A Look At 401(k) Plan Fees
In a 401(k) plan, your account balance will determine the amount of retirement income you will receive from the plan. While contributions to your account and the earnings on your investments will increase your retirement income, fees and expenses paid by your plan may substantially reduce the growth in your account. The following example demonstrates how fees and expenses can impact your account.
Assume that you are an employee with 35 years until retirement and a current 401(k) 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.
In recent years, there has been a dramatic increase in the number of investment options typically offered under 401(k) plans as well as the level and types of services provided to participants. These changes give today’s employees who direct their 401(k) investments greater opportunity than ever before to affect their retirement savings. As a participant you may welcome the variety of investment alternatives and the additional services, but you may not be aware of their cost. As shown above, the cumulative effect of the fees and expenses on your retirement savings can be substantial.
You should be aware that your employer also has a specific obligation to consider the fees and expenses paid by your plan. ERISA requires employers to follow certain rules in managing 401(k) plans. Employers are held to a high standard of care and diligence and must discharge their duties solely in the interest of the plan participants and their beneficiaries. Among other things, this means that employers must:
If you want to know how fees affect your retirement savings, you will need to know about the different types of fees and expenses and the different ways in which they are charged.
401(k) plan fees and expenses generally fall into three categories:
Plan Administration Fees - The day-to-day operation of a 401(k) plan involves expenses for basic administrative services -- such as plan recordkeeping, accounting, legal and trustee services -- that are necessary for administering the plan as a whole. Today, a 401(k) plan also may offer a host of additional services, such as telephone voice response systems, access to a customer service representative, educational seminars, retirement planning software, investment advice, electronic access to plan information, daily valuation and online transactions.
In some instances, the costs of administrative services will be covered by investment fees that are deducted directly from investment returns. Otherwise, if administrative costs are separately charged, they will be borne either by your employer or charged directly against the assets of the plan. When paid directly by the plan, administrative fees are either allocated among individual accounts in proportion to each account balance (i.e., participants with larger account balances pay more of the allocated expenses) or passed through as a flat fee against each participant’s account. Either way, generally the more services provided, the higher the fees.
Investment Fees - By far the largest component of 401(k) plan fees and expenses is associated with managing plan investments. Fees for investment management and other investment-related services generally are assessed as a percentage of assets invested. You should pay attention to these fees. You pay for them in the form of an indirect charge against your account because they are deducted directly from your investment returns. Your net total return is your return after these fees have been deducted. For this reason, these fees, which are not specifically identified on statements of investments, may not be immediately apparent. (see below for more information on investment-related fees)
Individual Service Fees - In addition to overall administrative expenses, there may be individual service fees associated with optional features offered under a 401(k) plan. Individual service fees are charged separately to the accounts of individuals who choose to take advantage of a particular plan feature. For example, individual service fees may be charged to a participant for taking a loan from the plan or for executing participant investment directions.
401(k) plan investments and services may be provided through a variety of arrangements:
Employers may directly provide, or separately negotiate for, some or all of the various services and investment alternatives offered under their 401(k) plans (sometimes referred to as an unbundled arrangement). The expenses of each provider (i.e., investment manager, trustee, recordkeeper, communications firm) are charged separately.
In many plans, some or all of the various services and investment alternatives may be offered by one provider for a fee paid to that provider (sometimes referred to as a bundled arrangement). The provider will then pay out of that fee any other service providers that it may have contracted with to provide the services.
Some plans may use an arrangement that combines a single provider for certain services, such as administrative services, with a number of providers for investment options.
Fees need to be evaluated, keeping in mind the cost of all covered services.
Apart from fees charged for direct administration of the plan itself, there are three basic types of fees that may be charged in connection with investment alternatives in a 401(k) plan. These fees, which can be referred to by different terms, include:
In addition, there are some fees that are unique to specific types of investments. Following are brief descriptions of some of the more common investments offered under 401(k) plans and explanations of some of the different terminology or unique fees associated with them.
Most investments offered under 401(k) plans today pool the money of a large number of individual investors. Pooling money makes it possible for individual participants to diversify investments, to benefit from economies of scale and to lower their transaction costs. These funds may invest in stocks, bonds, real estate and other investments. Larger plans, by virtue of their size, are more likely to pool investments on their own -- for example, by using a separate account held with a financial institution. Smaller plans generally invest in commingled pooled investment vehicles offered by financial institutions, such as banks, insurance companies or mutual funds. Generally, investment-related fees, usually charged as a percentage of assets invested, are paid by the participant.
Mutual Funds - Mutual funds pool and invest the money of many people. Each investor owns shares in the mutual fund that represent a part of the mutual fund’s holdings. The portfolio of securities held by a mutual fund is managed by a professional investment adviser following a specific investment policy. In addition to investment management and administration fees, you may find these fees:
Collective Investment Funds - A collective investment fund is a trust fund managed by a bank or trust company that pools investments of 401(k) plans and other similar investors. Each investor has a proportionate interest in the trust fund assets. For example, if a collective investment fund holds $10 million in assets and your investment in the fund is $10,000, you have a 0.1 percent interest in the fund. Like mutual funds, collective investment funds may have different investment objectives. There are no front- or back-end fees associated with a collective investment fund, but there are investment management and administrative fees.
Variable Annuities - Insurance companies frequently offer a range of investment alternatives for 401(k) plans through a group variable annuity contract between an insurance company and an employer on behalf of a plan. The variable annuity contract “wraps” around investment alternatives, often a number of mutual funds. Participants select from among the investment alternatives offered, and the returns to their individual accounts vary with their choice of investments. Variable annuities also include one or more insurance elements, which are not present in other investment alternatives. Generally, these elements include an annuity feature, interest and expense guarantees and any death benefit provided during the term of the contract. In addition to investment management fees and administration fees, you may find these fees:
Pooled Guaranteed Investment Contract (GIC) Funds - A common fixed income investment option, a pooled GIC fund generally includes a number of contracts issued by an insurance company or bank paying an interest rate that blends the fixed interest rates of each of the GICs included in the pool. There are investment management and administrative fees associated with the pooled GIC fund.
While the investments described above are common, 401(k) plans also may offer other investments which are not described here (such as employer securities).
If you have questions about the fees and expenses charged to your 401(k) plan, contact your plan administrator, who should be able to assist you with the following documents:
In addition, you may want to consult the business section of major daily newspapers, business and financial publications, rating services, the business librarian at the public library or the Internet (see the list of helpful Web sites below). These sources will provide information and help you compare the performance and expenses of your investment options with other investments outside of your 401(k) plan.
If, after doing your own analysis, you have questions regarding the rates of return or fees of your plan’s investment options, ask your plan administrator for an explanation.
There is an array of investment options and services offered under today’s 401(k) plans. While there is no easy way to calculate the fees and expenses paid by your 401(k) plan due to the number of variables involved, you can begin by asking yourself questions and, if you cannot find the answers, by asking your plan administrator. Answers to the following 10 questions will help in gathering information about the fees and expenses paid by your plan.
401(k) Fees Checklist
This booklet is only the beginning of your educational process. You should ask questions and educate yourself about investments. Monitoring your current investment selections and reviewing the investment alternatives offered under your plan are part of a process that you, as an informed participant, will need to undertake continually.
Keep in mind that the law requires the fees charged to a 401(k) plan be “reasonable” rather than setting a specific level of fees that are permissible. Therefore, the reasonableness of fees must be determined in each case.
When you consider the fees in your 401(k) plan and their impact on your retirement income, remember that all services have costs. If your employer has selected a bundled program of services and investments, compare all services received with the total cost.
Remember, too, that higher investment management fees do not necessarily mean better performance. Nor is cheaper necessarily better. Compare the net returns relative to the risks among available investment options.
And, finally, don’t consider fees in a vacuum. They are only one part of the bigger picture including investment risk and returns and the extent and quality of services provided.
Listed below are some organizations and their Web sites, phone numbers and publications that can help in your research.
This publication has been developed by the U.S. Department of Labor, Employee Benefits Security Administration. It is available on the Internet at www.dol.gov/ebsa. For a complete list of EBSA publications, call toll-free 1-866-444-3272. This material will be made available to sensory impaired individuals upon request:
This booklet constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.
Revised October 2010