Understanding Types of 401k Fees
Saving for retirement through a 401(k) plan sounds simple enough. Make money, save money, spend money, stash some away in a retirement fund.
However, there's one thing many people are still unaware of when it comes to 401(k)'s:
Remember, a 401(k) plan is a retirement savings contribution provided by an employer.
Each paycheck an employee receives has a portion of the total amount taken out and used towards the 401(k) plan -- this is known as a contribution.
We've broken down the fees associated with 401(k) plans, as well as what to look out for and helpful tips to secure your savings.
The United States Department of Labor has an excellent resource that helps people understand all of the fees associated with a 401(k) plan.
There are three main fees that are typically associated with 401(k) plans, and then other fees that fall into those categories. Those three main fees are:
- Plan administration fees
- Investment fees, and
- Individual service fees
Apart from these administrative fees, there are three basic fees that may be assessed, additionally, in connection to the investment options that are chosen with your 401k. Those three basic fees are:
- Sales charge fees (also known as loads or commissions)
Management fees (also known as investment advisory fees or account maintenance
- Other fees (this may include record-keeping, furnishing statements, toll-free telephone numbers and investment advice)
Here is a breakdown chart of fees you should expect to pay:
Types of 401k Fees
|Administration fees||Keeping records of documents, accounting, and all other administrative tasks all fall under this category. These fees are associated with services such as online transactions and investment advice.|
|Investment fees||This is the portion of your money that goes to an investment management service, or any related investment service.|
|Sales charge||Whenever you buy or sell a share, you are charged for completing the transaction.|
|Individual service fee||If you take a loan from your plan, or execute participant investment directions, you are subject to pay a fee.|
|Target date retirement funds||If a target date fund invests into another mutual fund, there may be fees associated with this process.|
Why Are Fees Important?
While it may seem like storing your money in a retirement fund will only yield positive, maximal results, that may not be the case if you're not taking fees into consideration.
Random fees that you're not aware of or taking into account, that are being paid for by your 401k plan, will substantially reduce your chances of saving the most for retirement.
Consider this example, courtesy of the Department of Labor:
Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000.
If returns on investments in your account over the next 35 years average 7 percent, and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement (even if there are no further contributions to your account).
If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000.
The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.
The percentage of fees that are being paid by your retirement plan may be small, but make a big difference in your retirement savings.
Yearly contribution limits
Every year the Internal Revenue Service sets limits to how much a person can contribute to their 401(k).
For 2020 and 2021, you may contribute up to $19,500 to your 401(k).
Review the limit every year to understand the maximum amount of money you can contribute to your retirement account.
The rule of thumb is to contribute to your 401(k), regardless of cost, up to the maximum employer match.
The immediate return from the match will offset nearly any fee. After that, max out your IRA and choose low-cost investments.
What About Taxes?
The way a 401(k) plan works is that you are not taxed until you start to receive your money during retirement.
Most people do not collect their retirement money until they are done working, but some tap into the account early when they need money very quickly.
If you’re younger than 59 1/2 and want to take money out of a Traditional IRA or 401(k), or want to take your investment earnings out of a Roth IRA, you’re making an early withdrawal.
The tax impact of this move depends on why you’re taking out the money.
There are a few situations when you can take out money and not owe an extra penalty. This includes the following types of withdrawals:
Made to a beneficiary on or after the death of the participant
Made because the participant has a qualifying disability
Made as part of a series of equal payments beginning after separation from service and made at least annually for the life or life expectancy of the participant
Made to a participant after separation from service if the separation occurred during or after the participant reached age 55
Made to an alternate payee under a qualified domestic relations order
Made to a participant for medical care up to the amount allowable as a medical expense deduction
Timely made to reduce excess contributions
Timely made to reduce excess employee or matching employer contributions
Timely made to reduce excess elective deferrals
Made because of an IRS levy on the plan.
Made on account of certain disasters for which IRS relief has been granted
With the IRA, you can also take out up to $10,000 penalty-free to buy your first house.
You’ll owe income tax on all these withdrawals, so it is a bit of an expensive source of money.
For example, if you’re in a 25 percent income tax bracket, every dollar you take out for a non-penalized withdrawal will lead to an extra 25 cents in taxes that year.
2020 Tax brackets
|10%||$0 - $9,875|
|12%||$9,876 - $40,125|
|22%||$40,126 - $85,525|
|24%||$85,526 - $163,300|
|32%||$163,301 - $207,350|
|35%||$207,351 - $518,400|
You are taxed based on the date you withdraw money from your retirement account.
So if you decide to take out money two years from now, and you're far from retirement, you will be subject to pay taxes and fees at that time.
Have you heard that 401(k) plans come with hidden fees? This is not necessarily true.
There are fees you may overlook because you are not paying attention to your retirement account.
Make sure you read the fine details and pay attention to these fees.
If you deal with a third party entity who manages your 401(k) account, you are most likely paying more fees than someone who doesn't use this type of service.
A person who has a plan through a third party administrator should expect to pay the following fees:
- Administrative fees
- Investment fees
- Asset fees
To learn about the fees you have to pay in detail, read the contents of your 401(k) contract with your employer or a trusted advisor to get an overview of the fees that come with a retirement account.
Related: Do You Know When Your Retirement Funds Will Run Out?
Other Factors to Consider
The fees that are assessed to your 401(k) account can differ depending on how the account is managed.
We've put together this chart to go over some of the types of funds and factors that can impact your 401(k):
Types of Funds and Fees Associated With Them
|Actively-managed funds||Funds with an investment adviser who continually researches the holdings of the fund to seek a higher return, generally have higher fees tacked on to them, due to the highly active trading that's involved with them. While these accounts are attempting to seek the highest return (and thus the high fees that go along with them), there is no guarantee that these funds will actually yield a higher return.|
|Passively-managed funds||Funds that require little research, management, and trading activity, typically have lower administrative fees. The goal of these funds is to obtain the investment results of an established market index, such as the Standard and Poor’s 500, by copying the index's holdings.|
|Bundled program funds||Some or all of the costs of plan services may not be separately charged to the plan or to your employer. It's possible that these costs may be subsidized by the asset-based fees charged on investments.|
|Retail or brand-name funds||Plans with more total assets may be able to lower fees by using special funds or classes of stock in funds, which generally are sold to larger group investors. Funds that are listed in the newspaper tend to charge higher fees -- you can opt out of these funds.|
Anything that sounds like it's extra and not included in your 401(k), is probably extra and not included in your 401(k).
Everything has a price, but that doesn't necessarily mean cheaper is better, or vice versa.
Make sure to take note of various additions, like participant loan programs and insurance benefits offered under variable annuity contracts.
If these extras do not have value to you -- let your employer know, so you can have them removed.
When it comes to saving money for your retirement, it's important to make sure you're not spending money on unnecessary fees.
Compare all services in relation to the total cost, and ensure you're maximizing your savings potential.
Here's a quick checklist you can use to help you review your 401(k) plan's fees:
- What investment options are offered under your company’s 401(k) plan?
- Do you have all available documentation about the investment options under your plan and the fees charged to your plan?
- What types of investment education are available under your plan?
- What arrangement is used to provide services under your plan (i.e., are any or all of the services or investment options provided by a single provider)?
- Do you and other participants use most or all of the optional services offered under your 401(k) plan, such as a participant loan program and insurance coverage?
- If administrative services are paid separately from investment management fees, are they paid for by the plan, your employer, or are they shared?
- Do any of the investment options under your plan include any fees related to specific investments, such as 12b-1 fees, insurance charges, or surrender fees, and what do they cover?