[Editor's Note: Today's guest post was submitted by Nicolle Willson, JD, CFP®, C(K)P®, the Head of Retirement Consulting at Guideline, a company that specializes in 401(k) plans for small businesses, and a company that has advertised with us from time to time. Today we're going to talk about 401(k) fees. Fees, like taxes, create a drag on returns, especially over long periods of time. The 401(k) structure protects you from taxes as your money grows, but not fees. Make sure you pay attention to all fees, whether set-up fees, flat fees or AUM fees. Like when using a financial advisor, do the math each year to know how much you're paying and remember that AUM fees become more significant with larger accounts.]
We all know we should be saving for retirement. There’s no guarantee that safety nets like Social Security will last forever, and even if they do, they’re not enough for most Americans to live on.401(k) account isn’t necessarily free. Sure, we all assume employers pay something, but participants? One study found that over a third of account holders believed they didn’t owe fees at all. You can’t necessarily blame them—401(k) providers rarely bring up those hidden costs in fees in their employee onboarding materials.
We’re not talking about a few cents here or there. Over a forty-year career, you can lose out on hundreds of thousands of dollars thanks to the way 401(k) provider fees work.
How 401(k) Fees Work
We’ve mentioned “providers”, but operating a retirement plan takes behind-the-scenes work from recordkeepers, investment managers, plan administrators, and others so things run smoothly.
The Department of Labor divides retirement fees into three categories. Each of these types of fees can be charged to either the plan sponsor (your employer) and the plan participants (you), or both.
- Investment Fees
- Administration Fees
- Individual Service Fees
Investment fees are exactly what they sound like. These serve as commission for the investment managers who invest your 401(k) account funds on your behalf. These fees are usually charged as a percentage of assets under management, and typically make up the lion’s share of your costs. To add insult to injury, you might also be charged a 12b-1 fee, which is often embedded in the investment fee. These compensate the marketing and salespeople responsible for attracting more investors into your mutual fund, which (in theory) means bigger investment earnings for you. In 2020, you really shouldn’t be paying these—reconsider your options if you are.
Second, administration fees pay for all the administrative, recordkeeping, and compliance work that keep your practice’s 401(k) plan up and running. We’ll give providers a pass here since retirement plans are subject to some of investing’s most stringent federal and state regulations. Like investment fees, these are charged as a percentage of assets, or sometimes as a flat fee.
Individual Service Fees
Then there are individual service fees. Basically, a catch-all category for rollovers, distributions, and other one-off services that providers charge extra for. Rules might vary depending on the specific service, but most of these are flat fees.
What should you expect to pay in each of these areas? Different 401(k) providers will distribute fees in various ways between investment fees and administration fees. To know if you’re getting a good deal, we prefer to look at everything together with another metric—the expense ratio of a 401(k) plan.
Know Your Expense Ratio
You know the fees. And given all the time you’ve spent investing, you might even be resigned to them. Nothing’s free, and in the case of saving for retirement, no good deed goes unpunished.
But whether you’re a plan sponsor or enrolled in your practice’s plan, there are ways to do right by your employees and your wallet. First of all, find out what your plan’s “total expense ratio” is.
Your expense ratio is simply your plan’s total fees relative to assets held—meaning it’s a reliable measure of whether you’re being ripped off (or not). If you have $100,000 in a 401(k) account, a 1% expense ratio means you’ll pay $1,000 in fees. According to the 401(k) Book of Averages (20th edition, updated in 2019), the average 25-participant small business plan, with $250,000 in assets has a 1.68% expense ratio.
Remember when we said 401(k) fees could cost you hundreds of thousands?
Blame compound interest, the same thing that makes putting money aside in a 401(k) account so smart to begin with. Year-over-year, retirement fees take away the money you could be investing out of the equation. That $1,000 from earlier? You’ll see it grow slower and throughout your career, the news gets worse and worse—a bigger retirement portfolio means more fees.
Guideline, a low-fee 401(k) provider, ran the numbers to see just how much Americans lose out to these fees. If someone puts aside $5,750 per year over 40 years, the difference between having a 1.68% and 0.067%—the average of Guideline’s managed portfolios—expense ratio comes out to over $494,000. That math assumes a 7.6% annual return, based on the S&P 500’s historical performance. If you max out your 401(k) account (as of 2020, $57,000) the losses are even greater.
Other Costs to Avoid
Turnover rates in healthcare are on the rise, and not just because of COVID-19 or layoffs. Burnout among doctors remains high (WCI wrote about this a few weeks ago) and workers, in general, are just moving around a lot more. Point is, there’s a good chance many of us have a few retirement accounts to our names.
If that’s the case, consider consolidating those into the account with the lowest expense ratio. Remember, you’re paying fees on each of these accounts. In other words, if you have three accounts with lousy expense ratios, that means you’re being ripped in three different accounts.
One last thing—remember those service fees we mentioned? Those one-time transaction fees can add up for both individuals and plan sponsors. Ask your current provider to provide you with a schedule of what their services fees are.
The Bottom Line on 401(k) Fees
A lot of work goes into keeping 401(k) plans up and running and compliant, so they won’t ever be 100% cost-free. But what you can do is be mindful of what those costs are—whether you’re a plan sponsor or participant.
Take the time to review those quarterly statements, summary annual reports, and fee disclosures your plan provider sends along. At the very least, give your provider a call and ask what your expense ratio is if it’s not spelled out on paper. And if you’re shopping for plans, consider some of the more affordable, transparent options like Guideline—which charges employers a flat fee, and participants individual fees for transactions (like distributions and loans) but no added investment fees.
Bottom line? As is always the mantra at WCI, know what you’re paying for. Don’t let fees like these get in the way of a secure, comfortable retirement. You’ve earned it.
How have you reduced 401(k) fees? What advice do you have for someone with a crummy 401(k)? Sound off below!
For good advice at a fair price see WCI's recommended Small Practice Retirement Plan Providers!