If your 401(k) plan is a major part of your overall retirement strategy, you will naturally be concerned with how much money you need to save each year, what your investment allocation will be, and of course, the expected rate of return on your plan. But there is another variable that you should consider as well, and that’s 401(k) fees.
But before you can figure out what the impact of those fees will be, you first have to identify what fees will apply to your plan. Once you do, you can total up the fees, and determine the dollar amount, percentage, and result of the fees that you are paying.
Let’s start with identifying the most common 401(k) fees.
Common 401(k) fees
Plan administrative fees
Many plans have a fee that is charged for the administration of the 401(k) plan. This is a charge to cover services, such as record keeping, compliance, accounting, legal, and trustee services. In some 401(k) plans, the cost of this fee is paid by the employer.
This is typically a flat fee, say $50, that is charged annually. While it won’t have much affect on a high-balance plan, it can impact plan returns on smaller accounts. It’s also possible that the administrative fee will be higher, say $100 or $150, in which case it will be a factor even on larger accounts.
Individual service fees
These fees may apply if the plan offers optional services. These services can include customer service contact, educational services, retirement planning software, and even investment advice from an investment professional. Such services may come with a flat fee arrangement, or be based on services actually rendered.
Investment advisory fees
If the plan is being managed by a professional investment advisor, there may be a fee charged as a percentage of your total 401(k) portfolio balance. For example, the investment advisor may charge 1 percent of the value of your plan in order to manage the investments contained within it.
Since most plans offer numerous mutual fund options, the fees associated with these can be a major part of the overall fee structure of the plan.
These are sales charges imposed by mutual funds. They are expressed as a percentage of the principal amount invested in a fund. They can be as high as 8.5 percent, but generally do not exceed 3 percent.
Load fees can be charged upon the purchase of a fund, commonly known as a front-end load. They can also be charged on the sale of the fund, which are commonly known as back-end loads, deferred sales charges, or redemption fees.
Some funds may charge a front-end load only, while others may charge only a back-end load. Still other funds charge both. In a situation where both loads are charged, it might be set up as something like a 1 percent front-end load and a 1 percent back-end load, or even as a 2 percent front-end load and a 1 percent back-end load.
With many funds, the back-end load can be waived if the fund is held for a certain minimum period of time, such as two years or three years.
Loads are most often charged in connection with mutual funds, because such funds are typically actively managed (involving management activity and frequent trading within the fund). On the other hand, index funds—as well as exchange-traded funds (ETFs)—are no-load funds, since the portfolio is tied to an underlying index, and involves very little trading or management expertise.
These are fees that cover commissions to brokers and salespeople, as well as advertising and any costs associated with marketing the fund, as well as certain fees for bundled-services arrangements with 401(k) plans.
The fee can range between 0.25 percent and 1 percent of fund assets. It is often overlooked, since it is deducted from the fund balance, and not charged to the account owner as a stand-alone fee. However, all mutual funds are required to disclose their 12(b)-1 fees to their shareholders in their prospectus.
This is an annual fee charged by some funds, most typically as an account maintenance fee on fund positions that are below a certain dollar threshold. It is not universal, and the amount of the fee will vary from one mutual fund to another.
Apart from load fees, there may also be certain fees charged by an investment brokerage account for specific transactions.
These are sales charges paid to the investment broker that is actually holding the account. They’re most typically charged on the purchase and sale of stocks, options, futures, and certain types of mutual funds. They are usually a flat fee per trade, such as $9.95 on either the purchase or sale of the security position.
Purchase, redemption, or exchange fees
These are fees that can be charged by a mutual fund that is considered to be a no-load fund. It is essentially a small fee, like a commission, that will be charged on any exchanges involving a particular mutual fund.
These fees are not considered loads because they are paid directly to the fund itself, and not paid to brokers.
Interest rate spreads
These are fees charged in connection with stable-value funds, including short-term bond funds and individual fixed-income securities, such as Treasury securities or certificates of deposit. Because such investments rely primarily on interest-rate returns, and because short-term interest rates are so low, they do not charge load fees. Rather they charge a certain percentage of the interest-rate return on the underlying securities.
For example, on a portfolio of short-term fixed income securities yielding 1 percent, the net amount payable to you may be 0.90 percent. The difference between the two—0.10 percent—is the interest-rate spread paid to the fund manager.
Interest rate spreads can apply in either a mutual fund, or in a brokerage account that allows the direct purchase of individual interest-bearing securities.
Calculating your 401(k) fees
This can be a complicated process since different types of fees are being charged in connection with the various components of your plan. In addition, how much you will pay depends largely on how active you are with your account. For example, if you frequently purchase or sell securities or funds, your overall fees will be much higher.
Much also depends upon the type of funds your plan holds. For example, if your plan is comprised mostly of actively managed mutual funds, you will likely have to pay loads on those funds. If on the other hand, the plan has mostly index-based ETFs, there won’t be any load fees.
If you’re the do-it-yourself type, you can start by using FINRA’s Fund Analyzer, which can analyze more than 18,000 mutual funds, ETFs, and exchange-traded notes (ETNs). The tool provides an estimate of the fees and expenses connected with each fund.
Once you have that information, you can add in the dollar costs of any fixed fees associated with the 401(k) plan itself, as well as any investment advisory fees. You should also calculate the cost of any commissions or other applicable trading fees.
If you can convert all of your percentage-based fees into actual dollar amounts, you can total up those amounts, and divide them by your average 401(k) account balance for the year. This will give you the percentage that you are paying in 401(k) fees every year.
For example, if you have a plan administrative fee of $100, and during the past year, you paid $1,000 in mutual fund loads, $200 in commissions, and $300 in 12(b)-1 fees, your total expenses are $1,600. If your 401(k) plan had an average balance of $100,000 for the past year, your 401(k) fees paid will be 1.6 percent ($1,600 divided by $100,000).
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Why 401(k) fees matter
Small differences in the 401(k) fees that you pay on your plan can be more significant than you might imagine.
As an example, let’s look at the difference in the value of two 401(k) plans, each with a current balance of $100,000, and an expected annual rate of return of 8 percent. The only difference between the two plans is that Plan A pays an average annual rate of 2 percent in 401(k) fees, while Plan B pays just 1 percent. (For simplicity’s sake, we will ignore the impact of additional contributions to the plan.)
How will the difference in 401(k) fees affected the value of each plan after 30 years?
Since this plan has fees of 2 percent per year, the net effective rate of return on the portfolio is reduced from 8 percent to 6 percent. After 30 years, the $100,000 plan has grown to $574,350.
Since this plan has fees of 1 percent per year, the net effective rate of return on the portfolio is reduced from 8 percent to 7 percent. After 30 years, the $100,000 plan has grown to $761,225.
The difference of “only” 1 percent per year in 401(k) fees added $186,875 to the 30-year performance of Plan B. Put another way, Plan B will be worth 32.5 percent more than Plan A after 30 years.
The moral of the story: When calculating how much money you will need to save in your 401(k) plan, as well as your investment allocation, and your expected annual rate of return, never ignore the impact of 401(k) fees on the final outcome. They matter.
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