There’s no such thing as a free lunch and 401(k) plans are no exception to this business maxim. Whether it’s you, your employer, or both, somebody has to cover the costs involved in setting up, managing, reporting on, and meeting compliance requirements for your retirement plan. About seven in ten 401(k) plan holders aren’t aware that they pay fees to their plan administrator and six of in ten aren’t aware of how much they pay in fees. Because these fees are typically taken out automatically from your savings, it's not always easy to see exactly how much you're being charged, and that this amount will grow over time -- just as interest compounds, so do fees.
Here’s why your 401(k) fees matter: Let’s assume that you have a $100,000 balance and that you are 30 years away from retirement. Here are three investment scenarios in a fund with an annual 6% rate of return and various annual expense ratios (the automatic fee you pay on your investments). Expense ratios are also called "fund fees" and they are typically the most egregious when it comes to 401(k)-related fees, so we'll be focusing on this type of fee first.
|Annual 401(k) fee (expense ratio)||Balance After 30 years||Difference from 0% scenario|
In our example, a 0.25% annual expense ratio means that you pay $250 in 401(k) fees for a balance of $100,000. While $250 per year may not sound like much, it really adds up over a long period of time. This is why you need control your 401(k) fees. To help you evaluate the fees from your plan, let’s review nationwide averages for employee fees.
401(k) fund fees have been decreasing
While the average expense ratio for equity mutual funds offered in the U.S was 1.31%, the average expense ratio of any fund in a 401(k) plan tends to be much lower. According to data from the Investment Company Institute (ICI), the annual expense ratios for funds selected for 401(k) plans are decreasing.
Average expense ratio fees for 401(k) participants
|Year||Equity funds||Bond funds||Hybrid funds*|
* Funds investing in a mix of equities and bonds.
If you’re thinking about stopping right now and calling your plan administrator to give him an earful about how much you’re paying in investment fees, keep in mind that access to lower costs depends on the amount of assets in a plan. In 2013, a collaborative research effort between BrightScope and the ICI found that the fees for U.S. equity mutual funds that a 401(k) plan pays, decrease as the size of plan assets increases. A 401(k) plan with $250,000 to $500,000 in assets paid an average expense ratio for domestic equity mutual funds of 0.53%, 28 points less than a 401(k) plan with $1 million to $10 million in assets.
However, this doesn’t mean that your employer shouldn’t make a case for lower fees. The research from the ICI indicates that 401(k) plan holders tend to pay considerably lower than average industry fees. In 2015, the average industry expense ratio for an equity fund and the 401(k) average expense ratio were 0.68 and 0.53, respectively.
Averages for 401(k) recordkeeping, investment, advisory, 12b-1, and service fees
While knowing the annual expense ratio of your 401(k) is a first great step towards improving the performance of your nest egg, it’s just the beginning. Depending on the size of assets in your plan, the number of plan participants, and set of applicable plan rules, you may have to cover additional charges, such as record-keeping fees, 12-1b fees, and advisory service charges. By stacking up many of these fees, some 401(k) plan holders can end up paying up to 2% in annual fees!
Let’s take a closer look at some of them.
Some 401(k) plans charge an ongoing monthly or annual fee to manage your account. One of those fees is the fee to cover administrative processes and files. According to the data from 11th Annual NEPC Defined Contribution Plan and Fee Survey, recordkeeping fees stood at 0.42%, down from 0.57% back in 2006.
In response to individual investors chasing lower investments, plans have continuously lowered their recordkeeping fees. In 2015, the median recordkeeping fee was $64 per participant, down from $70 in 2014 and $118 in 2016. However, as recordkeeping fees have hit rock-bottom levels, there seems little room for further decreases.
From the total investment cost, one portion stays with the investment manager of the plan and another goes to providers other than the plan’s investment manager.
According to the 401(k) Averages Book, an account holder in 401(k) plan with 100 participants and $5 million in asset could expect her annual revenue sharing and net investment fees to be $340 and $270, respectively. The value of assets in a plan allows plan administrators to drive these fees. In 2016, a small plan generates 0.66% of revenue sharing fees, while a large plan generates 0.44% of revenue sharing fees, according to the 2016 edition of the 401(k) Averages Book.
Advisory service fees
Plan providers have reported charging plan participants anywhere a 0.15% to 1.0% asset-based fee for advisory services. With the advent of 401(k) robo-advisors, you can find streamlined advisory services with as little as a monthly flat fee of $5. Other 401(k) have already built in streamlined robo-adviser features into their fees. For example, Human Interest provides 401(k) automatic rebalancing at no extra charge to its plan holders.
As we have mentioned throughout this article, the larger the plan, the greater its power to drive down fees. That’s why in 1970’s several mutual funds started to charge fees to account for promotional efforts to attract new investors. While 12-1b fees were more common back then, today very few funds charge them.
Still, about 70% of mutual funds charge 12b-1 fees in at least one share class to 401(k) plan holders. The average annual 12b-1 fees is 0.13%, according to one estimate. However, the Securities Exchange Commission (SEC) allows plans to charge up to 2% per year in 12b-1 fees.
You can read more about 12b-1 fees here: What is This 12b-1 Fee in My 401(k)?
Individual service fees
Trying to meet the needs of his employees, an employer may choose to add certain features to an employer-sponsored 401(k). While some of those features may be beneficial for the employees, those add-ons often come with extra charges.
One feature that is gaining in popularity is the ability to borrow from your 401(k) balance. When you take a loan from your plan, you’re charged an origination fee for the loan. Unlike other 401(k) fees, loan originations fees have gone slightly up. In 2015, the average origination fee was $75, up from $72 four years earlier. A study from the National Bureau of Economic Research found that origination fees can go all the way up to $100 and periodic loan maintenance fees can up to $75.
In summary, the total annual expense ratio of your 401(k) can actually end up being higher than you expected. Taking out a 401(k) loan, choosing a fund with a 12-1b fee, and opting in for full-service financial advisor can contribute to a higher than average 401(k) cost per year. That’s why the national average cost for 401(k) can be as high as 1.37%!
Checklist for keeping your 401(k) fees low
Now that you’re aware of the average 401(k) costs, here’s your game plan to minimize them.
1. Review the prospectus of funds in your 401(k)
While many large 401(k) plans pick up the tab for front-end, back-end, and redemption fees, some mid-sized and many small-sized plans pass the bill to plan participants. Go beyond the annual expense ratio and the list of average returns and read the disclosure of fees in the prospectus for any fund that you’re considering for your 401(k).
After all, a study from Morningstar concluded that the annual cost of a fund is the only predictable predictor of future performance.
2. Choose equity index funds
As the data from the ICI revealed, equity funds have the lowest expense ratio (average of 0.53% in 2015). One way to drive down that annual expense ratio further down is to choose low-cost equity index funds.
Follow the lead from the Oracle of Omaha and choose a very low-cost S&P 500 index fund from Vanguard, as he recommended in his 2013 letter to Berkshire Hathaway shareholders. And for good reason: the Vanguard 500 Index Fund - Investor Class (VFINX) has an annual expense ratio of 0.16%. Holding $10,000 in this fund would save you an extra $37 per year than the ICI’s average annual expense ratio for equity funds.
3. Bump up your contributions
Money talks. When you hold a higher 401(k) balance you may gain access to funds with lower annual expense ratios. For example, a $10,000 minimum allows you to invest in the Fidelity Index Fund - Premium Class (FSUX), which has an annual expense ratio that is half of that from the Investor Class (0.045% versus 0.09%).
One way to give your contributions a boost is to meet the minimum percentage (generally 6% of your paycheck) for a full employer match.
4. Make your annual expense ratio more predictable
Instead of having of tracking so many 401(k), choose a plan administrator that offers an all-in fee that covers all fees. Human Interest charges plan holders 0.50% of account balance, including fiduciary, custodial, and advisory fees.
Through Human Interest, you can effectively invest in Vanguard Admiral class index funds, with annual expense ratios as low as 0.05% such as the Vanguard Total Stock Market Index Admiral (VTSAX) and the Vanguard 500 Index Admiral (VFIAX), without the $10,000 minimum investment requirement. By switching your 401(k) to Human Interest, you could have a clear 401(k) bill as low as 0.55% of account balance per month.
5. Avoid a forced rollover to an IRA
Don’t let all your hard work go to waste by forgetting to tell your employer what to do with your 401(k) once you part ways with the company! According to a Plan Sponsor Council of America survey, 57% of 401(k) plans with balances between $1,000 and $5,000 are forcefully transferred to an IRA of the plan’s choosing when the owner doesn’t indicate what to do after separation from employment.
In 2014, the U.S. Government Accountability Office (GAO) reported that high annual fees and annual returns as low as 0.01% can turn a forced-transfer IRA with a low balance to zero within 30 years.
7. Talk with your employer about reducing plan fees
When was the last time that your boss didn’t like an idea to save money? If you find that the fees from your 401(k) are too high when compared to those of alternative plan, then bring that up through the appropriate channels. If your 401(k) plan mostly offers target-date funds, you have a great opportunity to bring up low-cost index funds.
To get some ideas on why index funds are generally better than target-date funds, review Target Date Funds in 401(k) Plans: Good or Bad Idea?
If you want to set up or switch to an a 401(k) that's great for employees and employers, let your company know about Human Interest.
Related article: Are My 401(k) Fees Too High?
If you want to set up or switch to an a 401(k) that provides low costs for employees and employers, let your company know about Human Interest.