How Much Does a 401(k) Cost an Employer?

A 401(k) plan serves as a retirement savings vehicle employers offer to their employees, allowing participants to save and invest a portion of their paycheck before taxes are withheld. While offering a 401(k) can be a significant benefit for attracting and retaining talent, it involves various financial considerations for the employer. Understanding these costs is important for any business contemplating or currently offering such a plan. This overview clarifies the expenses associated with providing a 401(k) to employees.

Direct Employer Costs

Employers bear several direct costs when offering a 401(k) plan, with employer contributions often being the most substantial. These contributions can include matching funds, where the employer adds a certain amount for each dollar an employee contributes, such as matching a percentage of employee contributions. Another form is profit-sharing contributions, which are discretionary amounts employers can contribute to employee accounts, often tied to company performance. Employer contributions are generally tax-deductible for the business, subject to IRS limitations, which can help offset the expense.

Administrative fees constitute another direct cost for employers. Setting up a new 401(k) plan involves one-time setup fees, which can range from $500 to $3,000, depending on the provider and complexity. Small businesses with fewer than 100 employees may be eligible for tax credits of up to $5,000 annually for the first three years to cover setup and administration costs, as increased by the SECURE Act. Ongoing administrative fees include recordkeeping, which covers tracking participant accounts, contributions, and distributions, often costing $45 to $80 per participant annually or $750 to $3,000 per year as a base fee.

Third-Party Administrator (TPA) fees cover services like compliance testing, such as tests to ensure fair contributions, and preparing IRS Form 5500. TPA fees can range from $750 to $3,000 annually, with more complex plan designs incurring higher costs. Custodial fees, which cover the safekeeping of plan assets, are charged as a percentage of assets under management, ranging from 0.01% to 0.05% annually. Plans with 100 or more participants are required to undergo an annual independent audit, with costs ranging from $8,000 to $13,000.

Employers may also consider purchasing fiduciary liability insurance to protect themselves against potential claims of breach of fiduciary duty under the Employee Retirement Income Security Act (ERISA). This insurance provides a layer of protection for plan sponsors. The cost of such insurance depends on various factors, including plan assets and the number of participants.

Shared and Employee-Paid Expenses

While employers bear many direct costs, other expenses associated with 401(k) plans are paid by employees. Investment management fees represent a significant portion of these costs, deducted directly from participant accounts as a percentage of assets invested. These fees are known as expense ratios, reflecting the annual percentage of assets charged by mutual funds or other investment options within the plan. Expense ratios can vary widely, from as low as 0.07% for passively managed index funds to over 1.00% for actively managed funds.

Other investment-related fees may include trading fees, although these are embedded within the expense ratio. Sales loads, which are commissions paid when buying or selling mutual funds, can also impact participant costs. The Department of Labor mandates that 401(k) providers disclose all fees in a prospectus, which is updated annually. This transparency allows participants to understand the charges affecting their retirement savings.

Individual employees may incur specific fees based on their actions within the plan. These participant-specific fees include loan origination fees, ranging from $50 to $200, and annual loan maintenance fees, which are $25 to $50. Fees for distributions, such as rollovers or withdrawals, can range from $20 to $150 per transaction. Hardship withdrawal fees may also apply. While these fees are passed directly to employees, employers sometimes choose to absorb administrative or participant-specific fees to enhance the plan’s attractiveness or reduce the financial burden on their workforce.

Factors Influencing Overall Costs

The total cost of a 401(k) plan for an employer is influenced by several factors. The number of plan participants directly impacts per-participant administrative fees, where larger plans may benefit from economies of scale, leading to lower per-participant costs. A higher number of participants also means a larger total employer contribution if matching or profit-sharing is offered.

The total value of assets under management (AUM) within the plan also affects percentage-based fees, such as custodial fees and administrative charges. As AUM grows, the dollar amount of these fees increases, even if the percentage rate remains constant. The choice of service model and provider significantly impacts costs. Employers can opt for bundled services, where one provider handles all aspects, or unbundled arrangements, engaging separate providers for recordkeeping, administration, and investments. Different providers, from payroll companies to large financial institutions or independent TPAs, have varying fee structures and service levels.

Plan design complexity also plays a role in determining costs. Plans with intricate features like special eligibility rules, multiple contribution types, or complex vesting schedules may require more administrative effort, leading to higher TPA or recordkeeping fees. Conversely, simpler designs can result in lower ongoing expenses. The employer’s contribution strategy is a primary determinant of total cost, as the chosen level of matching or profit-sharing directly impacts the company’s financial outlay.

Finally, the specific investment options offered within the plan affect employee-paid costs, which indirectly influences the plan’s overall value proposition. Plans offering a range of low-cost index funds result in lower expense ratios for participants compared to those heavily weighted toward higher-cost actively managed funds. Employers have a fiduciary duty to ensure that plan fees are reasonable in light of the services provided, requiring periodic review and benchmarking of costs.