A 401(k) plan is one of the most valuable investment vehicles for retirement planning. Individual 401(k) plans are typically sponsored by an employer and are a part of employee benefit programs. Large companies often set up 401(k) vehicles to help employees plan for retirement and offer employer-matched payments in addition to the salaries they provide. Small business owners have fewer options, so they need to focus on all the associated expenses when deciding which 401(k) benefit plan they are going to offer.
Traditional 401(k) Investment Vehicles
Employers generally offer traditional 401(k) investment vehicles that include pre-tax contributions. They can also offer after-tax contributions through a Roth 401(k) plan. Regardless of the retirement investment vehicle offered by employers, the primary benefit of a 401(k) plan is its matching feature. With matching, employers contribute the same amount as the employee to an employer-sponsored 401(k) investment vehicle up to a certain percentage, usually around 3%.
When large companies act as plan sponsors, they have the luxury of working with nearly any 401(k) provider in the investment industry. Nearly all investment companies have 401(k) plan options available. A 401(k) plan also requires an administrator, which may be the plan provider if an investment company offers administration services along with 401(k) plans. A company might hire a separate administrator for individual 401(k) employee plans.
If you are a small business owner, you won't have the luxury of working with any 401(k) provider in the industry. However, that doesn't mean you don't have options. Three of the leading 401(k) plans for small business owners include the Merrill Edge 401(k), the Vanguard 401(k), and the Fidelity 401(k).
Merrill Edge 401(k)
The Merrill Edge 401(k) is provided by Merrill Lynch, and it offers one of the simplest and most convenient 401(k) plans to set up for an employer. Setting up the plan takes approximately 30 minutes.
Fees are minimal for the plan, and contributions are tax-deductible for the small business. The Merrill Edge plan also offers numerous model portfolios for employees. However, its model portfolio options are not as robust as options from plans with comprehensive portfolio management services such as Vanguard and Fidelity.
The fees and expenses for the Merrill Edge 401(k) plan are minimal. The plan offers a low comprehensive expense ratio of 0.52%. This expense ratio includes an investment fiduciary fee, participant servicing fee, and account servicing fee.
The Vanguard 401(k) offers all of the basic 401(k) investment vehicle features with optional administration services through Vanguard. One of the greatest advantages of a Vanguard 401(k) is that it allows all participants to access Vanguard’s suite of funds.
Overall, fees and expenses vary for each plan. However, most plans typically have a comprehensive expense ratio of 0.52%. Additionally, Vanguard’s investment funds offer some of the lowest expense ratios in the industry.
One disadvantage with the Vanguard 401(k) is its pricing structure. The plan’s annual recordkeeping fee is calculated per participant, and companies with a smaller number of participants may pay a higher recordkeeping fee.
The Fidelity 401(k) is also a smart option for small businesses. It includes basic 401(k) plan features as well as an administrative service through Fidelity.
Employers can expect an average expense ratio of 0.52%. Similar to Vanguard, Fidelity offers model portfolios that include its own funds, which is often appealing to employers and investors.
One disadvantage of the Fidelity 401(k) plan is that it primarily services employers with 20 or more employees. For small businesses with less than 20 employees, this plan can be costly.
401(k) Expense Ratios
Once you are enrolled in a 401(k), whether through a large company or a small business, it is your responsibility to manage the costs of the plan. But this can be tricky since there are only certain options for investments when your employer chooses the plan. You should closely monitor the opportunity costs of their 401(k) investments, while also keeping in mind that your plan sponsor is likely covering most of the fees associated with the investment vehicle. Your responsibility may be very small.
Total Expense Ratio
The expense ratio for a 401(k) plan is equal to the amount you pay in fees divided by the total investment. For 401(k) investors, some of the key fees to be aware of in a 401(k) investment vehicle include management fees, investment fiduciary fees, plan administration fees and individual account servicing fees. These fees are standard for a 401(k) plan. Investors can expect to have an approximate comprehensive 401(k) expense ratio of 0.3% to 2%.
An investor can manage some of the expenses in their 401(k) by the investments they choose. It is possible to lower an overall expense ratio by choosing individual investments with lower expense ratios. However, if the expense ratio of your plan exceeds 2%, and you've intentionally chosen investments with the lowest-fee funds, the opportunity costs of your portfolio are likely too high.