A 401(k) plan is one of the most valuable investment vehicles for retirement planning. It is typically sponsored by an employer, and individuals encounter it through their employee benefit programs. These investment vehicles are best known for their matching features. Employers set up 401(k) investment vehicles as a benefit to help employees plan for retirement, and also to offer employer-matched payments in addition to salaries.
Traditional 401(k) Investment Vehicles
Employers generally offer traditional 401(k) investment vehicles that include before-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. Employers that offer 401(k) plans also typically offer matching as an employee benefit. This means employers match the contributions in an employer-sponsored 401(k) investment vehicle up to a certain percentage, usually around 3%.
Large companies as plan sponsors typically 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 typically requires an administrator, which may be the plan provider if an investment company offers administration services along with 401(k) plans. A separate administrator may also be hired by a company to manage the administration of individual 401(k) plans for employees.
Small business owners usually have fewer options and more of a focus on expenses when seeking optimal 401(k) benefit plans. 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. Plan set up only 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 for servicing the plan. One of the greatest advantages of a Vanguard 401(k) is the access it allows for its participants to 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 con for the Vanguard 401(k) is its pricing structure per participant. 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 convenient plan for small businesses. It includes basic 401(k) plan features as well as an administrative service through Fidelity.
Fees and expenses vary widely; however, 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 con for the Fidelity 401(k) plan is 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
Managing the costs of a 401(k) plan for participants can be tricky since you only have certain options for investments designated by your employer’s plan. Therefore, investors must closely manage the opportunity costs of their 401(k) investments, keeping in mind the employer matching may be covering a large portion of the fees associated with the investment vehicle overall.
Total Expense Ratio
The total expense ratio for your 401(k) is equal to the amount you pay in fees divided by your total investment. For 401(k) investors, some of the key fees to focus on in your 401(k) investment vehicle include the management fees, investment fiduciary fee, plan administration fee and individual account servicing fee. These fees are standard for the management of a 401(k) plan. Investors can expect to have an approximate comprehensive 401(k) expense ratio of 0.3% to 2%.
As an investor, you can manage some of the expenses in your 401(k) by the investments you choose. You may be able to lower your overall expense ratio by choosing individual investments with lower expense ratios per investment. However, if you find your expense ratio exceeds 2% and you have adjusted your investments to the lowest-fee funds, then your opportunity costs may be too high. In this case, you may want to consider opening a personal retirement account with lower fees.