One of the biggest drawbacks of retirement plans is the fees associated with the plan. 401(K) plans, however, have some of the highest fees compared to other retirement saving accounts such as IRAs. This article will cover all 401(K) fees you should expect to pay and how you can avoid or reduce them.
The purpose of saving money for retirement is to build enough cash reserves and investments that will support you in your final days without relying on the government, friends, and family members. But if you are saving the money and someone else pockets your earnings in fees, then it would not make sense to have retirement accounts. You cannot get ahead financially with this setup.
That is why knowing how much you pay in 401(k) fees and strategies to avoid them is an essential step in your financial planning strategies.
What are the 401(K) fees?
There are a lot of 401(K) fees that come with the plan. These fees are grouped into 3 main categories which are administration fees, investment fees, and personal or individual service fees.
- Administration fees. Your 401(K) plan is not like a sinkhole where you put money and wait to see what happens 30 years later. Real people manage your plan and all administration activities will come with fees. Some of the administrative fees you will encounter include but are not limited to compliance, record keeping, reporting, etc.
- Investment Fees. These fees cover all investment activities related to your account and they are usually a percentage of total assets. The money in your 401(K) plan gets managed and invested to make sure you are getting the most out of your bucks. This management can be passive or active. Actively managed investments tend to come with higher fees compared to passively managed investments.
- Individual Service Fees: If you ever want personal/individual services such as processing your 401(K) loans, distributing money, etc; you will pay a fee known as an individual service fee.
What is the 401(K) expense ratio?
An expense ratio is the annual investment cost expressed as a percentage of the total asset that is charged to your account. This fee goes higher when the number of participants decreases. The fees you pay in your 401(K) plan will include expense ratio, individual services, and administrative fees.
According to Human Interest, the average investment expense on a 401(K) plan is 1.64% for plans with $250,000 in total assets and 25 employees. Keep in mind that once you combine this cost with the administrative fees and individual service fees, the total fees on your 401(K) will go higher.
The time you start contributing to your 401(K) plan and your income will affect the total amount you pay in fees over your lifetime.
A report published by American Progress showed that the dollar value paid if fees go higher with income. The report compared workers who started saving at 25 with a $30,502 salary and a higher earner with $75,000.
The report showed that a worker with a lower income would $42,309 and 0.25% in fees whereas the higher earner would pay $104,033. When this percentage was increased to 1.3%, however, there was a big difference in fees. The lower-income worker would pay $166,420 whereas a higher-income earner would pay $409,202. This proves that even if the percentage of your 401(K) fees seems smaller, it might cost you hundreds of thousands of dollars in your lifetime.
Although there is no exact value of 401(K) fees that everyone should pay, most plans fall into a certain range. According to SmartAsset, most people pay around 2.2% of their total assets in fees. On average, 401(K) fees can range from 0.2% to 5%. These fees can vary based on the investment options available in your plan and the number of participants. The higher the number of participants, the lower the fees.
If you are paying higher fees on your 401(k) plan, lowering them is the only way you will be able to keep most of your returns and grow your account faster.
Your expense ratio will be expressed as a percentage of the account and can vary from one provider to another based on:
- Investment options available for the plan, and
- The size of the plan: The more people contributing to the plan, the lower the expense ratio will be. So, you are more likely to have fewer fees when your plan has many participants.
Expense ratio vs number of participants
As denoted by Investopedia, the data from the 401(K) Books of Averages shows that the expense ratio goes lower as the number of plan participants increases. For example, a plan with 10 participants has an average expense ratio of 1.34% while a plan with 200 participants has an average ratio of 1%. If you increase the number of participants to 2,000; the expense ratio goes even lower to 0.7%.
Where can I find my 401(K) fees?
Understanding the fees you are paying on your 401(K) plan is very important. Not only that you use this knowledge when making investment decisions, but it also helps you know how you can mitigate some of these fees.
There are many ways you can use to figure out how much fees you are paying on your plan. Account providers are required to disclose 401(K) fees to their clients. Even if you have the information you need, however, it can be difficult to figure out exactly what you are looking for or make sense of these fees.
According to a publication from the U.S. Department of Labor, Employee Benefits Security Administration (EBSA), you can use the following methods to figure out what fees you are paying on your 401(K) plan.
- Use the quarterly statement to find out information regarding your fees related to administrative expenses and individual services paid on your account
- 401(K) fees may be included on the plan’s annual report or Form 5500 series
- You can call your account provider about fees on your account
- Evaluate the participant disclosure notice
After knowing exactly what fees you are paying, how can you lower your 401(K) fees?
How to reduce 401(K) fees?
The first step you need to take to lower your high 401(K) fees is to understand what they are and compare them with other accounts of the same size. If you are paying higher fees than other accounts of similar size, you can work with your company and account provider and see if they can lower these fees.
Another big reason you are probably paying high fees is that your portfolio is made of funds with high fees. To lower these fees, consider re-evaluating the investments you are holding in the account and replacing those with high fees.
By investing in low-fee index funds, ETFs, Mutual funds, target-date funds, etc., you can automatically lower your 401(K) fees.
Another effective method to lower 401(K) fees is by putting less money in your 401(K). There are many retirement plans you can sign up for and some of them come with lower fees. Instead of putting every dollar in your 401(K), put some of your money into an individual retirement account (IRA).
Use the following strategy
Contribute up to your employer matching percentage, then maximize your IRA accounts. If you have extra money left, you can add it to your 401(K). With an IRA, you can shop around for fewer fees. This will allow you to have the same retirement benefits while reducing fees on your plan.
Alternative to a 401(K) plan
Although your 401(K) plan is great, it comes with high account management fees that eat some of your profits. Your 401(K) fees are not just 1.2% or whatever percentage that comes with your account. This small percentage can cost you hundreds of thousands of dollars during your entire life.
Instead of putting all your money in an account that comes with high fees, you can consider an alternative to a 401(K) plan. These alternatives are individual retirement accounts (IRAs).
An IRA is a retirement account you open with your bank or a brokerage institution. It is easy to open an account and manage the account, and on top of that, fees are lower. In addition, you get to have a wider range of investments with your IRA account.
You can choose either a Traditional IRA or a Roth IRA. With a traditional IRA, your contribution can be tax-deductible depending on your filing status, your income, and other benefits you have from work such as 401(K) or 403(b).
On the other hand, your Roth IRA contributions are not tax-deductible. The good news is that you get to grow your account tax-free and pay no income tax on qualified distributions during retirement.
The downside of an IRA compared to 401(K) is that your contribution limit will be much lower. According to the IRS, your contribution limit to an IRA in 2024 is $7,000 or $8,000 if you are 50 or older. These contribution limits are much smaller compared to $23,000 or $30,500 if you are 50 or older for the 401(k) plans.
Related: 401(K) Vs Traditional IRA: What is the difference?
How much can I contribute to a 401(K) plan?
All retirement accounts come with the maximum contributions you can make in any given year. For the 401(K) in particular, the IRS has a contribution limit of $23,000 or $30,500 for people aged 50 or older in 2024. For 2023, the maximum contribution to the 401(k) plan is $22,500 or $30,000 if you are 50 or older.
Benefits of 401(K) plan
Your 401(K) fees do not have to deter you from signing up and contributing to this retirement plan. If done right, your 401(K) benefits will outweigh the drawbacks.
The biggest benefit of a 401(K) is that it lets you stash away a before-tax partition on your wages for retirement savings. This retirement saving strategy has two immediate effects.
- Your taxable income goes lower because your contributions are taken off before you pay the tax
- It helps you increase your retirement savings faster.
Keep in mind that you will pay income tax on your distributions during retirement. In addition, there are required minimum distributions(RMDs) you must take when you turn 72. According to the IRS, RMDs are applied to every employer-sponsored plan which includes 401(K), 457(b), and 403(b). Other accounts that are affected by RMDs include Traditional IRA and other IRA-based plans.
Your 401(K) may come with employer matching. Any percentage your employer contributes to your plan becomes free money for you. That is why many companies use their 401(K) plans and matching percentages to attract new employees and retain talent.
More details: 6 benefits of 401(k) plan: Why is 401(K) good?
How much should I contribute to my 401(K) plan?
Regardless of 401(K) fees, how much should you contribute to your 401(K) plan?
The best way to save for retirement is to allocate your funds to accounts with the highest tax benefits and flexibility.
A good way to contribute to your 401(K), is to contribute up to your employer matching percentage. That should be your first step. Then, max out on your IRA accounts. If you still have more money to contribute add it to your 401(k).
Let’s see what this means
By contributing up to your employer’s matching percentages, you are taking every free money your employer gives you. This helps you grow your account faster.
Since your 401(K) comes with higher fees and fewer investment options; you don’t want to keep all your money in the account. That is where an IRA comes in. The IRA may:
- Give you the same tax benefits as a 401(K) if you put the money in a Traditional IRA
- Come with fewer fees
- Have a lot of investment options.
Of course, if you have more money to contribute after reaching your contribution limits on IRAs, add it to your 401(K) plan. With this plan, you will be reducing your taxable income, growing your account fast, reducing fees, and having flexibility on the money you contribute to the plan.
More details: How much should you contribute to your 401(K) account
