Are you paying too much in high 401(k) fees? Unfortunately, you might well be – a 2015 study by American Progress found that the average 401(k) plan charged 1% of assets every year. Small business employees are even worse off: plans with fewer than 100 employees averaged 1.32% in fees.
1% here or there doesn’t sound like much, but it can eat away at your retirement savings and force you to work longer or lower your quality of life. Many Americans may have to put off retirement because of confusing, poorly disclosed fees. Here’s how to identify and avoid these costly charges.
How much can high fees hurt my retirement savings?
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
This Albert Einstein quote gets bandied about pretty frequently in finance, but in this case, it’s particularly appropriate. If you’re in your 20’s or 30’s, today’s contributions to your 401(k) now will grow for decades before you retire. Anything that eats away at those contributions will have an outsize effect.
Per American Progress, if a 25-year-old earns $30,502 (the median for that age group), contributes an employer-matched 5% to retirement (for a total of 10%) and retires at age 67, the effect of higher fees is monumental. A fee of 0.25% adds up to around $42,000 come retirement, while a fee of 1.3% hits a full $166,000 – an increase of more than a hundred grand. As a result, this 25-year-old can look forward to three extra years in the workforce to cover the difference.
The extra fees add up even more quickly for higher-income workers. If that same 25-year-old earned $75,000, a fund with 0.25% fees would charge about $104,000, while a fund with 1.3% fees would charge $409,000 – a difference of more than $300,000. An extra 1% in fees can be brutal when it compounds over time.
Now that you know the importance of avoiding high 401(k) fees, here’s what to look out for when choosing a plan.
What are the typical 401(k) fees?
401(k) fees can come from two sources: the funds you’ve invested in, and the 401(k) provider that administers your company’s retirement plan. We’ll break down the typical fees in each category.
401(k) provider fees
Administrative fees. These are – you guessed it – fees charged by the 401(k) provider (not the mutual fund itself) to administer the plan, including customer support, record-keeping, and legal services. Depending on your plan, your employer might cover the cost, or pass it on to employees as either a flat fee for each account or as a percentage of the assets you’ve invested.
Individual service fees. These are charges for optional services, like taking a loan against your 401(k) or executing individual investment actions. You probably won’t encounter these often, and when you do, you’ll know the charges before you agree to the service.
The biggest chunk of 401(k) fees are investment fees, levied by the funds in your 401(k) themselves. You can invest your 401(k) funds in either mutual funds or exchange-traded funds (ETF’s); typically, ETF’s and passively managed mutual funds have lower fees. Target-date funds (which are usually mutual funds) tend to charge higher fees. These fees are usually charged as a percentage of assets – for example, a 1% fee would charge you 1% of your current assets in that fund every year. Here are the typical investment fees:
- Front-end loads: These are basically commissions that the mutual fund pays out to brokers who sign up clients to that fund. They’re paid as an upfront percentage of your assets. For example, if a fund has a front-end load of 3% and you invest $10,000, the fund takes $300 right away and only $9,700 is actually invested.
- Purchase feesL: Some funds will charge a fee when you buy their shares. While front-end load fees go to brokers as commissions, mutual funds keep purchase fees in their pockets. They both have the same effect of lowering the amount that actually gets invested.
- Back-end loads: These are charged when you sell shares in a fund. Sometimes they’re charged as a flat fee, and other times the fee gradually decreases until the holding period ends, after which the fee is waived. Say you invested $10,000 in a fund that has a 6% annual return and a 3% back-end load. After two years, your balance is $11,236. If you withdraw at that point, the fund will collect $337 and you’ll get $10,899 back.
- 12b-1 fees: 12b-1 fees, also known as level-load fees, are ongoing charges for marketing and servicing the fund. In practice, they’re often used as broker commissions, and are capped at 1%. 12b-1 fees are included in a fund’s operating expenses.
- Investment management fees: Finally, the mutual fund’s managers and advisors take an annual cut of their assets under management (AUM). This fee basically covers the mutual fund’s expenses, from office space to visiting potential investments to paying research analysts’ and managers’ salaries. Investment management fees are included alongside 12b-1 fees in the fund’s operating expenses.
You may also incur an account fee if you invest less than a certain amount in a mutual fund, or an exchange fee if you transfer to another fund in the same group.
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Where can I see my 401(k) fees?
401(k) fees are listed in different places, depending on who’s charging them.
401(k) provider fees. The fees charged by your company’s 401(k) plan administrator will be listed by the administrator directly – usually on their website or in the informational material given to you when you first enroll in the plan. Like we mentioned, these fees are sometimes covered by your employer, or you might have to pay them yourself.
Front- and back-end loads. You can see a specific fund’s front- and back-end loads in its prospectus, which is available on the SEC’s website as well as on services like Morningstar. Prospectuses are always available to you before, during and after you hold shares in the fund. “No-load funds” are funds that charge neither a front- nor back-end load, but some still charge a 12b-1 fee (aka a level load).
Operating expenses. 12b-1 fees, investment management fees, and miscellaneous other annual fees (like legal or accounting expenses) are all gathered into one figure: the fund’s expense ratio. This figure is expressed as a percentage of the average AUM. For example, if you’ve invested $10,000 in a fund with a 5% expense ratio, you’ll pay $500 a year in fees.
What’s a good expense ratio for a 401(k)?
On average, 401(k) providers charge 1.37% of assets invested in the plan, in addition to whatever they charge employers to service their accounts. That includes the mutual funds’ and provider’s fees. While you as an employee can’t really do anything to lower the provider’s fees, you can choose low-cost funds in your plan. Generally speaking, actively managed mutual funds charge higher fees than passively managed mutual funds or ETF’s. That’s because active funds require a lot of decision-making from investment managers and researchers, which means more salaries to pay. The latter group simply tracks different stock indices, which reduces the fund’s overhead.
Here at Human Interest’s, our provider fee is just 0.5%, and employer can choose to cover most of that. We offer Vanguard mutual funds because they have some of the lowest fees out there; the average fund fee for our portfolio is 0.08%, for a total average fee of 0.58%.
Want to ask your employer for a lower-cost 401(k)?
Excessive fees can take away as much as 28% of your retirement savings. If your company’s 401(k) provider is charging high fees or doesn’t offer low-cost funds, tell your HR manager about Human Interest’s investment policy – we’re committed to making retirement possible for everyone.