A Guide to 401k Plan Fees and Expenses
Alita Rosenfeld, 60, doesn't mind paying $400 a year to maintain a brokerage window in her 401k plan. In gaining a wider choice of investments for her retirement savings, she offset that cost as her portfolio retained $3,000 in value that would have been lost if she had stuck with her plan's limited offerings.
But when she received a $252 bill for setting up the account, she hit the roof. She hadn't been told about it in advance.
It's not as if she hadn't asked. She had. "I was only told about the quarterly fee," she said.
Rosenfeld's experience illustrates a common problem. Many participants don't know how much they pay in fees for their 401ks, or don't realize they pay any fees at all. Those who try to educate themselves often wind up confused about how much the fees are and what they cover. In fact, Rosenfeld was lucky to receive a bill. Often, fees are simply deducted from assets in the plan without any notice to the participant.
Even if you're told you don't pay any 401k fees, don't believe it. You're likely being charged in some way, experts say.
While your options for reducing fees are often limited, it's still important to know what you are getting for your money.
"You need to know about the fees because it affects your bottom line," said Carmela Elco, vice president of client services with Resources for Retirement Plans Inc., a 401k plan consulting firm.
Fees reduce your overall return. To take a simple example, if your investments return 7 percent but you are charged a fee of 1.5 percent, your real return is 5.5 percent. When the stock market was regularly posting double-digit returns in the 1990s, a 1.5 percent fee probably seemed insignificant. But, as the stock market declined recently, retirement savers became more aware of fees' impact on their accounts.
A Department of Labor example taken from its pamphlet "A Look at 401k Plan Fees" shows how they can affect your returns. This is available for free on the DOL's Web site, www.dol.gov.
"Assume you are an employee with 35 years until retirement and a current 401k account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent."
What Fees and Costs Are You Paying
In 2012, the U.S. Department of Labor implemented new regulations regarding 401k fee disclosure and fee transparency. As a result, you should be getting information on the total fees and costs you are paying in your plan.
Even so, the average worker is still confused when it comes to the fees they are paying. So, if you have questions about the fees and expenses charged to your 401k plan, contact your plan administrator, who should be able to assist.
Three Fee Categories
401k plan fees typically fall into three categories: investment, administrative and individual service fees.
The investment fee is likely the single largest fee you will pay. These fees, commonly disclosed in mutual fund prospectuses and annual reports, cover the cost of managing the investments.
Additionally, mutual funds sometimes charge what is known as a load, an industry term for a sales charge or commission. This may be paid up front, in which case it is called a front-end load. Or, it may be paid when the shares are sold, known as a back-end load or redemption fee. Many mutual fund companies waive sales charges for 401k plans.
Another type of investment fee is the 12b-1 fee, named after the section of the Securities and Exchange Commission rules requiring its disclosure. This fee covers a mutual fund's marketing and distribution costs and commissions to brokers, and typically runs between 0.25 and 1.0 percent of assets, charged to the participant annually. Mutual fund companies sometimes use this fee as a way to reduce or eliminate loads charged to customers.
In total, investment fees can range from 10 basis points (in index funds) to 2 to 3 percent (in actively managed funds). These fees are charged against your investment.
Administrative fees cover the costs of maintaining the plan. They pay for account statements and educational materials, and often cover the costs of running Web sites and offering access to customer service reps and investment advice. Administrative fees often run about $100 to $200 per participant per year. These fees may or may not be disclosed.
Employers sometimes pay these fees, said Julia Vander Els, senior vice president of retirement education with Delaware Investments.
In other cases administrative fees are taken out of plan assets, meaning the participants pay the fees, said Donald Black, president of MBM Advisors, Inc., an investment advisory and pension-consulting firm.
Some administrative fees may be hidden. One example is revenue sharing, in which the mutual fund provider pays a percentage of the plan assets to the company administering the plan. This effectively hides an administration fee within the investment fees charged to participants by the mutual fund company, reducing or eliminating the administrative cost for the employer. The reason: "corporations don't want to write a check for the administration of the plan," Black said.
Another commonly undisclosed fee is the wrap fee. This is often charged to plans too small to be of direct interest to the fund companies. To provide 401k plans to small employers, a middleman, often an insurance company, aggregates several plans in order to create a large enough pool of accounts to interest the mutual fund company. The insurance company often offers the investments through an annuity and charges a wrap fee for this service.
While wrap fees attract criticism, the reality is that many small employers wouldn't be able to offer 401k plans without this arrangement, said Elco. One alternative is a completely Internet-based provider where the costs are lower, but the services are also lower, she added.
The last category of fees is individual service fees. These are typically charged for use of special plan features, such as a brokerage window, or for certain transactions, such as a loan or hardship withdrawal while working or a regular withdrawal after terminating employment. These fees can range from $20 to $150 or more, depending on the transaction, Elco said. They may be disclosed in a summary plan description or on your statement.
Rosenfeld paid two individual service fees for her brokerage window account. The first was the extra $100 quarterly fee, which was disclosed. The second was the $252 account setup fee, which upset her because it was not disclosed. Such a fee is not required to be disclosed. Rosenfeld has complained to her employer about the fee and the lack of disclosure. Her employer raised this issue with the 401k provider. At the time of writing, she had not yet heard back.
The Long View
If you are tempted to stop contributing to your 401k because you think the fees are too high, reconsider. There is no free lunch -- all services have costs. Someone has to pay for this benefit.
Sometimes the higher fees are worth it because you get extra services or higher quality investment management. Look at Rosenfeld. Despite the set-up fee and $100 quarterly fee, she's still coming out ahead by using a brokerage window.
And, what's the alternative? Going it alone?
"I think it is worth it to contribute to the plan," Elco said. "Even if you are paying 2 percent of assets to fees, which is high, that is cheaper than doing it on your own."
If you saved in an IRA, you would likely pay loads for the same funds and not have the access to the same institutional-quality mutual fund shares, which often have lower fees than those offered to retail investors, she said.
Also, by abandoning your 401k plan, you lose the ability to take advantage of higher contribution limits. You will also lose any employer contribution. Traditional and Roth IRAs don't have employer contributions.
If you think your plan fees are egregious, try making a little noise at work.
Some Additional Resources
Infographic on 401k Plan Fees
A Look at 401k Plan Fees
This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.