Enrolling in a 401(k) plan is like getting hold of a cheat code for retirement: Not only is it tax-advantaged, but it often includes a company match.
It’s true that 401(k) plans can be immensely helpful to building your retirement portfolio. But not all 401(k) plans are equal. Some companies offer a dollar-for-dollar match, and others offer 50 cents on the dollar. Some offer to match up to 3% of your income, and some offer 6%.
Even if you pay attention to those details, you may not have considered the impact of your company’s 401(k) fees.
Table of Contents
- How Much Do 401(k) Fees Really Matter?
- Defining an ‘Expensive’ 401(k) Plan
- What To Do if Your 401(k) Fees Are High
- How To Figure Out Your 401(k) Fees
How Much Do 401(k) Fees Really Matter?
It may seem like the difference between fees of 0.25% and 0.75% isn’t a big deal. But over decades, with large sums of money, that seemingly negligible difference can make a huge financial impact.
Assuming a 6% annual return and a combined $20,000 in annual contributions for 30 years, the difference between 0.25% and 0.75% in fees is $140,215.46.
|Annual Investment*||Years||Annual ROI||Expenses||Total Fees||Net Value|
*This hypothetical includes your contributions plus your employer’s match.
Defining an ‘Expensive’ 401(k) Plan
Now that, you understand the difference that fees can make, you may be wondering what defines a “good” amount of fees to pay for a 401(k) plan?
You’re actually paying two separate fees when you hold a 401(k) account balance.
First, you’re paying an administrative fee to the entity that oversees your account. Second, you’re paying what’s known as an expense ratio. If you have a 1% expense ratio on a $200 investment, you’d owe $2 plus a set administrative fee.
Money expert Clark Howard has a clear target in mind.
“If your expenses all-in on your 401(k) are higher than 0.5% — the expenses of the investments you’re in plus whatever administrative costs the employer passes on — you can do your own Roth IRA a lot cheaper,” Clark says.
What To Do if Your 401(k) Fees Are High
Let’s explain that last bit further. No matter what your 401(k) fees are, Clark wants you to contribute enough to the plan to qualify for the full company match.
“Unless you’re at a point that you’re facing a bankruptcy filing or you’re going to be evicted or you’re going to have your car repossessed, you want to put into a 401(k) at least enough to get the match,” Clark says.
“That’s free money. It’s always befuddled me people who don’t pick up the free money. How often in life is there free money to take that there’s no scam involved with it?”
If your company offers a low-cost 401(k) plan, your next step to fund your retirement is to contribute to your 401(k) even past the company match, all the way up to your annual 401(k) contribution limit.
4 Steps To Follow if Your 401(k) Fees Are Expensive
1. Secure the Company Match
If you’re facing annual expenses of more than 0.5%, Clark says to contribute just enough to receive the company match and not a dollar more.
2. Open a Low-Cost IRA
If you have additional money to invest, find a low-cost IRA provider (Fidelity, Schwab and Vanguard are great options) and contribute until you reach your contribution limit there. Clark prefers a Roth IRA to a traditional IRA.
3. Contribute to an HSA
Once you’ve maxed out your IRA contributions, Clark recommends that you put money into an HSA (if your company offers one). An HSA is a Health Savings Account that offers a triple benefit in terms of taxes and investing.
4. Add to Your 401(k) or Open a Brokerage Account
Have even more money to invest? Kudos to you. You’re doing well. In your case, you can either return to your high-cost 401(k) and max out there or open a taxable brokerage account and invest in low-cost or free funds such as the Fidelity Zero funds.
How To Figure Out Your 401(k) Fees
Now that you know what the magic number is in terms of annual expenses, you may want to check on how much you’re actually paying.
If you log into your 401(k) account online or review your company’s documentation on its 401(k) investment options, you should be able to determine the expense ratio of your investment(s).
Calculating your expense ratio is easier if you follow Clark’s primary investing advice and put all your 401(k) money into a single target date fund.
Finding the administrative fees can be trickier, even if you locate the fine print and comb through it carefully.
The communication you received from the company when you set up your 401(k) account should contain the number. But if you don’t have that, you should be able to reach out to your 401(k) plan administrator to find out.
“If you’re with a very large employer, odds are they’re going to have an extremely low-cost 401(k),” Clark says. “If you’re with a smaller employer, an employer with less than 500 employees, usually it’s going to be cheaper to pick up the employer match and then do your own Roth IRA.”
Contributing to your 401(k) is almost always a great idea especially if your company offers a match. But it’s important to know whether your 401(k) is particularly expensive.
If it is, you may be able to save huge sums of money by investing only up to your company match and then avoiding those fees by putting additional dollars elsewhere.