Updated on March 31, 2023
Did you know that just 1 in 4 Americans are aware of the 401(k) fees they’re paying? These fees can be tough to find, but even seemingly small ones can add up quickly. A recent survey found that individuals who invest in high-fee, poorly-allocated 401(k) accounts can lose out on up to $700K over their lifetime. That’s enough money to give $1 to every man, woman, and child in Washington, DC – and still have money left over to take your family of four on a week-long European excursion.
Thankfully, it’s easier to save smarter when you know where to look. In this blog, we’ll go through the following topics, so you can gain a better understanding of 401(k) plan fees (and take that international holiday):
A good place to start is to understand the difference between account-level fees and investment-level fees. Account-level fees are charged to you simply for having the account open and funded, while investment-level fees are found within the investments you’ve chosen. Taken together, these fees can have a meaningful impact on your ultimate retirement balance, costing you quite a bit of money if left ignored.
Administrative fees include any costs the plan provider incurs to maintain the plan, like legal, accounting, recordkeeping, and other miscellaneous charges. Generally, these fees won’t make up an outsized portion of your total fee burden, but they’re worth knowing about and investigating. These are considered “account-level” fees.
Administration fees might be charged monthly, quarterly, semi-annually, or annually – the only way to know for sure is to look at your plan’s account history.
Unfortunately, you won’t have much control over these fees, since they’re inevitable for all participants of the plan. If these fees ever rose beyond the realm of reasonability, it may be a signal that it’s time for your employer to look into other retirement plan providers.
These are charged at the account level, much like plan administration fees, but only apply to certain individuals that use certain services. For example, if you were to take out a 401(k) plan loan, you might be charged a fee for loan origination. This would only apply to the person taking out the loan, not all plan participants. But it’s of course a good idea to review your company’s 401(k) plan document to see which specific services come with an additional charge.
These fees make up a piece of an investment’s expense ratio, which is the percentage fee charged within the mutual funds you’ve chosen within your 401(k). These fees can range anywhere from 0% to 2%, depending on the types of funds on your employer’s investment menu. Typically, passively managed mutual funds that simply follow an index may come with close-to-zero management fees, while actively managed mutual funds can come at far greater cost.
Research shows that it’s unlikely – but of course not impossible – for active managers to beat the major indices, like the S&P 500 or Russell 2000, on a regular basis. Somewhat ironically, active funds also come at much greater cost. Keeping your costs as low as possible should be front-of-mind so you can give yourself the best chance of success while investing for retirement. This is usually best accomplished with the passive, low-expense funds found on your 401(k) menu.
Another big component of a mutual fund’s expense ratio is made up by >12(b)-1 fees, which represent the costs of distributing and selling the related fund to investors. These fees have come under particular scrutiny as of late, given they can be unnecessarily high for certain funds. Higher costs ultimately mean lower returns for investors, so it’s really important to know which funds in your plan have these embedded fees.
12(b)-1 fees are broken into two pieces: the distribution and marketing component, which is capped at 0.75%, and a service fee, which is capped at 0.25%. Funds with high 12(b)-1 fees should be avoided, generally speaking, unless you’re absolutely certain that the investment fund you’ve chosen is worth the high cost.
Some plans, though not many any more, might charge a commission or a “front-end load” to buy into certain mutual funds. While this practice isn’t as commonplace as it once was, it’s important to know if you’re paying to get into a particular fund. Investment and trading costs have come down significantly over the last decade, so if your plan is still charging these fees, you might want to raise this as concerning.
The following formula illustrates the relationship amongst these different fees, and your goal as an investor should be to minimize total fees wherever possible:
Total Investment Fees = Investment Management Fee + 12(b)-1 Fees + Trading Fees
The best place to look for information about plan fees is your company’s 401(k) plan document, which will give you all information about the plan itself as well as the offered investments. You may also find similar information on your 401(k) plan statement – which is usually produced quarterly or annually – though it’s not likely to be as detailed as the plan document.
If your 401(k) is from an employer you left years ago, you might find the company’s 401(k) plan document available publicly on the company’s HR website. If it’s not available there, you should look to contact your old employer through the proper HR channel and request the document.
For any investment you’re considering within your 401(k), the single most important cost-related number to look for is the investment’s expense ratio, which will tell you how much you’ll pay annually to own that specific security.
For example, if you have $10,000 invested in a mutual fund with a 1.00% expense ratio, you’ll pay $100 to own that investment for a year. The expense ratio is charged on any growth as well as your starting amount, which is why it’s so important to keep expenses as low as possible.
On the other hand, if you have $10,000 invested in a mutual fund with a .10% expense ratio, you’ll pay $10 to own that investment for a year.
The reality remains: the compounded effect of higher expense ratios can meaningfully eat into your hard-earned investment returns, and consequently, add years on to your working life.
Imagine two people, both of whom are 25 years old, earn $75,000 and will be ready to retire as soon as they’ve personally amassed $1,000,000 in retirement savings.
The first person, who we’ll call Gary, annually invests $10,000 into his 401(k) plan on a pre-tax basis, and is able to reliably earn 8% on his investments. Unfortunately, the investments available in Gary’s 401(k) plan are expensive, averaging a cost of 2% annually. As a result, Gary’s net annual return is 6% (8% gross return less 2% in expenses).
Assuming these variables, Gary should expect to retire at age 58.
The second person, Lisa, is the same age, earns the same salary, and makes the same 401(k) contributions. Luckily, Lisa’s employer uses a low-cost 401(k) plan provider and pays .10% annually in total fees. Therefore, her net return every year is 7.9% (8% – 0.10%).
Assuming these variables, Lisa should expect to retire at age 52.
It’s pretty amazing that Gary’s 401(k) plan fee – a seemingly small detail at first glance – has the power to keep him in the workforce 6 years longer than he would have been if he had access to a low-cost 401(k).
This is why – even though it might not be the most exciting activity – it’s absolutely imperative that you understand the costs associated with your 401(k) investments. Your 401(k) plan provider is required to disclose these costs to you, so try to find a free hour to become clear on what you’re up against.
On the account level, you shouldn’t be paying more than $100 to $200 a year, on the higher end, for a 401(k) plan to administer your retirement assets. Even these numbers by many standards are considered high, but some plans do have administrative costs that pass down to employees. A nominal fee should be expected, but it shouldn’t be anything outrageous.
On the investment level, aim to find funds with expense ratios below 0.25% and as close to 0% as possible. Markets have become increasingly efficient to the point where only minimal investment management costs are warranted. Remember, the lower your expense ratio, the more of your returns you actually get to keep!
