What Are the 401k Fees That You Are Paying?

Enrolling in your employer’s 401(k) is one of the main ways of saving up for retirement. A 401(k) plan allows you to put away a portion of your paycheck to help you meet your needs in retirement. Plus, you may get free money in the form of an employer match.

A 2018 study by the Investment Company Institute reported that the total 401(k) savings in the United States amounted to $5.2 trillion, which is equivalent to 20% of all retirement savings. However, despite the big numbers, TD Ameritrade reported that only 27% of 401(k) savers were aware of how much they were paying in 401(k) fees.

How much are you paying in 401(k) fees? Let’s find out.

Why 401(k) Fees Matter

Most 401(k) plans charge anywhere from 1% to 2% of the total value of assets in the participant’s account, but there are certain plans that charge as high as 3.5%. The amount of fees you pay may vary depending on the investment options you choose, the services you receive, and the total value of assets or retirement savings in the account.

While the percentage may not seem like a lot of money, the fees take out a sizable chunk of your retirement savings. A 1% difference in the rate charge may also mean thousands or tens of thousands in extra costs to you.  

For example, assume that John and Ahmed have a 401(k) account balance of $25,000 and they both expect to retire in 35 years. During this period, their funds will earn an annual return of 7%. John's 401(k) charges a 0.5% fee while Ahmed pays 1% in account fees. At retirement, John's savings will grow to $226,556 while Ahmed's savings will grow to $192,152. Therefore, a 0.5% difference in 401(k) fees results in a $34,404 difference in their retirement savings.

***Source: Bankrate 401(k) Calculator ***

Types of 401(k) Fees

The US Department of Labor groups 401(k) fees into the following three categories: 

Investment fees

Investment fees are the costs of managing your investments to help maximize their potential returns. These fees comprise the costs incurred in managing your mutual fund investments and consulting fees from financial advisors included in the 401(k) statement.

The investment fees charged to 401(k) retirement savers vary, depending on whether the fund is actively-managed or passively managed. Actively managed funds charge higher investment fees due to the high level of involvement of investment managers. Investment fees are charged as a percentage of assets under management, and they account for the largest share of 401(k) fees.

Plan administration fees

Depending on whether your employer’s 401(k) is managed by a bank or other financial institution, there is a plan administrator who is responsible for the day-to-day management of the plan. Plan administration fees cover operating costs such as bookkeeping, legal, administrator, and compliance testing.

To meet these costs, the plan administrator may charge a flat fee to all 401(k) plan participants or charge a percentage of assets depending on the value of assets in the participant’s account. Sometimes, the employer may decide to cover these costs internally.

Individual Service fees

These are one-off fees for services that you opt into. They are charged for services such as rolling over 401(k) into an IRA, taking out a 401(k) loan, funds distribution, or for getting financial advisory services. They are assessed depending on the services you use.

What is 401(k) Expense Ratio?

Knowing the expense ratio charged by your 401(k) plan administrator is a good way to know how much you are paying in 401(k) fees. The expense ratio is assessed as a percentage of the total value of assets in the participant’s plan. It is calculated by taking the total expenses of the fund divided by the average dollar value of assets under management.

If a mutual fund has an expense ratio of 1%, and your 401(k) asset value is $50,000, it means that you are paying $500 in fees. These fees are used to cover investment costs, administrative costs, compliance, etc. The expense ratio is calculated annually, and it reduces the investor’s return over time since it will compound as the investments grow.

Who Pays 401(k) Fees?

Wondering who is paying the fees for your 401(k)? The 401(k) fees may be shared between the employer and the employee as follows:

401(k) fees paid by the employer

Some employers may agree to pay some of the fees instead of passing on the entire cost to the plan participants. This keeps the fees as low as possible so that a big portion of their contribution is invested in retirement.

Most employers agree to pay plan-related business expenses such as consulting fees or administrative fees. If the employer works with specialized 401(k) advisors in areas such as employee training and engagement, they will be charged a consulting fee that is based on the total assets in the plan. The employer can pay these costs, or pass on the cost to the plan participant.

Some employers may also agree to pay administrative costs of managing the 401(k) plan, which are the costs incurred in managing the retirement plan. While this may be a significant cost to the employer, the employer can benefit from reduced income taxes. Administration costs are tax-deductible, and the employer can deduct these costs when calculating the tax due for the year.

401(k) fees paid by the employee

Employees enrolled in the employer’s 401(k) plan can be charged any of the three types of 401(k) fees. However, the main types of fees that employees pay include investment fees and administrative fees. Also, where the employer does not cover fiduciary and consulting fees charged by 401(k) specialized advisors, these costs will be passed on to the employee.

Employees will also be subject to the 12b-1 fee, which derives its name from the Investment Company Act of 1940. This fee is charged by mutual funds, and it pays for the cost of marketing and distributing mutual funds, and to compensate salespeople for bringing in new clients into the retirement plan. As more investors join the retirement plan, there will be more money to invest into the mutual fund, and this will reduce the operating costs per investor. The 12b-1 fee ranges from 0.25% to 0.75%.

Rolling Over Your Old 401(k) Accounts to Reduce Fees

If you have a string of 401(k) accounts with your former employers, merging them into one account can help you eliminate the multiple 401(k) fees. Rolling over your 401(k) accounts into an IRA has some tax advantages, and you can merge all your old retirement accounts without paying income taxes or penalty taxes on the retirement money.

While a rollover IRA is not free of taxes, you have access to a huge selection of investments, some of which have the lowest fees. You can invest in REITs, ETFs, stocks, bonds, and other investments with lower fees. For example, you can find Robo-managed investments that charge less than 0.25% of the assets under management to cut your account operating costs.