What Is Your 401(k) Really Costing You?

Question: I have both an IRA and a 401(k) account. I know how to figure out costs associated with the IRA, but how do I determine what my 401(k) plan is costing me?

Answer: Figuring out who foots the bill for your 401(k) plan is a noble but, at present, complicated pursuit. Many workers who participate in 401(k)s just assume the plan costs them nothing outside of what their funds charge, but this is often untrue. Finding out what your plan's fees are is a good idea, especially given that funds may be held in a 401(k) for decades, making the impact of high fees that much greater. In fact, the Department of Labor estimates that an employee with $25,000 in a 401(k) account earning 7% per year and fees and expenses of 0.5% would have $227,000 after 35 years. But in a plan charging 1.5% in fees and expenses that amount drops to $163,000, or 28% less than with the lower-fee plan.

You might be wondering why 401(k) plans need to charge non-investment-related fees at all. These go to cover services such as record-keeping, mailing out plan documents, maintaining the website, and paying that friendly customer-service person who answers the phone when you have a question. How these costs are covered varies by plan, but they are usually shared by both employer and employee. The fees might take the form of direct payments from the employer or employee(s) to the plan administrator, they might be baked into the costs of the underlying investments, or they might be paid through a combination of these. Rolling administrative fees into investment fees is common. So, for example, when you put money into a mutual fund through your 401(k), a portion of the expense ratio you pay on that fund might go to the plan administrator as part of its compensation for running the plan. If a fund or funds offered through your plan have unusually high expense ratios (1.5% or greater) it could be because they include plan administrative fees. Regardless, such a high cost to invest in the fund should raise a red flag.  

Bigger Plan, Lower Fees
Now that you know why and how plans charge fees, let's turn to your situation. In general, the larger the plan--both in terms of number of participants and assets--the lower the fees. The reason for this is simple: With larger plans there is an economy of scale that allows fixed costs to be spread among a larger pool of participants and assets than with smaller plans.  

To determine what your employer's 401(k) plan costs to run and who pays for it, the best thing to do at this point is ask your employer's human resources department for a copy of the Summary Plan Description, a document that lays out how the plan operates, including administrative fees. You might see these fees expressed as percentages or as dollar amounts, which you can then divide by the total assets in the plan (also available in the Summary Plan Description) to arrive at a percentage. By multiplying this percentage by the amount in your 401(k) account you can estimate how much you are paying annually to the plan. If you have trouble finding this information, ask someone from human resources to help.

If your 401(k) plan charges you based on a percentage of assets held in the account, as opposed to a flat fee per participant, this means you might be paying quite a bit more in administrative fees than someone with a much lower account balance. So, for example, a participant with a 401(k) balance of $300,000 in a plan that charges 0.5% of assets for administrative fees would be paying $1,500 per year for those services, whereas a participant with $10,000 in the plan would pay just $50. Administrative fees above 0.5% are considered a sign of an expensive plan.

New Rules Should Help
Although this process might seem cumbersome, there is good news on the horizon. At the end of August, new federal transparency rules governing 401(k) plans are set to take effect. Among these new requirements are easier-to-use 401(k) statements that spell out how much participants are paying in investing and administrative fees. (Plan Sponsor Council of America president David Wray recently answered our questions about the new fee disclosures, and you can read the interview here.)

When evaluating the quality of your employer's 401(k) plan remember that administrative fees, while important, are only one piece of the puzzle. Plans also charge fees for individual services such as taking out a loan against an account. But perhaps the most important consideration is the quality and cost of the funds in the plan. A low-cost plan with subpar or expensive funds is still no bargain. Christine Benz, Morningstar's director of personal finance, provided a list of questions to ask if your employer offers a lousy 401(k) plan.

Fortunately, 401(k) plans tend to offer funds that are cheaper-than-average. In 2008, the average 401(k) stock fund had an expense ratio of 0.72%, compared with an average of 0.84% for all stock funds, a study by Deloitte and the Investment Company Institute found. Likewise, the average 401(k) bond fund had an expense ratio of 0.52% compared with an average of 0.63% for all bond funds.

Even if your employer's 401(k) plan turns out to be on the pricey side, it might still be worth contributing at least enough to get any company match. After all, the guaranteed rate of return the match provides should more than offset the high fees that the plan charges. Then you can take any other funds you would have contributed to the 401(k) and open an IRA with low-cost funds.

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