Okay, let’s say this plainly: when it comes to 401(k) fees, a lot of participants are paying way too much. And one of the biggest reasons for this is because, for many plans the 401(k) expense ratios are way too high.
But if you’re reading this post today, you might be wondering: what the heck is a 401(k) expense ratio? What are participants paying on average, how does my plan stack up, and what can be done to lower these fees?
If you find yourself asking any of these questions, not to worry - you’ve come to the right place!
In this post, we’ll quickly break down what 401(k) expense ratios are and why they matter. Then we’ll walk you through the latest data on average fund fees, and end with insider tips sourced from industry experts on how you can lower fund fees for your plan.
By the end of this post, you’ll be well on your way to lowering your plan’s average expense ratio and saving you and your employees a lot of money.
Ready to get started? Let’s jump right in!
What is a 401(k) Expense Ratio?
Your 401(k) expense ratio is the percentage of retirement fund assets that plan participants pay for their investments. The total expense ratio can cover the administrative fees, operating expenses, recordkeeping fees, management fees, and marketing (12b1) fees, as well as all other investment fees and expenses.
Essentially, the 401(k) expense ratio is the entire asset-based fee you and your participants pay for the plan - which, again, can include both investment costs AND recordkeeping costs.
However, for the purpose of this blog post, we’ll use the term 401(k) expense ratio to talk about only investment costs.
Here’s a quick example of how fund expenses impact investor return:
A fund’s expense ratio is 1% a year, and the fund reports an annual asset increase of 7%. This means the plan provider takes 1% of the investor’s assets off the top, which nets out to a 6% annual return for the investor.
|Annual Asset Increase||Expense Ratio||Annual Net Return to Investor|
That’s a pretty clear-cut description of the expense ratio and how it works - but since it’s expressed as a percentage, it can be difficult to understand how the expense ratio impacts your actual retirement savings. We’ll talk about that next.
High 401(k) Expense Ratios Can Demolish Your Retirement Savings
Ouch. Demolish might seem a bit intense, but we are talking about the harsh truth that over 35 or 40 years, high 401(k) expense ratios can erase thousands - even hundreds of thousands - of dollars from your retirement savings.
For a plan sponsor, imagining that impact for a large number of employees is particularly stressful.
So, how exactly does that savings demolition play out? In the chart below, we’ve laid down the impact of various expense ratios on retirement plan assets over the long-term.
For simplicity, we’ve assumed 40 years of saving, $10K saved every year, and a 7% annual return every year (well done, hypothetical economy!).
|Plan A||Plan B||Plan C|
|Gross Annual Return||7%||7%||7%|
|Net Annual Return||6.89%||6.30%||5.66%|
|Assets in Year 40||$2,007,474||$1,721,912||$1,461,662|
|Difference from Plan A||-||-$285,562||-$545,812|
|Shortfall in Assets in Year 40 vs. Plan A||-||-14.2%||-27.2%|
Hearing “your 401(k) expense ratio is 1.34%” probably doesn’t trigger panic sweats in the average plan participant. But if the same fee impact is phrased as “you’ll have half a million less in your savings” - it should set off some seriously loud alarm bells.
And it should - this is your retirement, after all. Think of what that $545,812 could mean in your golden years...
We often say: high fees defeat the purpose of having a 401(k). A study by Yale University showed that high fees may effectively negate the tax advantage of their company’s 401(k) for some young investors!
Truly, the last thing a company-sponsored 401(k) plan should do is incentivize employees to save elsewhere, like in an IRA.
Average 401(k) Expense Ratios - How Does Your Plan Compare?
One of the first steps in getting low expense ratios is evaluating how your plan stacks up against others of similar size. Here are the most recent average 401(k) expense ratios from the 401(k) Book of Averages.
|Number of Participants||Average Expense Ratio|
Now naturally, these are averages, and your plan’s actual expense ratio could be quite a bit higher or lower. In truth, costs can vary widely from plan to plan.
In fact, the 401(k) Book of Averages found that a company with 10 employees could pay anywhere from 0.25% annually on the low end to 1.92% on the high end. ForUsAll clients of all sizes on our recommended fund lineup generally only pay 0.11%.
All of this is to say that, though 401(k) expense ratios can be wildly different for different plans, with the average being 1.34%, most are paying way too much.
So… why are 401(k) expense ratios are so high?
Much of the total expense ratio depends on the types of funds chosen by the plan sponsor or their advisor. Actively-managed funds often have significantly higher fees than passively-managed funds.
Mutual fund share classes can also have an impact on the fund’s expense ratio, as some classes may carry additional fees - like the notorious 12b-1 fee.
Really though, with high quality passive investments being so readily available, you should be able to select funds with closer to a 0.20% average expense ratio.
How to Lower 401(k) Expense Ratios
The good news (or silver lining): there are a few simple things you can do to lower your expense ratio:
1. Build a low-cost fund lineup.
Thankfully, this isn’t all that hard to do. Replace high-cost actively-managed funds with passive index funds or target date funds - which will almost always have lower fees.
A few examples of solid-performing funds with delightfully low expense ratios are:
- Fidelity Total Market Index F - 0.02%
- Vanguard Target Date Fund 2035 - 0.14%
- Schwab S&P 500 Index - 0.03%
2. Remove funds that have 12b1 fees.
If high mutual fund expense ratios are concerning to you, then paying an investment company a little extra to help their marketing effort might not be in your best interest. Remove mutual funds that charge 12b1 fees and keep that money for yourself.
3. Shop around!
Fund options change all the time, and if you haven’t re-evaluated your situation in a while, there’s a good chance you’ll be able to select cheaper funds with similar or better performance.
401(k) expense ratios can be devastating to your retirement accounts, but dealing with these fees can be boiled down to a couple, simple questions:
- Is my 401(k) expense ratio too high?
- What am I going to do about it?
In this article, we’ve given you the tools to answer both questions. Now it’s up to you.
Remember, even a small reduction in fees can mean thousands in additional savings down the line. And on the flip side, high fees can obliterate years and years of hard work and frugality. As all of us who deal with planning for retirement know - now is the time to actually make the most for your retirement.