for the matching contribution. In other words, if you earn $50,000 a year, and your employer will match up to 5 percent of your salary, invest $2,500…but not a penny more.

Consider, then, investing additional sums in an IRA instead. If you still have money to invest, put it in a low-cost taxable portfolio, instead of contributing extra funds to an expensive 401(k).

Don’t let the lure of a high-cost, tax-free plan pull the wool over your future.

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas