Only 27% of Americans who participate in a 401(k) plan know how much they're paying in fees, according to a TD Ameritrade survey. And many of those who don't know mistakenly think that they're not paying anything at all.
To be perfectly clear, all 401(k) plans have fees. It's just a matter of how much. Here's a rundown of the potential fees you could be paying for your 401(k) investments, how to figure out yours, and why it's important to know your fees.
Most Americans have no idea how much their 401(k) fees are -- or if they have any at all
According to TD Ameritrade's survey, an alarming 37% of participants believe they don't pay any 401(k) fees at all. Another 22% don't know if their plan has fees (it does), and 14% say they don't know how to determine their fees.
As I mentioned, all 401(k) plans have fees in one form or another. And there are three broad categories of 401(k) fees you may be paying -- investment fees, participation fees, and individual service fees. Fortunately, 401(k) administrators are required by law to send you a quarterly statement with fees and expenses clearly disclosed, so they're generally easy to find if you simply read through yours. With that in mind, here's what you need to know about the fees you might be paying.
401(k) investment fees
The investment fees are something everyone pays, and they're generally the largest component of 401(k) fees by far.
You can find your fees in your plan's literature, or on its website. They should be listed along with each individual investment fund offered as the "expense ratio."
The expense ratio is expressed as a percentage of your assets that you'll pay in fees to that particular fund on an annual basis. For example, if you invest in a "large-cap stock fund" with an expense ratio of 1%, that means if you have $10,000 of your 401(k) assets invested in the fund at the end of 2018, you'll pay $100 in fees.
Expense ratios cover the various expenses of operating an investment fund. Just to name a few of the most common, the expense ratio includes the compensation paid to the fund's manager(s), as well as the office and administrative expenses associated with the fund's day-to-day operations.
These fees can vary widely, based not only on your plan, but also on the type of fund. Specifically, actively managed mutual funds tend to charge far higher fees than passive index funds.
401(k) participation fees
In addition to investment fees, about 95% of 401(k) participants are also paying some sort of participation fees, which are commonly referred to as "administrative" fees. These cover expenses of the plan, not the individual investment funds, such as record-keeping, accounting, and legal fees.
These fees can be rolled into the investment fees listed along with the investment funds the plan offers, or they can be charged directly -- say, as $25 per year subtracted from your account.
401(k) individual service fees
These aren't mandatory fees, but since they're one of the three recognized types of 401(k) fees, they're worth briefly mentioning.
Individual service fees include anything charged for an optional service your 401(k) offers. If you take out a 401(k) loan, for example, and there are fees associated with the loan, these would fall under the individual service fee category.
What if your 401(k) is expensive?
As a final point, it's important to realize that some 401(k) plans are expensive. This is especially true for plans from smaller employers, and plans that mostly offer actively managed mutual funds.
On average, a smaller employer's plan charges 1.4% in annual fees, compared with 0.85% for mid-sized employers and 0.5% for larger employers.
Furthermore, the average actively managed stock fund charges 0.84% compared to just 0.11% for their passively managed counterparts. For bond funds, there's a similar difference -- 0.60% versus 0.10%. Over time, passive index funds end to do just as well, or better, than active mutual funds, so if your plan offers some index funds, they could be worthy of consideration -- you may be surprised how much of a difference a seemingly small difference in fees can make over time.
If your 401(k) fees are on the high end (I've seen several plans with fees of 2% or more), that doesn't necessarily mean you shouldn't contribute. As I've written before, if your employer offers any kind of 401(k) matching program, it's generally a good idea to still contribute enough to take full advantage, even if your plan's fees are high. Not doing so is literally refusing free money because of the investment fees that will be charged to it.
Having said that, if you have an expensive 401(k) and want to contribute more than your employer's matching limit, it may be a smart idea to contribute the excess to an IRA instead Even if you prefer a hands-off approach to investing, the emergence of robo-advisors and low-cost index funds have made investing easier than you might think.