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Understanding 401(k) Fees

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If you're like many Americans -- 71 percent, according to a recent AARP survey -- you might be under the impression that your 401(k) plan administrator doesn't charge you anything to maintain your account.

You'd be wrong.

In fact, these companies typically charge fees equivalent to 0.5 to 2 percent of your 401(k) account balance each year -- sometimes as high as 5 percent. In addition to ongoing tariffs for managing your investment options, plan administrators often deduct numerous other fees from individuals' accounts, including charges for administrative costs, sales commissions, advertising, insurance, and trading expenses.

Perhaps equally disturbing is that many employers -- which have a fiduciary responsibility to ensure the retirement plans they sponsor have reasonable fees and expenses -- often don't know what fees their employees are being charged, either.

Over time, out-of-control plan administration fees can take a serious toll. The Department of Labor (DOL) estimates that paying just 1 percent in extraneous fees each year could reduce your account balance by 28 percent during an average working career.

Finding -- let alone understanding -- such fee disclosures can be time-consuming and often involves wading through complex plan documents and fund prospectuses where details are usually buried in the fine print. That's why last year the DOL issued regulations requiring fund administrators to provide a more transparent breakdown of their fees to employers, which in turn must pass the information along to employees.

During the first disclosure phase, investment companies were required to send a detailed statement about their plan's investment options, including fund performance and fees. You should have received this information from your employer by August 31, 2012. This statement, which will hereafter be sent annually, should include:
  • An explanation of any fees and expenses for general plan administration, such as legal, accounting and recordkeeping services.
  • Total annual operating expenses expressed as a percentage of account assets and a dollar amount per $1,000 invested.
  • An explanation of fees and expenses incurred based on your actions (e.g., trading fees, loans, service charges for low balances, hardship withdrawals, processing divorce decrees or qualified domestic relations orders, etc.)
  • The historical performance of each fund in which you invest (at 1, 5 and 10 years, and since the fund's inception.)
  • Benchmark performance -- for example, if you invest in an S&P index fund, it should be compared to the average expense ratios for the S&P 500 over the same periods.

The second phase of fund disclosure was the release of quarterly performance statements tied to your particular investment accounts. The first of these statements was for July 1 to September 30, 2012, and most people should have received theirs by mid-November. It should include specific dollar amounts of plan-related expenses or fees charged to or deducted from your accounts that quarter, along with a detailed description of the related services.

For many, these statements are a wake-up call for why they need to choose more carefully among available investment options. The statements won't do all the work, however. You'll still need to crunch the numbers on how your current investment choices stack up against other funds. And no piece of paper can determine your appetite for risk vs. reward. But they're a start.

There are tools to help with your analysis:
  • Brightscope gathers data on more than 46,000 401(k) and 403(b) plans and rates them both individually and against industry peers. (Note: Most smaller plans aren't included.)
  • AARP's 401(k) Fee Calculator can help you determine your plan's fees and compare them to the average for low-cost 401(k) investors. You can also use it to calculate in dollars the potential impact of the fees on your 401(k) balance at retirement age.
  • Use a site like Morningstar to compare expense ratios for comparable funds outside your 401(k) plan to get a sense whether your fees are too high.

Keep in mind that employees at smaller companies generally have fewer investment options available than those at large companies (whose greater size gives them more bargaining clout). And, they often pay higher fees because plan costs are spread across fewer employees.

The DOL hopes that by shining daylight on 401(k) plan costs, employers will be motivated to rein in costs and seek better investment options for their employees -- and that employees will be more inclined to seek out the most cost-effective funds for their retirement savings.

If you feel your options are too limited or costly, ask your company's benefits department whether they're considering expanding your plan. Chances are, after seeing their new fee statements, many more employees will be speaking up.

This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.