Understanding 401(k) Fees
Come retirement time, the number of 401(k) plan fees charged can make a major difference in your employees’ account balances—and their futures.
Did you know that the smallest 401(k) plans often pay the most in fees? According to a research study, most large plans with over $100 million in assets pay fees below 1%. However, small plans often pay between 1.5% and 2%—or even more!
We believe that you don’t have to pay high fees to provide your employees with a top-notch 401(k) plan. In fact, Betterment offers comprehensive plan solutions for a fraction of the cost of most providers.
Why do 401(k) fees matter?
The difference between a 1% fee and a 2% fee may not sound like much, but in reality, higher 401(k) fees can take a major bite out of your participants’ retirement savings.
Consider this example:
Triplets Jane, Julie, and Janet each began investing in their employers’ 401(k) plan at the age of 25. Each had a starting salary of $50,000, increased by 3% annually, and contributed 6% of their pre-tax salary with no company matching contribution. Their investments returned 6% annually. The only difference is that their retirement accounts were charged annual 401(k) fees of 1%, 1.5%, and 2%, respectively. Forty years later, they’re all thinking about retiring and decide to compare their account balances. Here’s what they look like:
|Annual 401(k) fee||Account balance at age 65|
As you can see, come retirement time, the amount of fees charged can make a major difference in your employees’ account balances—and their futures.
Why should employers care about 401(k) fees?
You care about your employees, so naturally, you want to help them build brighter futures. But beyond that, it’s your fiduciary duty as a plan sponsor to make sure you’re only paying reasonable 401(k) fees for services that are necessary for your plan. The Department of Labor (DOL) outlines rules that you must follow to fulfill this fiduciary responsibility, including “ensur[ing] that the services provided to the plan are necessary and that the cost of those services is reasonable” and has published a guide to assist you in this process. Generally, any firm providing services of $1,000 or more to your 401(k) plan is required to provide a fee disclosure, which is the first step in understanding your plan’s fees and expenses.
It’s important to note that the regulations do not require you to ensure your fees are the lowest available, but that they are reasonable given the level and quality of service and support you and your employees receive. Benchmark the fees against similar retirement plans (by number of employees and plan assets, for example) to see if they’re reasonable. Your 401(k) provider should be able to assist you with the benchmarking process or you may wish to use other industry resources such as the 401k Averages Book.
What are the main types of fees?
Typically, 401(k) fees fall into three categories: administrative fees, individual service fees, and investment fees. Let’s dig a little deeper into each category:
- Plan administration fees—Paid to your 401(k) provider, plan administration fees typically cover 401(k) set-up fees, as well as general expenses such as recordkeeping, communications, support, legal, and trustee services. These costs are often assessed as a flat annual fee.
- Investment fees—Investment fees, typically assessed as a percentage of assets under management, may take two forms: fund fees that are expressed as an expense ratio or percentage of assets, and investment advisory fees for portfolio construction and the ongoing management of the plan assets. Betterment, for instance, acts as investment advisor to its 401(k) clients, assuming full fiduciary responsibility for the selection and monitoring of funds. And as is also the case with Betterment, the investment advisory fee may even include personalized investment advice for every employee.
- Individual service fees—If participants elect certain services—such as taking out a 401(k) loan—they may be assessed individual fees for each service.
Wondering what you and your employees are paying in 401(k) fees? Fund fees are detailed in the funds’ prospectuses and are often wrapped up into one figure known as the expense ratio, expressed as a percentage of assets. Other fees are described in agreements with your service providers.
High quality, low fees
Typically, mutual funds have dominated the retirement investment landscape, but in recent years, exchange-traded funds (ETFs) have become increasingly popular in large part because of their lower fees. At Betterment, we believe that a portfolio of ETFs, in conjunction with personalized, unbiased advice, is the ideal solution for today’s retirement savers.
Who pays 401(k) fees: the employer or the participant?
The short answer is that it depends. As the employer, you may have options with respect to whether certain fees may be allocated to plan participants.
Expenses incurred as a result of plan-related business expenses (so-called “settlor expenses”) cannot be paid from plan assets. An example of such an expense would be a consulting fee related to the decision to offer a plan in the first place. Other costs associated with plan administration are eligible to be charged to plan assets. Of course, just because certain expenses can be paid by plan assets doesn’t mean you are off the hook in monitoring them and ensuring they remain reasonable.
Plan administration fees are often paid by the employer. While it could be a significant financial responsibility for you as the business owner, there are three significant upsides:
- Reduced fiduciary liability—As you read, paying excessive fees is a major source of fiduciary liability. If you pay for the fees from a corporate account, you reduce potential liability.
- Lowered income taxes—If your company pays for the administration fees, they’re tax deductible! Plus, you can potentially save even more with the new SECURE Act tax credits for starting a new plan and for adding automatic enrollment.
- Increased 401(k) returns—Do you take part in your own 401(k) plan? If so, paying 401(k) fees from company assets means you’ll be keeping more of your personal retirement savings.
Fund fees are tied to the individual investment options in each participant’s portfolio. Therefore, these fees are paid from each participant’s plan assets. Individual service fees are also paid directly by investors who elect the service, for example, taking a plan loan.
How can you minimize your 401(k) fees?
Minimizing your fees starts with the 401(k) provider you choose. In the past, the price for 401(k) plan administration was quite high. However, things have changed, and now the era of expensive, impersonal, unguided retirement saving is over. Innovative companies like Betterment now offer comprehensive plan solutions at a fraction of the cost of most providers. Betterment combines the power of efficient technology with personalized advice so that employers can provide a benefit that’s truly a benefit, and employees can know that they’re invested correctly for retirement.
No hidden fees. Maximum transparency.
Costs are often passed to the employee through fund fees, and in fact, mutual fund pricing structures incorporate non-investment fees that can be used to pay for other types of expenses. Because they are embedded in mutual fund expense ratios, they may not be explicit, therefore making it difficult for you to know exactly how much you and your employees are paying. In other words, most mutual funds in 401(k) plans contain hidden fees.
At Betterment, we believe in transparency. Our use of ETFs means there are no hidden fees, so you and your employees are able to know how much you’re paying. Plus, our pricing structure unbundles the key offerings we provide—advisory, investment, recordkeeping, and compliance—and assigns a fee to each service. A clearly defined fee structure means no surprises for you—and more money working harder for your employees.