All About 401(k) Fees
posted by Fisher 401(k) June 4, 2020 Updated
What Fees Are There in a 401(k) Plan?
Typically, 401(k) plans have three types of fees: Investment fees, administrative fees, and fiduciary and consulting fees. Some of these 401(k) fees are charged at a plan level for the management and administration of a plan, while others are related to the investments made by employees within the plan. Sometimes, the fees paid in a 401(k) are taken directly from plan assets by your service provider and then paid out to the various vendors working on the plan. In other cases, the investments themselves will carry fees, which are taken out of the money invested in that specific investment. All together, fees in a 401(k) plan can go to many places, including:
• Investment Managers, who oversee the investments in a fund;
• Administrators, who handle things like the transfer of assets in and out of a fund;
• Recordkeepers, who keep detailed records of a 401(k) plan’s transactions;
• Lawyers, who draft legal documents and oversee regulatory compliance;
• Accountants, who may perform audits of a 401(k) plan’s activities;
• The Government, which collects any applicable taxes related to a fund’s activities.
What is a 401(k) Expense Ratio?
Investments like mutual funds and index funds have an “expense ratio,” which refers to the percentage of an investor’s assets used to cover expenses associated with the mutual fund. Expense ratios are determined by dividing the total expenses for a mutual fund by the dollar amount of its average assets. For example, if a mutual fund has an expense ratio of 1%, that means that 1% of your employee’s total investment into that fund will be taken each year in fees.1
One type of fee to look out for if you’re examining the costs covered by the expense ratios of your 401(k) plan’s investments is the “load,” which represents a commission paid to a broker for buying and selling shares of a fund. Some loads are paid when a share is purchased and others are paid when a share is sold.
The money paid in an expense ratio generally covers investment fees for the management and marketing of the fund, but the expense ratio of an investment can sometimes also contain some often overlooked fees which are often spread among the many partners involved in running a 401(k) plan in a process called “revenue sharing.”
What is the Range for Average 401(k) Fees?
Typically, 401(k) plans cost somewhere between 1% and 2% of the plan assets, or the money saved in the account. Some outliers can see fees as high as 3.5%, but these high fees can have a significant impact on your employees’ ability to retire and should be avoided if at all possible.2 There are many factors which can impact the cost of a plan, from the amount of money in the plan, to the investment options you choose to include, to the level of service you receive.
401(k) Fees Paid by Employers
Of the three different types of 401(k) fees, employers can choose to pay either administrative or fiduciary and consulting fees, pay both, or have all fees paid by employees who participate in the plan. Investment fees are almost exclusively paid by employees. Employers who do choose to pay some of these fees often do so in order to keep costs as low as possible for their employees, so that more of their money is saved and invested for retirement. However, only 17.8% of employers fully pay administrative fees. A further 19.5% share these expenses with employees.3 The rest have set up their plans so that these fees are paid out of the plan’s assets or, in other words, by anyone who participates in the plan.
Additionally, some employers choose to work with specialized 401(k) advisers who will charge their own fiduciary and consulting fees. These providers can offer help in the form of fiduciary services to share in the employer’s legal liabilities, or things like employee engagement and education assistance. Advisory fees like this are typically charged quarterly and are asset-based, which means they will be based on a percentage of the total assets in the 401(k) plan. Employers can choose to pay these expenses or, as we’ll touch on later, this cost can be passed on to employees.
401(k) Fees Paid by Employees
Employees participating in a 401(k) plan can pay any of the three types of fees, but most commonly pay investment and administrative fees. Investment management fees are associated with what employees invest in within their 401(k) accounts, like mutual funds. As discussed above, the expense ratios tied to the funds your employees invest in may also go towards covering administrative costs for the plan.
Finally, fiduciary and consulting fees that are charged by 401(k) advisers for things like fiduciary services or employee education might be taken directly from plan assets, effectively meaning the employees and not the employer are covering those expenses.
401(K) FEES: WHAT IS REASONABLE?
The goal of protecting your employees’ retirement savings is worthwhile in and of itself, it’s also a fundamental part of your legal responsibility as a fiduciary to your company 401(k) plan. The Employee Retirement Income Security Act of 1974 (ERISA) requires that employers who sponsor a 401(k) plan take a personal, legal responsibility to make good decisions on behalf of their employees. Managing fees and ensuring employees don’t pay more than they should for their retirement plan is a key element of this responsibility.
But how do you tell what is “reasonable” when it comes to those 401(k) fees? Though we’ve already shared that fees in the range of 1-2% are average2, evaluating your plan’s fees isn’t a simple matter of comparing your expense ratio to the average. No two retirement plans are the same, and the level of service your plan receives might be different from another company’s. For that reason, it’s important to periodically benchmark your plan’s fees against those paid by other companies with similar 401(k) plans. This should come as part of a broader review whose aim is to give you total clarity on all of the service providers being paid out of your plan, what service they are providing, and how much they’re being paid.
HOW TO REVIEW YOUR 401(K) PLAN FEES AND COMPARE THEM
1. GATHER THE RIGHT DOCUMENTATION.
When you’re working to understand exactly what fees you and your employees are paying, your best tool is the fee disclosure document, which is required by section 408(b)(2) of ERISA. You can request one of these from your 401(k) provider at any time to get a clear look at:
- All services provided by your 401(k) provider and their affiliates or subcontractors;
- Each service provider’s fiduciary status;
- And all compensation expected to be paid to any of these providers.
Your 408(b)(2) disclosure will also tell you both about “direct” and “indirect compensation,” so you will be able to see if any of your providers are being paid through revenue sharing. This will help you understand if the expense ratios being paid by your employees contain any revenue sharing and give you a better understanding not only of the true cost of your 401(k) plan, but also whether or not your plan may be subject to any potential conflicts of interest.
Additionally, you may also gather your plan’s asset statement and invoices you have from service providers as available.
2. UNDERSTAND WHO IS GETTING PAID AND HOW MUCH.
With these documents in hand, you can now identify every service provider receiving payment from your plan. Depending on your adviser and the level of support they offer in administration, you may have met all or just a few members of your service provider team. This team might include:
- Third Party Administrator (TPA): Handles many of the ongoing tasks required to keep your plan functioning.
- Custodian: Holds your plan’s assets and processes transactions in and out of the plan.
- Recordkeeper: Documents participants, their assets and investments, and how money moves in and out of the plan.
- Bundled: Some 401(k) providers bundle the TPA, custodian, and recordkeeper into one solution, which typically shows up in fee statements with the designation “Bundled.” If you see fees for Bundled service, that would replace the first three providers in this list.
- Adviser: Helps you make good decisions managing your plan, and helps your employees make the most of their savings and investments.
- Other Third-Party Vendors: Your plan may also utilize the services of other vendors, as well, including auditors, brokers, asset managers, or fund managers.
To get a complete picture of who you and your employees are paying, call each of your known service providers and ask them who else is involved with providing service to your plan. This will help you better understand all parties who may be paid out of your expense ratio in a revenue sharing arrangement so you can see where all of the funds from your plan end up.
3. CALCULATE FEES PAID TO EACH SERVICE PROVIDER.
Once you understand the flow of funds out of your plan, you can perform some calculations, either in the form of percentage of total plan assets or in a dollar amount, to demonstrate how much of the money flowing out of your plan ended up with each service provider. This is where you’ll use things like your invoices for your different providers or your contracts to determine what portion of the expense ratio goes to each service providers.
4. COMPARE YOUR FEES AGAINST OTHER 401(K) PROVIDERS.
Now that you know how much each service provider is charging, compare those numbers to other, similar plans to see how those plans’ fees stack up against yours. This is called benchmarking.
It can be hard to know how much similar plans are paying for similar services, or what “similar” even looks like. If your provider is doing very little for you, it might make sense that their fees are lower than the industry benchmark you find while comparing expenses. Likewise, a provider that offers an exceptionally high level of service might reasonably charge higher fees. But there is lots of grey area between those two extremes, and that’s why it’s so important to look at as many plans as possible to get a sense for where yours sits along the spectrum of service and cost.
Ask your 401(k) adviser for a report from a third-party benchmarking tool for an unbiased comparison. Review at least 100 plans in the benchmark so that you can really get a good view of how your plan’s fees compare to comparable plans, but also so you can look at the subset where the services are very similar.
5. STAY WITH YOUR CURRENT 401(K) SERVICE PROVIDER OR CHOOSE A NEW ONE.
The last step of this process is to review your findings and decide whether or not the fees in your plan are reasonable. It’s critical to document not only the direct cost-to-cost comparison between your plan and others, but also what you perceive about your plan’s service level and how it stacks up. If you get the sense that you’re paying too much for the service you’re receiving, document that notion and then seek out proposals from other providers to see if you can find either better service or a better price.
MONITOR AND MANAGE 401(K) FEES FOR YOUR EMPLOYEES’ SAKE
It’s critical employers understand exactly how much their employees will pay in 401(k) fees. These fees can add a lot of cost to your employees, and that’s not good. Even an extra 1% in annual fees can reduce an employee’s 401(k) account balance by about one-third after 35 years, meaning the average American household will pay $155,000 in 401(k) fees over a lifetime!4 The pursuit of clarity around your plan’s fees will help you not only better understand the value of the service you’re receiving, but also better find opportunities to keep money in your employees’ accounts. After all, every dollar saved is a dollar that can grow and secure your employees’ futures—and that’s what your 401(k) plan is all about.