Are Expense Ratios Higher for Fund Options in a 401(k)?

In recent years, the 401(k) has become the most common way for full-time employees to save for retirement. With a 401(k), employees can take money from their salary before it is taxed, and they can choose to invest that money in a variety of stock and bond mutual funds. At the same time, many millions of Americans are investing directly in the stock market via a regular brokerage account.

It’s often possible to invest in the same fund in both ways—through your 401(k) and through your brokerage account. However, you might find that the expense ratio associated with the investment is higher if it is held in your 401(k). In this article, we’ll explain why that might be the case and what you can do about it.

Understanding Expense Ratios for 401(k) Accounts

At first glance, it might seem strange that expense ratios for investments held in a 401(k) should be different from the same investments held in other types of investment accounts. If you are investing in Vanguard’s VWUSX, a popular choice for 401(k) plans, you might be attracted by the competitive 0.38% expense ratio the fund offers. But if you invest in this same fund via your 401(k) and carefully calculate the actual expense ratio you are paying, you may well find it’s higher than the advertised rate. 

The reason is that 401(k) plans have costs and fees associated with them, and these are in addition to the fees charged by individual stock and bond funds. All 401(k) plans, in fact, are subject to a wide range of administrative (also called “participation”) fees that are charged alongside investment fees. These administrative fees cover costs like customer support, legal services, record keeping, and transaction processing. Some of these fees are covered by your employer, but typically most fees are passed onto the plan’s participants (i.e., the employees). All of these fees are lumped into the aggregate expense ratio for your 401(k).

As of 2022, the average expense ratio for 401(k) investments in actively managed mutual funds is about 1%. However, this can vary a great deal depending on your employer, and in particular, the size of your employer. A 401(k) plan with many participants benefits from economies of scale and therefore has lower expense ratios. A 401(k) plan with 10 participants has expense ratios higher than 1%, and plans with more than a thousand participants can have expense ratios far lower than this.

Though 1% might not sound like much, it can make a big difference over the long term. Research by the Pew Charitable Trusts confirms that fees have a serious impact, noting that “fees can affect savings directly by reducing the amount saved, and indirectly by lowering the amount available for compounding—a frequently overlooked but significant detriment to savings growth.”

Reducing 401(k) Expense Ratios

There are a number of ways you can reduce your 401(k) expense ratios. Because the total expense ratio you pay depends on fees and charges from two main sources—the funds you invest in and your own employer’s administration costs—you should look to both as a way of reducing your costs.

The first step is to calculate the expense ratio you are paying at the moment. Start with your 401(k) statement and participant fee disclosure notice, which will provide details about the fees you pay. You can then compare plans using a website like BrightScope, which rates corporate and government retirement plans. If you find that your fees are much higher than the average, it’s worth approaching your employer’s plan administrator—your employer has a responsibility to find the best plan for their employees, after all.

As part of this research, you might find that you are paying for independent investment advice whether you’ve actually received this or not. This is a common fee for corporate 401(k) plans and can add up to 1% to your expense ratio. Because the options you can choose from with the average 401(k) are relatively limited, you can likely stop paying for this advice. You can replace it with your own research or schedule a session with a certified financial planner who will charge you a one-off fee for a consultation and not an ongoing percentage on your retirement portfolio.

Finally, you can try to reduce the cost of your actual investments. You’ll find the lowest fees in index funds, institutional funds, and some target-date funds. If your plan doesn’t have these low-cost options, find out if it offers a self-directed brokerage window that allows you to choose other investments. 

If all else fails, or your company isn’t interested in making changes to lower your expense ratio, you can invest some of your money elsewhere. Though it’s almost always a good idea to invest enough in your employer’s fund to make the most of any matching funds they offer, you can use some of your savings above this level to fund a self-directed IRA.

The Bottom Line

Many people have both a self-directed brokerage account and a 401(k) plan provided by their employer. If that applies to you, you might notice that your expense ratios for the employer-sponsored plan are higher than they are for your self-directed account. That’s because running and overseeing 401(k) plans comes with costs. Plans with more participants generally have lower costs; smaller employers may charge more.

If you feel your expense ratios are high—more than about 1%—you should talk to your employer about ways to reduce them. Alternatively, you can choose investments that have lower base costs or start investing some of your income outside your 401(k) plan.