Employers might not be paying much attention to the fraction of a percentage point in fees that separate many 401(k) plan providers, but they should. Not only can this seemingly minute distinction chip away tens of thousands of dollars from an employee's retirement savings and force the typical worker to work years longer than they had planned, but it can also cause many employers to essentially throw away between 15 and 20 cents of every dollar they intended to go toward their workers' retirement.
To understand how this is possible, we must first unpack the real effect of even small differences in fees between 401(k) plan providers. At first glance it may not seem to make much difference if an employer offers their employees a plan charging 1 percent of assets annually -- roughly the average among currently available plans -- as opposed to a low-fee plan charging 0.25 percent. But over time these seemingly small differences add up to big money.
Let's take the case of a company currently contributing 4 percent of salary -- industry average -- into the 401(k) account of a 25-year-old worker. This worker is earning the median salary for her age of $30,502 and intends on staying with the company until her retirement at age 67. For the sake of illustrating the impact that fees have just on employer contributions, let's assume that the employee is contributing nothing to their 401(k).
When a company provides this employee with an average-fee retirement plan instead of a low-cost option, they are effectively reducing his or her account balance at retirement. The first year of employer contributions, excess fees take only a small bite -- about $9.00. However, as an employee's assets grow over time with compounding investment returns, the fees add up. The difference in an employees' account balance at retirement using a plan with average fees versus a plan with low fees is equivalent to an employer having slashed their annual contribution from 4 percent to only 3.4 percent per year. In other words, choosing an average-fee plan over a low-fee plan effectively cuts 15 cents off of every dollar an employer intends to contribute to their worker.
The cost for many small businesses can be even more dramatic. An employer choosing a plan charging fees of 1.3 percent of assets annually -- a fee level common among plans sold to small businesses -- is the functional equivalent of that employer cutting their annual contribution from 4 percent all the way down to 3.19 percent -- or a reduction of 20 cents on every dollar. By choosing these average and high-fee retirement options, it is as if employers are purposefully reducing their retirement contributions to their workers.
Of course, employees also contribute to their 401(k) plans. When incorporating the annual contributions made by employees into this analysis -- roughly 6 percent of pay -- the total costs of steep fees for a typical worker could amount to $100,000 over their lifetime and could potentially force them to work between 3 and 4 years longer than they had originally planned.
And company management would do well to remember that they, too, are likely suffering the same account balance erosion as their employees. Rather than wasting contributions -- individual and corporate -- on high fee plans with no promise for greater returns, responsible companies should work to offer quality, low-cost options that won't eat away at account balances.
But right now many employers don't know just how corrosive fees can be. In fact, just finding out total fees charged can involve navigating a byzantine annual disclosure that can run 30 pages long.
To help address the problems posed by excessive fees, we can employ a simple, market-based solution that is informed by the best practices in public disclosure from nutrition labels to energy star ratings. At less than 25 words, standardized labels can provide both employers and their workers with easy-to-understand comparisons for what is available in the marketplace.
Since employers are increasingly relying on 401(k) plans for the retirement benefit they offer to workers, it is critical that they have the tools they need to make sure that they aren't wasting a huge part of their contribution.
Jennifer Erickson is the director of competitiveness and economic growth at the Center for American Progress. David Madland is the managing director for economic policy and the director of the American Worker Project at the Center for American Progress.
