Plan participants: Are your 401(k) fees too high?

Do you know how much you’re paying in 401(k) fees as a plan participant?

If you don’t know off the top of your head, you’re not alone. Nearly two-thirds of Americans say they don’t understand how a 401(k) plan works. And it’s estimated that millions of Americans have no idea whether they’re paying fees (or how much they’re paying) and find the task of figuring it out to be confusing and difficult. However, it is good to understand your 401(k) fees, as they could be affecting your retirement savings.

To set the stage, the average investment expense of plan assets is 1.6% (for plans with 25 participants and $250,000 in total assets)². While this may not seem like much, investment expenses can eat away at your retirement savings and even force you to work longer. Many Americans may have to put off retirement because of confusing, poorly disclosed fees. That’s why it’s essential to have a clear idea of how much you’re paying in 401(k) fees. 

This guide will help explain 401(k) fees that plan participants may be responsible for paying—and teach you how to identify and avoid 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. What can be defined simply as "interest on interest," compound interest occurs when the interest you earn on a balance is reinvested. If you’re in your 20s or 30s, today’s contributions to your 401(k) now will grow for decades before you retire. And anything that eats away at those contributions will have an outsize effect.

An extra 1% in fees can be brutal when it compounds over time. And extra 401(k) fees add up even more quickly for higher-income workers. A scenario from NerdWallet analyzes a 25-year-old who plans to retire at 65, has $25,000 in retirement savings, saves $10,000 in the account each year, and earns a 7% average annual return. In this example, paying just 1% in fees costs the saver more than $590,000 in sacrificed returns over 40 years of saving.

Three different types of 401(k) fees

Now that you know the importance of avoiding high 401(k) plan fees and expenses, here’s what to look out for when choosing a plan. According to the U.S. Department of Labor, there are three basic categories of 401(k) fees:

1. Investment fees 

2. Plan administration fees 

3. Individual service fees

Let’s break down the typical fees in each category.

1. 401(k) investment fees

Investment fees may account for the largest portion of 401(K) fees and often come from the cost of investment-related services levied by the funds in your 401(k) themselves. 401(k) plans generally offer a range of mutual funds that account for risk tolerance, age, and other factors. Target-date funds (usually mutual funds) tend to charge higher fees. Investment fees are usually charged as a percentage of assets invested and can be broken down into sales loads, expense ratios, and other additional costs. For example, a 1% fee would charge you 1% of your current assets in that fund every year. 

Because they’re often deducted directly from your investment returns, you most likely pay for investment fees as indirect charges against your account balance. While often buried in your plan statement, it’s important to pay attention to investment fees! To reiterate, the average investment expense for small business plans is 1.6%. This may seem like a small percentage—but over time, this amount adds up, making a big dent in your return. 

Investment management fees and related services are generally charged as a percentage of your assets invested and can be broken down into expense ratios, sales loads, and other costs. Here are some 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, you have to pay $300 right away in 401(k) mutual fund fees, meaning you’ll actually be investing only $9,700.

• Purchase fees: 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.

• 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 often 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.

• Account fees: 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.

2. 401(k) plan administrative fees 

When you have a financial institution managing your 401(k), there will be administration fees. Charged by the 401(k) provider (not the mutual fund itself), these fees cover general management such as legal and trustee services, record-keeping, and accounting. They also include day-to-day operations of the financial institution like customer service representatives, electronic access to plan information, and educational seminars.

In some cases, service costs are covered by investment fees deducted directly from returns. If administrative costs are charged separately, they’ll either be charged against your employer or against the assets of your plan. Usually, however, these fees are passed on to you, the employee, as a flat fee or as a percentage of your assets invested. Administrative fees are then allocated among individual accounts in proportion to their account balances, or as a flat fee against each participant’s account. Regardless, the more services provided, the higher the fees.

3. 401(k) individual service fees

Individual service fees cover extra plan features that you choose to opt into. Some of these extra features include:

• Distribution services (including RMDs): Most account owners eventually withdraw funds from their retirement plans. For example, a required minimum distribution (RMD) is the minimum amount participants must withdraw once they meet specific qualifications the IRS sets annually (including age).

• Rolling over 401(k) investments: When starting a new job, you have the option to move some or all of your savings into another account. Most 401(k) plans are portable, meaning you often have options when switching jobs. 401(k) rollovers occur when plan participants choose to transfer your existing 401(k) balance to either an IRA or your new employer’s 401(k) plan (if it accepts transfers).

• Taking out a loan: 401(k) plans are designed for employees to hold until retirement. However, there are several ways to withdraw funds before age 59 ½, including short-term loans and hardship withdrawals (which, according to the IRS, are prompted by an immediate, heavy financial need).

• QDROs: Dividing up assets during divorce may involve 401(k) plans. Qualified domestic relations order (also known as a QDRO) is the process of splitting retirement accounts due to a divorce settlement.

Not all individual service fees are required to be disclosed—such as account setup fees or other indirect fees—but most of your individual fees should be disclosed on your quarterly statements. That’s why it’s important to find out the average 401(k) advisor fees, loan fees, and investment execution fees, so that you won’t be paying too much for optional 401(k) services. These fees can range anywhere from $20 to over $150, depending on the type. 

Human Interest provides services that come with zero transaction fees. This includes $0 for RMD distribution fees, rollover fees, loan setup, and more. We believe it’s unfair for plan participants to be blindsided by hidden fees. These fees—especially unexpected ones—can really eat away at your nest egg. The elimination of many individual service fees builds on our already low-cost offerings.

How do I find out 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-end and back-end loads: You can see a specific fund’s front-end 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-end nor a back-end load, but some still charge a 12b-1 fee (a.k.a. a level load).

• Operating expenses: 12b-1 fees, investment management fees, and miscellaneous other annual fees (like legal, marketing or accounting expenses) are all gathered into one figure: the 401(k) 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. In most cases, the annual gross expense ratio for 401(k) is the same amount as the net expense ratio. However, if there are waivers and reimbursements affecting the gross expenses, the gross expense ratio for a 401(k) plan may be higher.

It’s important to note that, sometimes, plan administration fees aren’t disclosed on your statements when paid out of plan’s funds. At a minimum, you might want to check into the administrative fee line item on your statement and see what it really includes—because it may be more than just a small annual fee. Because plan administration fees are paying for services from the financial institution, you might as well make sure you’re getting your money’s worth and take advantage of all the services your financial institution has to offer. 

Potential for hidden or overlooked 401(k) fees?

In late 2020, the DOL released a final version of its fiduciary rule proposal. “Improving Investment Advice for Workers & Retirees Exemption” requires fiduciaries to recommend retirement options that adhere to a “best interest standard, a reasonable compensation standard, and a requirement to make no material misleading statements.” Essentially, investment professionals cannot put their own interests ahead of the interests of their clients (this includes keeping costs low!). While the rule originally went into effect in February 2021, the DOL extended the grace period for fiduciaries to comply through the end of January 2022.

Even with this forthcoming fiduciary rule, there could still be 401(k) fees that go unnoticed. An example of commonly overlooked fees are plan management and service fees, because some administrators don’t send yearly bills. Or, participants may receive statements that don’t itemize individual fees and instead show fees in relation to the plan’s reduced net returns. What’s more, 401(k) statements may use technical terms that aren’t easy to decipher, (i.e., expense ratios, total operating expenses as a percentage, or total asset-based fees). Regardless, it’s usually still possible to figure out what the numbers really represent if you know to look for them. 

What’s a good expense ratio for a 401(k)?

The average investment expense of plan assets is 1.6% (for plans with 25 participants and $250,000 in total assets)², in addition to whatever a provider charges employers to service their accounts. That includes the mutual funds’ and provider’s fees. While you as an employee can’t do much 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 ETFs—and low-cost index funds can be an efficient way to optimize your portfolio. Whereas active funds require decision-making from investment managers and researchers (more salaries to pay), ETFs track different stock indices, which reduces the fund’s overhead.

Being proactive: How to protect yourself from high 401(k) fees

Figuring out exactly how many fees and what types of fees you are paying for your 401(k) plan can get complicated, especially when statement disclosures can range from a short summary to dozens of pages. You may have to do a little homework—and it may require some time—but it’s critical to your long-term goals to know exactly how much you’re paying. 

• Tip: Start by seeing if you can identify any conversion-related charges, plan administration costs, investment product fees, or service provider charges. The DOL provides some useful examples of 401(k) plan fee disclosure forms, along with videos, charts, and other resources that you may find helpful. 

You’ll be able to make better retirement savings decisions if you’re well informed about the 401(k) fees you’re paying. However, if you still think you’re overpaying, you can investigate whether your plan has a low-fee fund option—or ask your employer to include more low-cost investment options. 

Want to ask your employer for a lower-cost 401(k)?

Here at Human Interest a monthly investment advisory fee of up to 0.01% of the plan's assets is charged to the plan and allocated to participants' account. In addition, participants using Human Interest Advisors' Model Portfolios tend to see average fund expense ratios of 0.07%¹, and employers can choose to cover most of that. We offer access to nearly every mutual fund and index fund on the market, including low-cost funds from Vanguard, Dimensional Fund Advisors, BlackRock, Charles Schwab, and more. In fact, the average fund fee for our model portfolios is 0.07%, for a total average fee of 0.57%. By offering lower charges than the average 401(k) fees, expenses, and other costs, we can help plan participants such as yourself maximize 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. Get in touch with our helpful representatives to find out more about our 401(k) services.