Even if you’ve so far managed to avoid sitting through a company benefits meeting, you’re probably familiar with the concept of a 401(k) plan. A 401(k), of course, is a defined-contribution plan, which means that payments into it are fixed. You put in a set amount per paycheck, your employer may match some percentage of that amount, and, years later, you’re enjoying some degree of financial independence instead of lining up at the local soup kitchen.

It warrants repeating that you should accept that employer match-up to the maximum provided. Otherwise, you’re rejecting free money. That's the good part.

But even if you know how a 401(k) works and enthusiastically contribute to one, do you know about hidden fees that can come with it?

Finding the Fees in 401(k)s

If you don't, don't feel dumb. A late-2018 TD Ameritrade survey of 1,000 investors found that only 27% knew how much they’re paying in 401(k) fees; 37% didn't realize they were paying fees at all. 

Unfortunately, investor naiveté is such that millions of people never stop to ask how much the 401(k) provider—usually, the investment company that devises and manages the mutual funds and exchange-traded funds (ETFs) into which your money goes—is making off the cash you give it to invest. Your provider doesn't offer these services for free. It collects a fee every month, and the cumulative size of those fees can impact your eventual returns. Some 95% of 401(k) participants pay fees.

In a way, it's a little mean of us to call these “hidden” fees. Thanks to a 2012 mandate of the U.S. Department of Labor, your 401(k) provider is now required to disclose all its fees in the prospectus that it gives you when you enroll in the plan, and which it updates and sends you every year. We know you devour these statements the minute they arrive.

Seriously, though, as the fees are no longer hard to locate, it pays to pay attention to them. When you receive a 401(k) statement or prospectus, check for line items or categories like “Total Asset-Based Fees,” “Total Operating Expenses As a %” or “Expense Ratios.”

Key Takeaways

  • 401(k) plans come with a variety of fees that aren't always evident to the investor but can greatly impact an account's return over the long-term.
  • Ranging from .5% to 2%, 401(k) plan fees can vary greatly, depending on the size of your employer’s 401(k) plan, the number of participants, and the plan provider.
  • Reflecting mostly administrative and investment management costs, 401(k) fees spring from two sources: the plan provider and the individual funds within the plan.
  • Individual investors can't do much about plan provider fees, but they can try to select funds within the plan with lower costs or expense ratios.

Two Key 401(k) Plan Fees

Of course, finding the fees is one thing. Understanding them is another.

The most firmly entrenched of the fees is the 12b-1 fee, named after the relevant section of the Investment Company Act of 1940, which was enacted decades before such investments had been popularized and democratized to the extent that they are today. Generally filed under “marketing fees,” 12b-1 fees are ostensibly earmarked for the intermediaries who sell the specific 401(k) plans to your employer. These fees, capped by the act at 1% of assets, constitute a commission, which is to say an expense—as distinguished from an investment in the fund’s possible returns.

Note that 12b-1 fees, which are charged by individual funds, are separate from investment management fees, which are the cut the 401(k) provider takes for itself. For instance, Fidelity Investments is America’s biggest provider of 401(k)s. A typical advisory fee for a Fidelity portfolio account starts at 1.7% and decreases from there by as much as half, depending on how much you put in. (So there’s a surefire way to avoid at least some fees: have a large balance—though, in this case, the provider is probably basing its percentage on the size of all the accounts in the plan, not just yours individually.)

401(k) fees fall into two basic categories: those charged by the plan provider, and those charged by the mutual funds or ETFs in the account.

Breaking Down 401(k) Plan Fees

401(k) plan fees typically fall into four categories: investment, administrative, individual service, and custodial. To illustrate the point, here’s a sample account quarterly summary, not from a 401(k) provider but rather from a third-party firm that administers plans and keeps records (yes, you can bet they get a cut too, but your employer probably picks that up). The figures, which represent dollar amounts, are on a total contribution of $3,207.70 for the quarter.

Expenses  
Administrative Fees 25.00
Investment Fees 4.35
Asset/Revenue Sharing 2.31
Audit, Fidiciuary & Consultng 13.25
TOTAL 44.91

This means the contributor is paying $44.91 in fees on a principal of $3,207.70. Curiously, that’s 1.4% to the penny, which makes it seem as though the expenses are retrofitted to the ratio.

Is it reasonable that only 98.6% of your contributions find their way into the designated investments? That’s not a rhetorical question.

The Impact of 401(k) Fees

401(k) plan fees can vary greatly, depending on the size of your employer’s 401(k) plan, the number of participants, and the plan provider. According to a study between financial research company BrightScope and the Investment Company Institute large plans (over $100 million in assets) almost uniformly have fees below 1%; the largest plans are usually below 0.50%. The small plan marketplace is a different story. Average fees for small plans (under $100 million in assets) is between 1.5% and 2%, with plenty of plans with less than $50 million in assets paying more than 2% a year in fees.

The difference in these percentage points doesn't sound like much, but it can really add up over the years (and presumably you're keeping your retirement plan for years, right?).

Take this example from Tom Zgainer, founder of America’s Best 401(k), a retirement plan advisory firm. Three childhood friends, Joe, Tyler, and David each invest $100,000 in a mutual fund at age 35. Each account earns an annualized return of 8% but the accounts charge annual fees of 1%, 2%, and 3% respectively. At age 65, they get together to compare account balances. David, who paid 3%, has $432,194. Tyler, who paid 2%, has $574,349. Joe, who paid 1%, has $761,225.

1%

The annual fee charged by the average 401(k) fund, according to the he Center for American Progress

What to Do About 401(K) Fees

Short of boycotting the 401(k), there's not much you can do about the fees charged by the 401(k) plan provider or administrator—although, if you discover they're egregious (like north of 2%), you could point it out to your human resources department. The 401(k) marketplace is an incredibly competitive one nowadays, and if one provider's fees are out-of-line, there are plenty of more reasonable alternatives out there.

However, you can take some action when it comes to charges of the individual funds within the 401(k) plan. Look in their prospectus, or online, for their listed expense ratios, which is the sum total of their fees, expressed as an annualized percentage; if you have a choice between two similar funds—two growth-stock funds, for example—go with the one with the lower expense ratio. In general, equity funds tend to be more expensive than bond funds, and ETFs are much cheaper than mutual funds. But of course, don't compromise your investment goals, risk tolerance, or common sense just in to score a lower fee.

The Bottom Line

Fees, regardless of how conspicuously they’re disclosed, should be but one criterion in choosing your 401(k) investments. Each fund is different, and the most important factor in how much you make is its overall return. Look at asset class, management’s relative competence, and track record first. Each of them will have a far greater impact on your long-term returns than fees. And don’t forget to factor in whether you are more comfortable with an index fund or an actively managed fund.