Hidden 401(k) Fees and What to Do About Them

“401(k) retirement plans are a great way to save for retirement.” “Lower your taxable income by contributing to a 401(k).” “For a retirement nest egg, grow your wealth within your 401(k).”

All of these 401(k) retirement plan characteristics are true. But, there’s more to the 401(k) story than the benefits. A 401(k) plan isn’t free. There are 401(k) plan fees and administration costs for both the employer and employees to consider. Any fees and costs take money away from your investment fund and won’t grow and compound for the future. Unfortunately, in 401(k)s it’s very easy for hidden fees to be overlooked because they’re automatically deducted from your savings. Also, because fees compound just like interest does, you could gradually end up losing large amounts of money that you could have saved to spend in retirement. Here’s what you need to know about 401(k) fees and what to do if the fees in your retirement plan are too high.

Fees matter: small, hidden percentages can make a big difference

Justin is aggressively saving in his workplace 401(k) plan. He’s looking forward to retiring in 35 years, at age 67. So far, he’s saved and invested $25,000 in his 401(k) and expects to earn 7% on his investments during the next three to four decades. Let’s assume that Justin adds no additional contributions to his retirement account. If his fees and expenses are 0.5%, then he’ll have $227,000 at retirement. Now, consider fees and expenses of 1.5%. With just 1.0% higher fees, his account balance grows to $163,000 at retirement. The higher fees cost Justin $64,000 in lost returns or a reduction of 28% from his retirement account. Fees matter!

The employer mandate: Hidden fees in your 401(k) plan can be illegal

Fortunately, your employer is required by law to disclose their fees. Here are the employer’s obligations regarding the 401(k) plan. Your employer is required to:

• Make certain that the fees paid to the plan providers as well as the expenses are reasonable.

• Follow a reasonable and responsible process when selecting the employee 401(k) plan.

• Choose investments that are diversified and responsible.

• Disclose the plan fees and the fund charges to the employees so that they may make responsible choices.

• Monitor the plan choices to ensure that they continue to remain reasonable.

Now you’re aware of the impact of fees on your retirement assets as well as the employer’s duty to make the expenses and fees transparent. But what types of fees do you need to pay and where do you find this information? Also, how can you discern whether the fee information is reasonable or not?

How much does your fund charge? It’s called the expense ratio

Every mutual fund and exchange traded fund, regardless of the fund family, charges a management fee. The fee is levied as a percent of the amount invested and can range from as low as 0.04% for the Vanguard S&P 500 ETF (VOO) on up to 1.17% for the Artisan International Investor (ARTIX). They’re often called “expense ratios“. This fee is constant and continues for as long as you own the fund. As mentioned in the beginning of the article, just a 1.0% difference in fees can make a huge difference in how much you’re able to spend in retirement as your savings grow over the years. Various types of funds have different fee structures. For example, many index mutual or exchange traded funds have very low fees. That’s because index funds hold investments that track a pre-determined stock or bond index such as the S&P 500 stock market index. There’s little management required, thus the fund doesn’t need to charge high fees. On the other hand, some funds have managers that frequently buy and sell the stocks and/or bonds in the fund. These types of funds are called actively managed funds and typically charge higher fees than passively managed index funds. Additionally, some funds charge sales commissions when you buy, when you sell or both. These commissions are also called loads and can significantly reduce your long term investment returns. To find out what the investment management fee for your fund is, simply look at the prospectus or search online for the fund description on either Yahoo! Finance or the fund family website. It is required by law to list the percentage management fees and also show the dollar impact these fees will have on your fund over time. Lower fees are better and the management charges for actively managed funds rarely merit the additional expense.

More hidden 401(k) fees: administrative fees, service fees, etc.

So far, you’ve learned about the fees charged by mutual fund companies. Your employer doesn’t create these charges nor benefit from the fees. Yet, the employer must pay for the management of the employee 401(k) plan. Whether or how much the employer passes on these administrative costs to the individual employees varies by company. Make sure to ask about this! Some employers charge a flat account management fee. It might be a few dollars a month or a quarter or it might be a percent of the assets in your account. If it’s a percent of the value of your account, then those employees with larger accounts will pay more than those folks just getting started in the plan. Next, there are individual service fees, like a 12b-1 fee. Some employers will offer add-on services, such as account management or access to financial advisors. Typically, there will be a fee for these types of benefits. If you decide to borrow or roll over money from or to your 401(k), there may be fees to process the loans and distributions. Again, the individual service fees will vary based upon your company’s specific plan. To find out about the plan fees there are several options:

• Call or email the plan administrator in your firm. That might be the human resources manager, or in a large company a benefits manager can help.

• Examine your monthly or quarterly account statement to see the entries for fees.

• Look at the plan documents either in print or online, that accompany your sign up information. The fees should be disclosed in this information packet.

My fees are too high: What can I do?

Take these steps when evaluating your 401(k) fees. After you’ve thought about your investment goals, risk tolerance, time horizon and future goals, you’re ready to tackle the fees. Understand the fees on the different types investment funds (like the common Target Date Funds) and the general 401(k) plan. In general, actively managed funds charge higher fees than passively managed index funds. International funds will usually have higher fees than domestic investment funds. The investment research is conclusive that in most cases passively managed, low fee index funds returns beat those of higher fee actively managed funds. But what if your firm doesn’t offer lower fee funds, or has very high overall management fees. Choose from these options to manage your 401(k) fees.

1. Visit your human resources department and ask for low-fee index funds to be added to the investment choices.

2. Invest only enough in the workplace retirement account to receive the employer match, and put the remainder of your investment dollars into a self-directed Roth or traditional IRA.

3. If there’s no match, then you might choose to invest outside the workplace account into IRA accounts, as mentioned above. Although due to higher dollar limits, you might consider placing some of your money in the higher fee 401(k) plan all the while lobbying your company to offer lower fee alternatives, such as those offered at Human Interest.

The takeaway

Fees aren’t the only consideration when investing in a workplace 401(k) account, but they are important. A difference of just a half or one percent in fees can mean thousands of dollars less in your ultimate retirement account. Spend a little time checking on the account fees today and you’ll likely be wealthier tomorrow.

Sources and additional resources

• 401(k) Decision Checklist

• How to Choose Funds in My 401(k)

• Employee Benefits Questions You Need to Ask Before You Enroll

• A Look at 401(k) Plan Fees (US Department of Labor)