3 secrets about 401(k) fees you didn't know
Figuring out 401(k) fees is challenging to plan sponsors -- the employers offering these retirement plans -- as well as workers, even with fee disclosure rules in place. The structure and price of retirement plans vary widely, as do the services provided.
Though participants are basically at the mercy of the employer when it comes to plan expenses and the investments offered, they can control the cost of their own investments to a certain degree. That's key, because the bulk of costs to employees comes in the form of investment expenses.
Minimizing the cost of investing could enrich a retirement account to a greater extent than any surplus in return that a skilled mutual fund manager could deliver over the benchmark. Returns are always uncertain while fees are a sure bet. A smart investment plan will take both into account.
Here are three little-known facts about 401(k) fees that participants should know before deciding where to invest their hard-earned money.
1. Your plan's size dictates cost
People who work for very large companies are most likely to pay comparatively little for their retirement plans. Employees of small companies are likely to pay a lot more.
That's because small plans cost a lot more to run. The difference in fees paid by participants in small plans versus large plans can be more than half of a percentage point, as shown in the table below.
Average fees per asset level
|$800 million-$1 billion||0.44%||0.42%||0.42%|
|$600 million-$800 million||0.45%||0.49%||0.44%|
|$400 million-$600 million||0.50%||0.49%||0.47%|
|$200 million-$400 million||0.53%||0.50%||0.50%|
|$50 million-$200 million||0.66%||0.64%||0.63%|
|< $50 million||0.97%||0.93%||0.94%|
Across all plan sizes, fees have trended downward over the past few years.
Why are large plans cheaper to run? "One reason is economies of scale. There are certain fixed costs to running a retirement plan," says Steven Utkus, principal at the Center for Retirement Research at Vanguard. "If a plan has 20,000 participants, those costs are amortized over 20,000 accounts. If a plan has 20 participants, those costs are amortized over 20 accounts."
No one can argue with the benefits of buying in bulk. But there may be another influence for which economics has no easily quantifiable answer: plan sponsors who just fell off the investing turnip truck. The responsibility for the retirement plan often falls to a person who has a full-time job that doesn't involve retirement plans.
"Small plans may not be as knowledgeable as large plans," says Utkus. "Large plans typically have full-time or more experienced staff that oversees their retirement plans. As a result, the large-plan sponsor may be more knowledgeable about the impact of costs on retirement outcomes, and so they focus more on lowering costs than smaller companies."
That focus on fees means that employees at a giant corporation can, after 35 years of work, amass more than $100,000 over their counterparts at mom-and-pop shops, everything else being equal.
The chart above shows the impact of fees on retirement accounts. Fees represent the average cost of different-size plans: 0.49 percent, or 49 basis points, for a plan with assets of $100 million-plus; 0.87 percent, or 87 basis points, for a plan with assets of $10 million to $100 million; 1.41 percent, or 141 basis points, for plans with less than $10 million in assets. A basis point is one-hundredth of 1 percentage point. The three participants in this hypothetical scenario all began their careers at age 25 earning $30,000 and deferred 7 percent of their salary into their 401(k) plan over 35 years. Each received a 3 percent match from their employers, and each earned 3 percent raises each year throughout their careers. Their investments generated returns of 8 percent, minus their plan's cost.
The difference in fees becomes stark over time. Compounding will eventually cause your savings to grow exponentially, but fees erode the number of dollars that are available to double and triple. Saving more and minimizing investment fees as much as possible are the best ways to keep fees from eating away at your nest egg.