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401k fees: Everything you need to know

At a glance:

  • What are 401k fees and how are they charged?

  • Why is it important to know about 401k fees?

  • What 401k fees will you pay?

  • 401k fees and investment choices

  • Where to get more information about 401k expenses

  • Factors that affect fees and expenses of a 401k Plan

  • Summary of 401k fees

Ever so often, you may notice a little fee on your retirement plan.

Maybe you ignore them because they’re fairly small amounts, maybe you you pay attention to them. But fees have an important purpose: Without them, your retirement plan may not be running at all.

Fees can sometimes eat into the value of your plan over time. In some cases, the effect can be substantial. If you are counting on your plan to see you through many years or decades of retirement, it is important that you take the time to learn about these fees and how they are assessed on your money.

Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)
Millennials aren't contributing as much to their retirement. (Graphic: David Foster/Cashay)

What are 401k plan fees and how are they charged?

Many investment accounts and retirement accounts charge fees for a variety of services.

There are people behind the scenes doing work to ensure that your account is running well and staying in line with the law. In that vein, 401k plan fees are charges paid to support a 401k plan.

Support services can vary a lot among plans, but they coalesce around administrative services, investment services, and various individualized services.

How they are charged

Fees are charged in any of several ways.

Some are charged directly to your account. Fees of this nature are done as flat fees or are allocated proportionately among individual accounts in your company.

In other cases, fees are paid by your employer. Or they’re deducted from the investment returns of the plan.

Where to learn about fees

Fees are described in your 401k plan literature, which is made available by employers and/or plan administrators.

It pays to know what yours are and how they are charged, because they impact the dollar value of your plan. If you keep your 401k over the course of decades, the fees could conceivably reduce the value of your plan more than you had expected.

Employers have a duty under the Employee Retirement Income Security Act (ERISA) to follow rules for the benefit of their plan participants. They must select investments prudently, they must ensure that expenses are reasonable, and they must monitor the plans and keep them appropriate for their employees.

They must disclose fees in a format that is easy to understand. The purpose of these rules is to bring to the surface the sometimes confusing and murky nature of fees that are charged.

What 401k fees will you pay?

Do you know what fees you are paying for your 401k plan?

Most people aren’t even aware that they’re being charged a fee. Even fewer know how much is coming out of their accounts each year to pay them.

Fees will impact your account balance, which you may come to depend on in your retirement years. If you are using general projections that take hypothetical earnings rates, employer matches, age, tax brackets, and other factors into account, you will arrive at retirement estimates that look rosier than they really are.

That is why it is a good idea to adjust the earnings rate as needed to reflect fees. Calculators don't typically include space for them. That also means you should know which fees are being charged to you, and how much.

An example

Consider a simplified scenario.

A hypothetical employee who is 35, earns $40,000 a year, and has made the brave decision to retire at 70 instead of 65. This person has $25,000 in her 401k plan. She defers 5% of her income into the plan each year, with an employer match of 3% and an annual salary increase of 2%.

With an average return of, say, 7%, she can expect to have $649,000 in her account by the time she's 70.

Not bad.

But if her various fees and other expenses are 1% and are coming out of her account balance in some way, she can expect only $502,000.

Still not bad, but her estimated earnings have dropped 23%. And that can cost her if she expects to live a long time after retiring.

This example is simplified, of course. Investment returns are never guaranteed, nor can they be predicted with full accuracy. This example's purpose is to show what even small fees can do to the money you are counting on to be there when you are old and gray.

The number of services available to 401k plan participants has increased a lot in the past few years.

These services come with expenses, which are passed on to you, with convenience come costs. Both employers and employees should weigh what they are getting with what they are paying.

What 401k fees will you pay?

There are several types of 401k fees:

Administrative fees

Many administrative services are needed for a 401k plan.

There are typically accounting and bookkeeping services, legal services, and trustee services. Other services may be offered as well — transactions, telephone voice response systems, educational initiatives, software, customer service, and online services.

Administrative fees can be charged in any of several ways. Some are charged directly to your account via a flat fee or allocated proportionately among individual accounts. Or they may be paid by your employer. In other cases, fees are deducted from the investment returns of the plan.

Investment fees

Investment fees are the biggest part of 401k plan fees.

They are assessed as a percentage of assets invested, and they are deducted from your investment returns. Investment fees cover the management of the investments in your 401k plan as well as any other investment-related services.

What kinds of services are covered under investment fees? There are sales charges (commissions), which cover buying and selling shares. There are management fees, which cover the managing of assets in the plan. There are also fees for bookkeeping, investment advice, toll-free phone numbers, and various administrative services. In addition to these costs, there may be special fees unique to certain investments.

Optional service fees

If you are taking advantage of optional features offered by your plan, such as a loan, you may pay a service fee. It will be charged to your account only, however.

401k expenses may be bundled together or handled separately. They may be offered by a single provider or several.

401k fees and investment choices

401k plans are built on a variety of different investments.

At a large company, they may offer the stock of that company. But it is most common for them to offer funds that are made of the pooled money of numerous participants. This allows them to offer a large variety of investments in those funds, which can diversify risk.

Another advantage of pooling money from numerous participants is to lower the overall costs of transactions.

The investments in these pooled funds are typically stocks, bonds, and money market investments. They may represent a sector of the economy or several different sectors.

Here are the most common types of funds and the fees associated with them:

Mutual funds

Mutual funds pool the money of many people and invest it in a selection of different investments such as stocks and bonds.

As an investor, you own shares in a fund and therefore share in its earnings and its fees. Every mutual fund has an investment objective, meaning that money in it is invested to achieve a particular goal, such as sustained growth.

These are the fees charged:

  • Mutual funds charge administrative fees for the day-to-day running of the funds. They also charge investment management fees.

  • They may also assess sales charges (front-end loads) when you buy shares or when you sell shares (back-end loads). Back-end loads may decrease the longer you keep your fund, eventually reaching zero. Mutual funds advertised as "no-load funds" do not charge these fees.

  • Mutual funds may charge 12b-1 fees, which cover various other expenses, such as advertising and promotion and various bundled services.

Variable annuities

Variable annuities are offered to a 401k plan through an insurance company.

They can be thought of as a "wrap" that contains a variety of mutual funds that participants can choose from. Because different participants will choose different funds, participants will therefore earn different investment returns. Variable annuities also come with insurance aspects, such as death benefits, a contract term, and interest and expense guarantees.

Fees charged by variable annuities include:

  • Investment management fees

  • Administrative fees

  • Insurance-related fees, such as mortality risk charges and costs for handling contacts

  • Surrender charges, which are levied if you withdraw money before the term expires

Collective investment funds

Collective investment funds are trusts managed by banks or trust companies.

They pool investments together. As an investor in a fund, you have a proportionate interest in it and receive your earnings in a similar manner. Collective investment funds charge administrative fees and investment management fees.

Guaranteed investment contracts

Guaranteed investment contracts are pools of funds created by banks or insurance companies. Their income is typically fixed. They charge administrative fees and investment management fees.

Where to get more information about 401k expenses

The 401k fees you pay as part of your plan are made known in several types of publications:

Account statement

Your account statement, which is typically provided four times a year, shows you the total assets in your account, how the assets are invested, and any increases or decreases in them. Administrative expenses may also be shown. The account statement is for your account alone, rather than the entire plan.

Prospectus

A prospectus is a document (usually in booklet form) that describes the aspects of the investment — past performance, fees, management, etc. — that your 401k invests in. If your plan lets you direct the investments in it, you will receive a prospectus with this information as well. Investment fees and other fees will be disclosed there.

Summary plan description

This document is a summary of your 401k plan. It is given to you when you join the plan. It will describe how the plan operates and what it provides to participants. It will also cover how administrative expenses are paid.

Annual report

The annual report, issued yearly, describes the state of your 401k plan. It provides information on the plan's assets and liabilities, income, and expenses.

Expenses include administrative fees and other expenses. It cannot show expenses that you paid individually for your account, nor does it show expenses deducted from investment earnings. You can view annual reports online at www.efast.dol.gov.

Your plan administrator should also have the information you need about fees and expenses, as well as access to the documents described here.

Factors that affect fees and expenses of a 401k plan

Not all 401k plans are the same. The fees you pay will depend on the size of the plan, how it is managed, and how you use it. Here are the most prominent factors that affect expenses.

The size of the plan

Size can matter. Larger plans have more freedom to choose specialized funds or different classes of stock. The result can be lower fees for you.

Whether it is actively or passively managed

Different plans have different levels of investment activity in them. An actively managed plan has investment advisors who actively trade the stocks and bonds in the plan in order to earn money.

Therefore, fees will be charged to your plan to compensate these advisors and the various sales charges for the transactions. Passively managed plans do not have this level of activity. Rather, their holdings are those of an existing market index, and so they do not need to change unless that index changes (which is fairly rare).

These plans are usually index funds. For example, a fund seeking to follow the Dow Jones Industrial Average's 30 stocks would contain these same 30 stocks and would not change them unless the Dow itself changed. This lower level of activity results in lower fees.

Whether the services and investments are bundled together or offered separately

Bundled services may not be charged separately. They may be covered by other fees.

Whether you take advantage of optional features

Optional features will cost you extra, so weigh their importance to you. A common optional feature is a loan program. You will pay various costs for taking out a loan.

If your plan is built on a variable annuity, there may be insurance benefits available for you to take advantage of. Those benefits may cost you extra.

Summary of 401k plan fees

Though it's probably not the stuff of bedtime reading, you should take the time to learn how your 401k plan charges its expenses. It should take only a short while. You can also sit down with your employer or contact your plan administrator if the topic seems overwhelming.

Fee management is an important part of investing. This is not to say that fees are to be avoided. Like any expense, they cover some kind of service. As an investor, you are aiming to maximize the value of your money for what you are putting into it.

You don't want to find yourself 90 years old and wondering how much more you could have gotten if you had just been more aware during your working years. Hindsight isn't always pleasant — it is made more palatable through foresight.

There are things you can do on your own to maximize the value of your plan.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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