Do Employers Pay 401k Fees or Do Employees?
Understand the complexities of 401(k) fees. Learn whether employers, employees, or both cover these costs and their financial effect.
A 401(k) plan serves as a widely used retirement savings vehicle, allowing individuals to contribute a portion of their earnings for future financial security. These plans offer various benefits, including potential tax advantages and employer contributions. While designed to help build retirement wealth, 401(k) plans involve various fees that can affect the growth of savings over time.
Understanding 401(k) Fees
Fees associated with 401(k) plans generally fall into three primary categories. These charges cover the operational aspects of the plan and the management of invested funds. Understanding these categories helps clarify the different components contributing to the overall cost of a 401(k) account.
Administrative fees cover the day-to-day operation of the 401(k) plan. These include recordkeeping, legal services, accounting, trustee services, customer service, educational materials, and online transaction capabilities.
Investment management fees are charged for overseeing assets within the 401(k) plan. These fees are assessed as a percentage of assets invested and are referred to as expense ratios. Expense ratios compensate fund managers and cover operational costs like marketing and distribution fees (12b-1 fees).
Individual service fees are charged to participants for specific actions. These fees apply only to those who initiate a particular transaction. Common examples include fees for taking a loan, processing a distribution, or executing specific investment directions.
Who Pays 401(k) Fees
The responsibility for paying 401(k) fees can fall on the employer, the employee, or a combination of both, depending on the specific plan’s structure. This arrangement varies significantly from one plan to another.
Employers cover some or all administrative fees. This decision can stem from their fiduciary responsibility to ensure fees are reasonable or as a means to attract and retain talent. These costs might be paid directly by the employer or through revenue sharing arrangements where a portion of investment fees covers administrative expenses.
Investment management fees, primarily expense ratios, are paid by the employee. These fees are indirectly deducted from investment returns, reducing the overall growth of an individual’s account balance. For example, if a fund earns a 7% return and has a 1% expense ratio, the net return to the investor is 6%.
Costs are shared, with employers covering certain administrative expenses while employees bear the investment-related fees. Some administrative costs may also be passed directly to employees as a flat fee or a percentage of their account balance. The specific allocation of fees is determined by the plan’s design and is communicated to participants.
Impact of 401(k) Fees
Fees, even those that seem small, can significantly impact the long-term growth of retirement savings due to the effect of compounding. A seemingly minor percentage can translate into substantial reductions in an account’s value over decades. For example, a 1% difference in fees can reduce a retirement account balance by a considerable amount, potentially hundreds of thousands of dollars over a 35-year period.
This reduction occurs because fees are continuously deducted from the investment principal and its earnings, slowing down the rate at which the money grows. Higher fees mean less money remains invested to generate future returns. Employees with higher fees may find themselves needing to save more or work longer to reach their retirement goals.
Employers also face considerations regarding fees, as offering a 401(k) plan is a benefit that comes with costs. Plan sponsors have a fiduciary duty under the Employee Retirement Income Security Act (ERISA) to ensure that all fees charged to the plan and its participants are reasonable for the services provided. This includes monitoring fees and benchmarking them against industry averages to ensure they are competitive.
Accessing 401(k) Fee Information
Employees can find detailed information about the fees associated with their 401(k) plan through several required disclosures and plan documents. This transparency allows participants to understand the costs impacting their retirement savings.
Plan administrators are legally obligated to provide fee disclosures to participants under ERISA Section 404. This disclosure outlines plan-related and investment-related information, including administrative fees, investment fees, and transaction fees. It must be provided to participants annually and upon request, including a comparative chart of investment options and their associated costs.
Employers, as plan fiduciaries, also receive disclosures from service providers under ERISA Section 408. This disclosure provides detailed information about services and all direct and indirect compensation received by service providers, helping employers ensure the reasonableness of fees. Participants can also review their periodic account statements, where fees are itemized or reflected in reduced net returns. Further details can be obtained by checking the Summary Plan Description (SPD) or contacting the plan administrator.