Even if you’ve managed to avoid sitting through a company benefits meeting, you’re no doubt familiar with the concept of a 401(k) plan. A 401(k) is a defined contribution plan. You sock away a set amount each paycheck, your employer may match some percentage of the contribution, and years later you declare your own financial independence. (There are other retirement-saving vehicles, such as an IRA, that can help you get there, as well.)
But even if you know how a 401(k) works and enthusiastically contribute to one, do you know about the hidden fees that can come with it?
Key Takeaways
- 401(k) plans come with various fees that aren't always evident to the investor but can greatly impact an account's return over the long term.
- Typically ranging from 0.5% to 2%, 401(k) plan fees can vary greatly, depending on the size of your employer’s 401(k) plan, the number of participants, and the plan provider.
- Reflecting mostly administrative and investment management costs, 401(k) fees spring from two sources: the plan provider and the individual funds within the plan.
- Although individual investors can't do much about plan provider fees, they can choose funds within the plan with lower expense ratios.
Finding the Fees in 401(k)s
Many workers don't take the time to investigate 401(k) fees. A TDAmeritrade survey found that just 1 in 4 (27%) investors knew how much they paid in 401(k) fees. In fact, 37% didn't realize they paid fees at all.
The reality is that your provider takes a fee every month, and over time these fees can impact your returns. Some 95% of 401(k) plan participants pay fees.
And these fees aren't truly "hidden." The U.S. Department of Labor requires 401(k) providers to disclose all fees in a prospectus that you receive when you enroll in a plan. It must be updated every year.
It pays to pay attention to these fees. When you receive a 401(k) statement or prospectus, check for line items or categories such as Total Asset-Based Fees, Total Operating Expenses As a %, and Expense Ratios.
Key 401(k) Plan Fees
Finding the fees is one thing. Understanding them is another. The most firmly entrenched of the fees is the 12b-1 fee, named after the relevant section of the Investment Company Act of 1940. Generally filed under marketing and distribution expenses, 12b-1 fees are ostensibly earmarked for the intermediaries who sell 401(k) plans to your employer. These fees are capped at 0.75% of assets, while some funds impose a 0.25% shareholder services fee.
Note that 12b-1 fees charged by individual funds are separate from investment management fees, which are the cut the 401(k) provider takes for itself.
401(k) fees fall into two basic categories: those charged by the plan provider, and those charged by the mutual funds or exchange-traded funds (ETFs) in the account.
Breaking Down 401(k) Plan Fees
401(k) plan fees typically fall into four categories:
- Investment
- Administrative
- Individual service
- Custodial
Here’s a sample quarterly summary from a third-party firm that administers plans and keeps records. The figures, which represent dollar amounts, are on a total contribution of $3,207.70 for the quarter.
| Expenses | |
| Administrative Fees | $25.00 |
| Investment Fees | $4.35 |
| Asset/Revenue Sharing | $2.31 |
| Audit, Fiduciary & Consulting | $13.25 |
| TOTAL | $44.91 |
This means the investor is paying $44.91 in fees on a principal of $3,207.70. (That’s 1.4%.)
The Impact of 401(k) Fees
401(k) plan fees can vary greatly, depending on the size of your employer’s 401(k) plan, the number of participants, and the plan provider. One study found that large plans (more than $100 million in assets) almost uniformly have fees below 1%. The largest plans are usually below 0.50%.
The small plan marketplace is a different story. Average fees for small plans (under $100 million in assets) were between 1.5% and 2%, with plenty of plans with less than $50 million in assets paying more than 2% a year in fees.
The difference in these percentage points doesn't sound like much, but it can really add up over the years. Take these three hypothetical friends: Mia, Tyler, and Jordan each have $100,000 invested in a mutual fund at age 35. Each account earns an annualized return of 8%, but the accounts charge annual fees of 1%, 2% and 3%. Jordan paid 3% and has $432,194 in assets at age 65. Tyler paid 2% and has $574,349 for retirement. Mia paid 1% and is the big winner, with $761,225 saved for retirement.
1%
The annual fee charged by the average 401(k) fund, according to the Center for American Progress.
What to Do About 401(K) Fees
Short of boycotting the 401(k), there's not much you can do about fees charged by the plan provider or administrator—although if you discover they're egregious (say 2% or higher), you could raise the issue with your human resources department. The marketplace is incredibly competitive. If one provider's fees are too much, there are plenty of alternatives.
You can also take some action on charges for individual funds within a 401(k) plan. Look in each fund's prospectus for the listed expense ratio, which is the sum of fees expressed as an annualized percentage. If you have a choice between two similar funds—two growth-stock funds, for example—consider prioritizing the one with the lower expense ratio.
In general, equity funds tend to be more expensive than bond funds, while exchange-traded funds (ETFs) are cheaper than mutual funds. Still, don't compromise your investment goals, risk tolerance, or common sense just to score a lower fee.
What Are Normal 401(k) Fees?
401(k) fees can range between 0.5% and 2% or even higher, based on the size of an employer's 401(k) plan, how many people are participating in the plan, and which provider is offering the plan. The average annual fee charged by most funds is 1%, according to the Center for American Progress.
How Can I Avoid 401(k) Fees?
401(k) fees are charged by both the plan provider and the funds within the plan and therefore can't be entirely avoided. Plan provider fees are static, but investors can avoid higher fees by picking funds within the plan that have the lowest expense ratios.
How Can I Find Hidden 401(k) Fees?
The fees aren't actually hidden, but are in fact disclosed in the prospectus that is given to new investors when they enroll in a plan. This prospectus is updated yearly, reflecting any change in fees. Disclosing fees is not optional, and is a requirement of the U.S. Department of Labor. To check fees, look through your 401(k) statement or prospectus for line items such as Total Asset-Based Fees, Total Operating Expenses As a %, and Expense Ratios.
The Bottom Line
Fees should be but one criterion in choosing a 401(k) investment. The most important factor should be overall return. Look at asset class and the fund manager’s competence and track record first. These areas should have a greater impact on long-term returns than fees. And don’t forget to consider whether you are more comfortable with an index fund or an actively managed fund.
