How to Lower Your 401(k) Fees

Without a doubt, 401(k) plans are attractive investment vehicles for retirement planning. In addition to the tax benefits, contributions are automatically deducted from participating employees’ paychecks—making it an easy (and painless) way to invest. What’s more, many companies match contributions up to a certain amount, which helps grow those nest eggs faster.

As of September 30, 2020, 401(k) plans hold an estimated $6.5 trillion in assets, in about 600,000 plans, on behalf of about 60 million active participants and millions of former employees and retirees, according to Washington, D.C.-based Investment Company Institute, the trade association for regulated fund companies in the U.S.

What does all that money mean for the typical 401(k) holder? As of the fourth quarter of 2020, the average 401(k) balance was $121,500, according to the most recent Fidelity Investments estimates.

Something that can really affect these balances over time—and not always in a good way—is the plan’s expense ratio. Here, we take a quick look at what expense ratios are, why they matter, and what employers and plan participants can do to keep them down.

What’s a 401(k) Expense Ratio?

All 401(k) plans are subject to a range of administrative (also called “participation”) fees and investment fees. Administrative fees cover costs like customer support, legal services, record keeping, and transaction processing. Investment fees are charged (not surprisingly) by the investment funds in which the plan invests and are typically disclosed as “expense ratios” in the plan’s literature. Some fees are covered by the employer, but typically, most fees are passed onto the plan’s participants (i.e., the employees).

The expense ratio is expressed as a percentage of assets—say, 0.75% or 1.25%. Across the board, the average 401(k) expense ratio is 1% of assets, or $1,000 for every $100,000 in plan assets (keep in mind, most fees aren’t one and done; they are paid every year).

Still, expense ratios vary greatly depending on the size of the plan and, in general, larger 401(k) plans have the lowest fees due to economies of scale, while small business 401(k)s—for example, plans with 10 participants—tend to be the priciest. Below are the average expense ratios by plan size, according to data from the 401(k) Books of Averages.

Why Does Expense Ratio Matter?

The difference between a 0.05% and 1% expense ratio might not hurt the bank over the course of one year—for the typical twentysomething’s 401(k) balance, it’s a difference of just $59—but it can have a huge effect on your bottom line over the lifetime of the investment. It can even mean the difference between retiring when you want to and having to wait a few years.

Here’s why. First, the higher fees mean you pay more each year (in actual dollars) as your investment grows: 1% of $10,000 is $100, but 1% of $100,000 is $1,000, and so on. The real damage, however, is that for every dollar spent on fees, that’s one less dollar in your account that could compound and grow over time.

Here’s an example. Assume you’re 40 years old and plan to retire at age 70. Your current 401(k) balance is $100,000 (that’s right in line with the average balance by age), and you plan to contribute $10,000 each year—about half the allowable amount. Finally, for this example, the assumed investment return (before fees) is 8%.

If you pay 0.5% in fees, you will have $1,909,490 in your account when you retire. If you pay 1% in fees, however, you’ll have $1,705,833—or $203,656 less. A calculator at 401kfee.com shows you would have to contribute $2,156 more each year (for three decades) to end up with the same amount at retirement if you paid 1% instead of the lower, 0.5% fee.

Indeed, 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.”

Of course, this is a hypothetical example that is overly simplified. In real life, it’s highly improbable that you would achieve a steady, 8% return each year. And it’s unlikely you would make the same $10,000 contribution each year (some years it may be more, some years less, depending on life). Still, it serves as a good example of why fees matter—especially in the long run.

How to Lower Your 401(k) Fees

The good news is that you can do something about high 401(k) costs—and boost your retirement savings in the process.

For starters, find out what you’re paying now. Since most people don’t know, this might take a little research. Review your 401(k) statement and participant fee disclosure notice, and then see how your plans stack up against plans of similar size. A good place to compare plans is at BrightScope, a website that rates corporate and government retirement plans. If your plan’s fees are in line with the industry, that’s good. If they’re higher, it may be time to meet with your plan administrator and lobby for a better plan with lower fees (employers have a fiduciary responsibility to make sure their 401(k) plans have “reasonable” fees).

Next, take a look at your investments. One of the best ways to minimize costs is to select cheaper investment options. In general, you’ll find the lowest fees in index funds, institutional funds, and some target-date funds (it’s worth noting that many mutual fund fees have come down in recent years). 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.

Another way to lower your costs is to see if you’re paying for independent investment advice—something many employers add to their retirement plans. If so, you may be paying an additional 1% or 2% of your funds each year to get this advice. In many cases, this is not money well spent, particularly since plans generally have fixed investment choices. To avoid these fees, consider doing your own research, or scheduling a session with a certified financial planner who can help get you pointed in the right direction.

Finally, if your plan has fees that you feel are too high—and your company isn’t receptive to making changes—you may want to consider investing some of your savings elsewhere, such as in an IRA. If you have an employer match, invest enough so that you get the full match first, and then stash what’s left in the IRA or other investment.

The Bottom Line

Ideally, your 401(k) fees should be well under 1%, especially if you’re part of a large-scale plan (anything over 1% should be scrutinized). Fees can have a significant impact on your bottom line, so it pays to find out what you’re paying—and take steps to lower them if appropriate. One good way to lower costs is to invest in low-fee funds like index funds, institutional funds, and target-date funds. Review your plan’s literature and ask your human resources or benefits coordinator to explain anything you don’t understand.