If you direct your own 401(k) plan investments you’ll need to consider the investment objectives, the risk and return characteristics, and the performance over time of each investment option offered by your plan in order to make sound investment decisions. Fees and expenses are factors that may affect your investment returns, and therefore impact your retirement income.
Why Should I Care About Plan Fees?
In a 401(k) plan, your account balance will determine the amount of retirement income you will receive from the plan. While contributions to your account and the earnings on your investments will increase your retirement income, fees and expenses paid by your plan may substantially reduce the balance of your account.
Assume that you’re an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7% and fees and expenses reduce your average returns by 0.5%, your account balance will grow to $226,556 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5%, however, your account balance will grow to only $162,846. The 1% difference in fees and expenses would reduce your account balance at retirement by 28%.*
The following table demonstrates how varying levels of fees and expenses can impact the growth of a hypothetical 401(k) plan account after 35 years, assuming a $25,000 starting balance, 7% annual return before expenses and fees, and no additional contributions.
How Do I Learn About My Plan’s Fees?
The first step is to become informed about the different types of fees and expenses charged by your plan, and the way they are allocated to plan participants. The best way to do this is to study the fee disclosure information that your 401(k) plan provides to you.
By far the largest component of 401(k) plan fees and expenses is associated with managing plan investments. Your disclosure statement should clearly indicate the total annual operating expenses of each investment option. For example, in the case of a mutual fund, these operating expenses may include investment management fees and 12b-1 fees. These fees are charged against the assets of the fund and reduce the fund’s total return. The annual operating expenses will be shown both as a percentage of assets (expense ratio) and as a dollar amount for each $1,000 invested. For example, a fund may have an expense ratio of.15%, or $1.50 for each $1,000 invested. In this case, $10,000 invested in the fund would cost $15.00 annually (10 times $1.50).
Your plan’s disclosure material will also describe any shareholder-type (transaction) fees that apply to each investment option–things like sales charges and loads, withdrawal fees and surrender charges, and fees to transfer between investment options.
Your plan must also provide a chart that lets you easily compare information about each investment option. For example, if your plan allows you to choose among different mutual funds (or from different families of mutual funds), the difference in fees and expenses may help you choose between two or more funds that are otherwise similar in performance and investment strategy.
The day-to-day operation of a 401(k) plan also involves expenses for basic services–plan record keeping, accounting, legal and trustee services–that are necessary for administering the plan as a whole. Sometimes employers pay these expenses. Sometimes they’re paid by the plan, and either allocated to all participants in proportion to account balances (that is, participants with larger accounts pay more of the allocated expenses) or charged as a flat fee to each participant’s account. Your fee disclosure should contain an explanation of any fees and expenses that may be charged to participants’ accounts. You’ll also receive an explanation of any fees and expenses that may be charged to your individual account–for example, fees for taking out a loan or processing a qualified domestic relations order.
Remember that fees and expenses are just one factor to consider when choosing an investment for your 401(k) plan account. You’ll also need to consider your asset allocation and your goals. All things being equal, minimizing the fees and expenses you pay to your 401(k) plan may help you increase your retirement nest egg–so be informed and review all your options carefully.