No matter the vehicle you’re using to invest for retirement, fees need to be at the forefront of your decisions. The fees that you pay to invest – in the current year, as well as the compounded value of those fees – can have a meaningful effect on how long you’ll need to work.
Here, we’ll explain the most common fee types for both 401(k)s and IRAs, what to look out for when choosing a provider, and which account type has higher fees.
401(k) Fees
It’s good to remember that 401(k)s are retirement vehicles offered through your employer, which means you won’t have much choice as to your provider if you’re employed at a company. But it’s still useful to know the fees that might exist in the plan. In the event you leave your employer in the future and want to roll over your 401(k), you’ll know what to look for.
Investment-level 401(k) fees
These are perhaps the most important fees within any 401(k) plan, and they’re the charges you see applied to each of your chosen investments. These fees are commonly bundled into what’s called the expense ratio, which comprises a suite of investment management fees paid to the 401(k) provider.
Most 401(k) plans offer an investment menu of mutual funds, each with an underlying expense ratio – this describes the annual cost to you of investing in a particular fund. For example, if you choose to invest $10,000 in a mutual fund with an expense ratio of 1.00%, you’ll pay $100 a year just for that investment option. Over time, the compounded value of these fees can really add up.
Helpful tip: Going through paperwork and long 401(k) plan documents can be tedious, but it’s really worth it to know exactly what you’re investing in, and ultimately, how much you’re paying for it. Good 401(k) plans in 2022 offer investments with minimal expense ratios.
Account-level maintenance 401(k) fees
Some 401(k) plans – though, fewer and fewer in recent years – will charge a maintenance fee simply for holding the account open. These fees can range from $50 to $300 a year, but it’s possible a provider could charge more.
Fees like these have come under great scrutiny because so many new providers offer extremely low-cost 401(k) plans, often for a very low fee or no fee at all. Ideally, your employer utilizes a low-cost 401(k) plan that’s accessible to all employees – this can make saving for retirement a lot more palatable.
Helpful tip: Account fees for a year should be very small in absolute terms, at most a few hundred dollars a year. If the fees are unusually high, it may be worth reaching out to your company’s 401(k) plan administrator to ask why this is the case.
Unfortunately, you won’t have much choice as to your 401(k) plan if you’re a W-2 employee, but you should be able to identify if the plan you’re offered is fair on fees or if you’re better off moving it as soon as you move on to a new role.
IRA Fees
Investment-level IRA fees
Much the same as your 401(k), you’ll need to look at any investment’s expense ratio before diving in to buy it. Higher expenses are associated with reduced account balances over time, so it’s absolutely imperative that you know what you’re paying before you invest.
For mutual funds and Exchange Traded Funds (ETFs), you’ll look at the expense ratio to find the cost; stocks and bonds don’t have expense ratios, but some brokers charge commissions to trade individual securities.
Helpful tip: Most online brokers, like Vanguard, Schwab, and Fidelity, offer extremely low-cost or no-cost trading, depending on the security you’re looking to buy. Commissions and other high-cost trading fees are beginning to be a thing of the past, especially if you’re committed to a buy-and-hold index strategy.
Account-level IRA fees
Similar to most 401(k) plans, certain IRA providers charge custodial fees to simply have the account open. Others may charge a fee for low-balance accounts. Since you have much more control over where to hold your IRA, try to find a provider that charges nothing to open and maintain an account. Similar to investment expenses, account-level fees have been compressed to zero or near-zero at most reputable providers.
Trading commissions and/or wrap IRA fees
Some brokers, usually those that involve human-assisted trading, charge commissions for each trade placed – usually depending on the number of shares traded or the size of the transaction. This is an antiquated way of doing business in the investment management world; there are many providers, like the three mentioned above, that allow no-cost trading in many of their products. App-based brokerage platforms also typically offer no-fee trading.
Wrap fees, sometimes also known as an “advisory fee”, are charged on your entire account balance in perpetuity. These usually arise if you’ve hired a traditional financial advisor to oversee your investments. These can be especially dangerous if you’re not getting your money’s worth – wrap fees can eat away at your IRA balance, and the effect gets worse as time goes on due to compounding.
Helpful tip: If you do decide to use a financial advisor, opt for a fee-only financial planner that is a fiduciary at all times. Ideally, this person is also a Certified Financial Planner, and has your best interests at heart from the initial conversation through to the end of the engagement. Many CFP(R) practitioners can be accessed for an hourly or flat fee, so you’ll benefit by avoiding the costly wrap fee that comes with some advisory relationships.
Full disclosure: the subject of IRA fees may not be the most glamorous, but it’s critical to know what you’re paying, to whom you’re paying it, and the value being delivered in return. You stand to be able retire much sooner if you can get ahead of these costs and structure your portfolio in accordance.
Which has higher fees: a 401(k) or an IRA?
There is no perfect answer to this question, as it depends greatly on the provider you use (or have access to through your employer) and the investments you’ve chosen within your accounts.
There are legacy 401(k)s that have exorbitant custodial fees and at the same time offer only high-expense ratio mutual funds. But there are also 401(k) providers that offer minimal maintenance fees and a suite of low-cost index investments. The median annual 401(k) fee is .85% of assets.
At the same time, IRAs are available for free at most online, low-cost providers, but some brokerages (usually those that offer live financial advice) may charge a recurring fee to hold an IRA open. Marketing-leading providers of automated or robo-advisor IRAs typically charge between 0.20% and 0.36% in advisory and investment fees, though some firms offer even lower ones.
Because IRAs are more flexible when it comes to investments, you can easily pick low- or no-cost choices, but you also have the freedom to choose more expensive options if you want them.
Key Takeaways
- 401(k)s and IRAs are separate vehicles that people use to save for retirement, and in certain cases, other expenses.
- Fees are more than just fine print: they matter quite a lot. Take the time to review the fees you’re paying and make sure you’re receiving adequate value.
- Account-level fees and trading commissions have been under siege over the past decade. Be wary of companies that charge fees that are outside of the (new) normal range.
- If you do decide to hire a financial advisor, consider a fee-only CFP(R) practitioner that also operates as a fiduciary. This way, you’ll be able to access objective advice without having to pay unnecessary fees.
