Are 401(k) Fees Costing You Too Much? Here’s what you can do | Smart Change: Personal Finance
If you have access to a 401(k) plan through your employer, it can be one of the best retirement savings tools in your arsenal. With a high contribution limit and many employers making a matching contribution, you’d do well to put at least some of your savings into your 401(k).
But one thing savers in these accounts should pay attention to is fees, which can be the difference between retiring enough and having to work longer to reach your goals. Although you probably won’t be able to eliminate all of the fees associated with your 401(k) plan, you can do a lot to reduce their impact.
Actual Cost 401(k) Fee
The cost of a 401(k) fee comes in two forms. First, there’s the actual amount deducted from your 401(k). Further, there are lost profits from deducting this amount from the account. If you have to pay $100 after contributing $10,000 to your account when you turn 25, for example, you’ll lose 40 years of compound growth on your $100.
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But 401(k) fees aren’t uniform across all plans. Smaller companies typically have higher costs per participant than larger plans, which can spread administrative expenses across more accounts. The average small business plan fee is 1.19% of assets, while larger plans charge an average of 0.88%, according to the latest release of 401k book averages.
To illustrate how much a 401(k) plan can cost you, imagine someone seriously saving 6% of their salary starting at age 25, until they retire at age 65. Their company even advanced 3% in total. The savings rate is 9%. Let’s also assume that this person earns an average annual return of 7% over their 40-year career.
Here’s the impact of the 401(k) fee on our typical portfolio.
As you can see, the cost of fees can be significant. Someone who earns the average wage while working for a small business can see their entire career have a $280,000 impact on their bottom line retirement portfolio. Even if your company offers a premium 401(k) plan — a plan that charges half the average for a large company — you’ll be paying tens of thousands of dollars over your career in fees and losses.
How to manage fees
There are three main types of fees in a 401(k) plan: management and investment fees, and individual service fees.
There is not much an employee can do about management fees. This fee goes to organizing and operating the plan. It may be a flat fee per participant or charged as a percentage of assets, potentially up to a certain limit. If you feel this fee is prohibitive, it may be worth mentioning HR or the plan administrator to see if anything can be done to lower it.
Investment fees are related to the investments you choose for your 401(k) and usually represent most of the fees paid. If you buy a lot of actively managed mutual funds, you are likely to pay more investment fees than you would if you bought passive index funds. Be sure to look at the expense ratios for each fund displayed in your plan documents. You may be able to find some low-cost alternatives to your current choices.
A one-time, individual service fee is charged for use of special plan features such as a loan or hardship withdrawal. These features may be worth the fee, and you should take them into account in your decision to use the plan feature.
The best way to avoid 401(k) fees is to get paid for your 401(k) as soon as possible by using an IRA or contributing directly to an IRA. IRAs usually have no management fees and much broader investment options. This means that you can buy stocks or funds at the lowest cost.
Once you meet your company match, you might consider prioritizing IRA contributions over incremental 401(k) contributions. You should be aware of the tax considerations and income limits for your IRA contributions, and it may be best for you to fully comply with your 401(k) if the fees aren’t too bad.
If you switch jobs in the middle of your career, there is a chance for you to convert your old 401(k) into an IRA. This will allow you to avoid paying your 401(k) fees on that money for the rest of your career.
While a 401(k) is a great tool to help you reach your retirement goals, you can get there sooner if you’re aware of the fees you’re paying.
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