Hidden Costs to 401k Plans and Who Pays These Fees

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It should not come as a shock that there are certain fees involved in maintaining a 401k plan – there is a degree of back office activity, such as signing up participants, tracking accounts, maintaining changes to accounts, distributing statements, and the like.  In addition, the plan administrator must provide certain reports to the government, along with required annual reports for participants (that annual Summary Report, written on cigarette paper, that you get in the mail once a year and promptly toss in the trash), as well as reports to the management of the sponsoring company on plan participation rates and such.

You would likely expect to share in the cost – after all, it’s benefiting your account, right? – and it seems like that sharing should be based on your account balance or at worst evenly distributed among all participants.  However (and there’s always a however in life)… depending upon your fund choices, you may be paying more toward those back office activities than the guy in the cubicle next to you.

Turns out, the more inherent fees in an investment choice, the greater portion of the overhead you’ll be taking on (in general).  If you’re in a money market account or (shockingly) the company stock, you might not pay any overhead.  If you are in a managed mutual fund, you could be paying as much as 0.6% in annualized overhead fees.  As with most things surrounding 401(k) fees, it’s not very clear just how these costs are allocated – and quite likely not very fair in the long run.

These fees are disclosed to you, by law, ever since the fee-disclosure rule went into effect in 2012. Under that rule, plan administrators are required to mail you a quarterly statement showing your investments’ rates of returns, investment-related fees, and expenses, including any amounts the plan deducted from your account to cover administrative expenses.

Like many documents surrounding your 401k plan, these are long-winded and confusing. Most participants in 401k plans don’t even know that this information is disclosed to them, and among the ones that are aware, a paltry few actually take action based on the disclosed information.

Three types of fees

There are three different categories of fees in the typical 401k plan:

• Administrative fees
• Investment fees
• Individual service fees

Of these fees, the Administrative fee is typically a per-account fee, such as $30 per year. This covers all of the back-end paperwork that each account, no matter the size, has to shoulder.

Investment fees are specific to the investments you’ve chosen, and can range quite wide. Depending upon the share class of the investments you have in your portfolio (in your 401k), you might be paying 1-2% annually in marketing and fund management fees. This one is the hardest to find (because it’s buried in a prospectus), but it is also likely the fee that causes the most drag on your account’s returns over time.

Individual service fees are based on actions you’ve taken with your account, such as taking out a loan against your 401k plan balance.

All of these fees cause a drag against your returns, but as mentioned previously, the investment fees are (potentially) the most harmful. Looking into these fees and adjusting your holdings to avoid the highest investment fees can make a huge difference in the long-term results.

For example, if you put $200 every payday ($5,200 a year) into your 401k, with an average return of 8%, you’d anticipate a balance of approximately $324,000 after 30 years. With an expense ratio of 1.2% on your mutual fund, however, the resulting balance would only be approximately $255,000. Changing from a mutual fund with a 1.20% expense ratio (another term for the investment fees) to one with a 0.30% expense ratio could bolster that result up to approximately $305,000 – an increase of $50,000!

You can look up the expense ratios for your 401k holdings pretty readily, most often by going to the plan administrator’s website. There, you should be able to find each offering’s expense ratio with a bit of searching. Swapping out the expensive fund for a less expensive alternative (but keeping the same asset class!) should be a relatively simple activity. It takes some time, but look at it this way: if you spend an hour doing this and the results are similar to the example above, you could be making $50,000 an hour for your work!