If you have access to a 401(k) plan through your employer, it can be one of the best retirement savings tools in your arsenal. With its high contribution limit and many employers throwing in a matching contribution, you'll do well to put at least some of your savings into a 401(k).
But one thing savers in these accounts need to be mindful of is fees, which can be the difference between retiring with enough and having to work longer to reach your goals. While you probably won't be able to get rid of all the fees associated with your 401(k) plan, you can do a lot to minimize their impact.
The real cost of 401(k) fees
The cost of 401(k) fees comes in two forms. First, there's the actual amount deducted from your 401(k) account. On top of that, however, is the lost earnings from deducting that amount from the account. If you have to pay $100 after contributing $10,000 to your account when you're 25, for example, you'll lose out on 40 years of compounding growth on that $100.
But 401(k) fees aren't uniform across all plans. Smaller companies generally have higher costs per participant than larger plans, which can spread administrative expenses across more accounts. The average fee for a small business plan is 1.19% of assets, while larger plans charge an average of 0.88%, according to the latest edition of the 401k Averages Book.
To illustrate just how much 401(k) plans can cost you, imagine someone who diligently saves 6% of their salary starting at age 25, all the way until they retire at 65. Their company even throws in a 3% match for a total savings rate of 9%. Let's also assume this person earns an average annual return of 7% over their 40-year career.
Here's the impact of 401(k) fees on our example portfolio.
As you can see, the cost of fees can be substantial. Someone earning an average wage while working at a small business their entire career could see a $280,000 impact on their final retirement portfolio. Even if your company offers a stellar 401(k) plan -- one that charges half of the large company average -- you'll pay tens of thousands of dollars over your career in fees and lost compounding.
How to manage fees
There are three main types of fees in a 401(k) plan: administrative, investment, and individual service fees.
There's not much an individual employee can do about administrative fees. These fees go toward organizing and operating the plan. They may be a flat fee per participant or charged as a percentage of assets, potentially up to a certain cap. If these fees feel exorbitant, it may be worth mentioning to HR or the plan administrator to see if anything can be done to lower them.
Investment fees are related to the investments you choose for your 401(k), and they usually account for most of the fees paid. If you buy a lot of actively managed mutual funds, you'll likely pay more in investment fees than if you buy passive index funds. Be sure to look at the expense ratios of each fund offered in your plan documents. You may be able to find some low-cost alternatives to your current choices.
Individual service fees are one-offs charged for using special plan features like taking a loan or hardship withdrawal. These features may be worth the fee, and you should factor them into your decision to use the plan feature.
The best way to avoid 401(k) fees is to get funds out of your 401(k) as soon as you can by using a rollover IRA or potentially contributing directly to an IRA. IRAs usually have no administrative fees and much broader investment options. That means you can buy stocks or funds with minimal expense.
Once you meet your company match, you may consider prioritizing IRA contributions over increased 401(k) contributions. You should be aware of the tax considerations and income thresholds for your IRA contributions, and you may be better off sticking entirely with the 401(k) if the fees aren't too bad.
If you switch jobs mid-career, there's an opportunity for you to roll over your old 401(k) to an IRA. That will allow you to avoid paying your 401(k) fees on that money for the rest of your career.
While the 401(k) is a great tool to help you reach your retirement goals, you can get there sooner if you're mindful of the fees you're paying.
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