The 401(k) is an incredibly powerful investing tool, and there are plenty of advantages of contributing to this type of account.
For one, 401(k)s have much higher annual contribution limits than IRAs ($19,500 per year compared to just $6,000 per year), and many 401(k) plans also offer employer matching contributions. It's also easy to get started investing in a 401(k), especially considering some employers automatically enroll new workers.
However, there's one major drawback to investing in a 401(k), and it could potentially cost you tens of thousands of dollars or more over a lifetime.
One potential risk of investing in a 401(k)
Despite its many advantages, the downside to investing in a 401(k) is that you typically don't have many investing options. That may not be a dealbreaker for some investors, but it can be more costly than you might think.
When deciding how to allocate your investments within your 401(k), you will typically have a few mutual funds to choose from. There's nothing inherently wrong with that, especially if you prefer to take a hands-off approach to investing and don't necessarily want to choose from hundreds of different investments. However, what could potentially be a problem is the high fees you may be stuck with.
Whether you realize it or not, you're paying fees when you contribute to a 401(k). The average 401(k) plan charges an annual fee of around 1% of total assets under management, according to a report from the Center for American Progress. In other words, if you have $100,000 stashed in your 401(k), you'll be paying $1,000 per year in fees.
Because you generally won't have many options when choosing which funds to invest in with a 401(k), you may be stuck with higher-than-average fees, whether you like it or not. And those fees can add up substantially over time.
How much is too much in fees?
To figure out how much you're paying in fees, check your account statements or talk to your plan administrator. One of the most important figures to look for is the expense ratio, which is the percentage of your savings that go toward general administrative and management costs. If you're paying more than the average 1% per year in fees, it could cost you over the long run.
Even if your fees are only slightly higher than average, it could still take a significant bite out of your savings. The average worker paying 1% per year in fees can expect to spend approximately $138,000 in fees alone over a lifetime, according to the Center for American Progress. However, if that same worker paid slightly higher fees of 1.3% per year, the lifetime fees jump to more than $166,000.
In other words, it pays to limit your fees as much as possible, because even slight differences in how much you're paying can potentially cost you tens of thousands of dollars over a lifetime.
What you can do about it
If you find you're paying higher-than-average 401(k) fees, you might consider switching to an IRA. IRAs offer a wide variety of investment options, often with lower fees than you might find with a 401(k).
The one exception, though, is if you're earning matching 401(k) contributions from your employer. These contributions are essentially free money, and they outweigh any fees you may be paying. So in this case, you're better off contributing enough to earn the full match from your employer, then stashing the rest of your savings in an IRA with lower fees.
Although the 401(k) offers plenty of perks, high fees can eat away at your savings. Even if you're only paying slightly-higher-than-average fees, those charges add up significantly over the years. By ensuring you're not paying more than necessary, you could potentially save thousands of dollars.