The expense ratio of a 401(k) plan is the amount an investment company charges investors for managing the fund. A total of administrative fees for the fund’s expenses, this rate is usually stated as a percentage-per-year.
In general, the lower the 401(k) expense ratio, the better. But it’s tough to say what paying too much might be. That answer lies in trying to assess how much an investor should be paying and what typical rates are. A July 2019 CNBC article found that 95% of 401(k) investors pay fees associated with their plans, with the national average for 401(k) fees .45% of all total invested assets.
To help determine whether a 401(k) expense ratio is good or even reasonable, there are a few facts and strategies investors might want to look into.
What Are Reasonable Fees for a 401(k)?
401(k) expense ratios are calculated by dividing a fund’s operating expenses by the average total dollar value of all assets in the fund.
Expense ratios can vary among plans for a variety of reasons, including how the 401(k) account is managed. In passively managed funds (where a portfolio mirrors a market index), the expense ratio should typically be lower as compared to actively managed funds which is roughly between 0.5% and 1.0% (where a fund manager employs different buying and selling strategies). Generally, this is because more work is being done on the manager’s part in an active strategy vs. a passive strategy.
Over time, just one or even half a percentage point could potentially make an impact on a retirement account. That impact could in turn mean the difference between retiring when planned, vs. working a few more years until the overall investment grows. A lower expense ratio could help an investor maximize their 401(k).
For example, a Government Accountability Office analysis found that someone who invests $20,000 every year for 20 years in a 401(k) plan that costs 1.5% per year to operate is likely to end up with 17% less than someone whose plan costs just .5%. The analysis concluded that after 20 years, that half a percentage point meant the difference of more than $10,000.
How To Reduce Your Expense Ratio
Before an investor can attempt to reduce their expense ratio, they need to be familiar with what it is.
Until relatively recently 401(k) expense ratio information was not public, and even now it can be somewhat difficult to locate. In 2007, the Securities and Exchange Commission (SEC) approved an amendment requiring the disclosure of these fees and expenses in mutual fund performance and sales materials.
Today, there are a few ways to get the information—and take action:
- Read the fine print. Look closely at 401(k) participant fee disclosure notices, which participants should receive at least annually with any plan. Or look for the current information in a funder’s prospectus on their website. Building on the 2007 amendment, the DOL introduced a rule in 2012 to improve transparency on the fees and expenses to workers in 401(k) retirement plans.
- Refer to expert sources. Today, many websites and trusted resources, like Bloomberg, have guides with comparisons on the rates and overall generosity of 401(k) plans.
- Ask outright. Investors seeking more information might also choose to call their fund’s client services number directly to get the most up-to-date lay of the land. Investors who work with a financial advisor can also ask their advisor for this information, as well as their opinions on these expenses.
401k Red Flags
Armed with information, investors can feel empowered to read these hard-won disclosures for any potential red flags:
- One issue, for example, would be corrective distributions—or when a company returns a portion of its 401(k) distribution made by highly-compensated employees (HCE).
- In and of themselves, corrective distributions aren’t a big deal, but if they occur frequently, it could indicate that the plan isn’t being carefully monitored by those at the helm, or the sponsor might not be as attentive to the plan’s requirements as they should be.
It can also be helpful to periodically look at the funds being offered by an employer, provider, or broker to see if there is a similar fund that comes with fewer expenses. For example, Charles Schwab has an average 0.04% expense ratio, relatively lower than the majority of brokers out there.
For investors whose 401(k) plan is not through a current full-time employer, they may also want to look at offerings from other brokers, as switching may offer enough of a savings to be worthwhile.
There’s no magic number that indicates a 401(k) expense ratio is too high or just right, although knowing the most recent average 401(k) fees can help give context.
Under federal law, employers have a fiduciary duty to offer reasonably priced options and to monitor the quality of the 401(k) plan they offer. The more an investor knows about their current plan, the better equipped they are to make compelling arguments for how to improve their plan.
A 401(k) is only one piece of the retirement puzzle. There are many ways for an investor to reach their financial goals.
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