How to Invest in a 401k With High Fees

You've taken a closer look at the 401(k) plan offered by your company and you've found out the worse:

It is very expensive.

401(k) plans are provided by employers as a benefit, much like insurance coverage or employee discounts. That means that of the employers that offer 401(k)s, no two employers will have the same plan.

The fact is:

401(k)s are not free to run.

Employers have to pay 401(k) administrators to set up and manage the plan. Some employers cover these costs. Others pass them on to their employees.

Typically, you also have to invest the money in your 401(k) into some type of mutual fund or money market account. These funds can charge significant fees as well.

All told, you could be paying huge fees to invest in your 401(k). This begs the question: how can you invest in a 401(k) with high fees?


Expensive 401(k) Plans

There are two common ways that 401(k) plans can be expensive to participate in.

These are the traits of a bad 401(k):

High administrative fees

Administrative fees are fees charged by the company that manages your employer’s 401(k) plan. While many companies cover these fees for their employees, not all do.

Administrative fees can vary widely from provider to provider.

Some will charge a flat rate per month, quarter, or year.

Others might charge a percentage of the money you invest upfront.

While paying a small amount a year in administrative fees is no big deal, paying hundreds a year in these fees can have a big impact on your 401(k)’s growth.

High expense ratios

Expense ratios are fees charged by companies that manage mutual funds.

When you invest in a mutual fund, what you’re investing in is a diversified portfolio of stocks, bonds, and other investments.

The company that manages the fund handles investing in those things on your behalf.

That makes it easy to diversify your portfolio while only having to invest in one or a few mutual funds.

Basically...

The expense ratio of a fund is expressed as a percentage.

This is the percentage of your invested money that you’ll be charged in fees each year. So, if you have $10,000 invested in a fund with a 1% expense ratio, you’re paying $100 per year to invest in that fund. Because your account’s balance is always changing, a better way to think about it is in relation to your investment’s growth.

If you invest in a fund with an expense ratio, your investment growth will be reduced when compared to the growth of an identical fund that has no expense ratio.

Types of 401k Fees

Type About
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.

The Pros of Investing in a High Fee 401(k)

Even if your 401(k) is expensive, there are a few reasons you might consider investing in it anyway.

401(k) matching

Many employers offer to match funds that you contribute to your 401(k), up to a point. For example, your employer might match 100% of your contributions on up to 5% of your salary.

If you make $50,000 per year, and contribute at least $2,500 to your 401(k) each year, your employer will also add $2,500 to the account. Even if your 401(k) is expensive, this is like getting an instant 100% return, which is worth it.

Tax savings

When you invest in a 401(k) you get some tax benefits.

With a traditional 401(k) plan, you are allowed to deduct your contributions from your income when you file your taxes. That means less money is taken out of your paycheck to cover taxes.

A Roth 401(k) doesn't provide immediate tax relief, but you can withdraw contributions and earnings tax-free during retirement.

Traditional 401(k) vs. Roth 401(k)

Traditional 401(k) Roth IRA 401(k)
Contributions are tax-deductible. Contributions are not tax-deductible.
Pay taxes upon withdrawal. Earnings can be withdrawn tax-free and without penalties if the funds were in the Roth 401(k) for 5 years and you've reached age 59 1/2.
Required minimum distributions (RMDs) are required starting at age 70 1/2. Required minimum distributions (RMDs) are required starting at age 70 1/2.

The Cons of Investing in a High Fee 401(k)

The biggest downside of investing in a 401(k) with high fees is slowed investment growth. High mutual fund expense ratios are a significant cost, even if a fee of 1 or 2% sounds low.

Consider this example: You invest in a mutual fund with a 1% expense ratio. The investment that the mutual fund purchases increase in value by 10%.

Because of the expense ratio, the value of your shares only grows by 9%. Even though a 1% difference may sound like a small amount, it actually has a huge impact on your account’s growth.

Over the past 90 years, the S&P 500 has returned an average of 9.8% per year.

If you invested $10,000 and left it for 45 years, it would grow to $671,591 with an annual return of 9.8%.

If you add a 1% expense ratio, the money will only grow at 8.8% per year. $10,000 invest for 45 years at that rate would only grow to $444,939.

So:

A 1% expense ratio can cost you more than $200,000 over your working career. That’s why you should try to invest in funds with low fees.

How to Invest in a High Fee 401(k)

If your employer offers a 401(k) with high fees, here are a few strategies you can use when you invest.

Index funds and target-date funds

Typically, 401(k) plans offer a variety of mutual funds for you to invest in.

You can choose which funds you want to put money in, and how much to add to each fund.

The most expensive mutual funds tend to be actively managed funds that try to beat the market.

Conversely, the cheapest funds tend to be index funds that simply aim to track the market and target date funds, that buy a mix of stocks and bonds based on when you hope to retire.

If there are any index or target date funds available in your 401(k) try to invest in those to take advantage of their lower fees.

Supplement your savings with an IRA

401(k)s aren’t the only tax-advantages retirement savings option out there.

Anyone who earns an income is allowed to open an Individual Retirement Account (IRA).

IRAs provide the same benefits that 401(k)s do, but aren’t tied to an employer. You can open one on your own with any financial company that offers one.

The downside: The 401(k) contribution limits are much higher. In 2019, you can contribute as much as $19,000 to a 401(k). You can only put $6,000 in an IRA. Open an IRA with a company that provides cheap investment options. Invest in your 401(k) up to the limit of your employer and match, then invest in your IRA until you max it out before adding more to your 401(k).

That lets you get the full benefit of your 401(k) while dodging some of the cost.

Try an in-service rollover

Another option that you might have is to perform an in-service rollover.

Most plans don’t offer this, but for plans that do, it can give you a lot more freedom to manage your retirement savings.

When you leave your employer, you typically have two options as to how to handle your 401(k) balance. You can leave it where it is, or you can roll it into another account. Usually, you’ll roll it into an IRA are your preferred provider.

Some employers allow an in-service rollover, meaning you can roll money out of your 401(k) and into an IRA even while you still work for your company.

If your 401(k) has high fees, you can perform an in-service rollover to move money out of your expensive 401(k) and into your IRA, where you can invest it in cheaper funds. In this way, you can use an in-service rollover to effectively expand your annual IRA contribution limit.

This option is uncommon, and many rules will apply to in-service rollovers, but it’s worth pursuing the option if it’s there. Make sure to consult tax professionals before taking any action.

Campaign for a better 401(k)

Employers offer 401(k) plans as a benefit for their employees. As an employee, you have the right to ask your employer to improve things, whether you ask for better working conditions or a better 401(k).

If your employer offers an expensive 401(k) plan, look into other providers who are able to offer better plans.

Get together with your coworkers and discuss the importance of a good 401(k) plan with low fees. Present your findings, and your support, to your employer and see if you can convince your employer to change 401(k), providers.

This strategy tends to be most effective with smaller employers where a few people can make meaningful change more easily. This can often be the best option since it will help you and all of your colleagues.

Final Thoughts

Saving for retirement isn’t easy and having an expensive 401(k) plan only makes it harder.

Use some of these tips to make the most of your expensive 401(k) plan, and do what you can to find reduce your costs.

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