The Hidden Fees in Your 401(k)

The word "hidden" is doing some work here. These fees are disclosed, in documents you have been sent. They are hidden in the sense that they are expressed as percentages of assets, deducted before the return you see is calculated, and buried in a statement that arrives once a year looking like junk mail.

You cannot negotiate most of them. You can usually change which funds you hold, which is where most of the money is.

The three layers

Investment fees dominate for most people, and they are the layer you control. A plan menu commonly contains both an index fund charging a few basis points and an actively managed fund in the same asset class charging fifty to a hundred times that. Both appear on the same screen, described in similar language.

What a percentage point actually costs

The Department of Labor publishes an illustration that has been quoted for two decades because the number is striking. A worker with 35 years to retirement and a $25,000 balance, contributing nothing further, at a 7% return: with 0.5% in annual fees the balance grows to about $227,000. With 1.5% — one extra percentage point — it grows to about $163,000. That is roughly 28% less, from a difference most people would not notice on a statement.

The mechanism is that the fee is charged on the whole balance every year, including on the growth the fee itself prevented. Running your own numbers with and without the fee is a more persuasive exercise than any article.

How to find your actual numbers, in twenty minutes

1. Find the annual fee disclosure. Required by federal regulation since 2012, it lists every investment option with its expense ratio, plus the plan-level fees and what they are charged for. Search your email for "annual fee disclosure" or "404a-5", or ask HR for it by name — asking by name gets a faster answer than asking about "fees".

2. Write down the expense ratio of everything you hold. Then find the cheapest fund in the same category on the menu and write that down next to it. The difference between those two columns is the part you can fix this afternoon.

3. Check the plan-level charge. It appears either as a flat dollar amount per quarter or as a percentage of assets. A percentage-based administration fee on top of fund expenses is the arrangement most worth complaining about.

4. Look up the plan’s Form 5500. Every plan files one, and they are public. It shows total plan assets and total costs paid to service providers — useful context for whether your plan is expensive for its size.

5. Check the share class. The same fund exists in several share classes at different prices. A plan holding the retail share class of a fund that also has an institutional class is leaving money on the table, and that is a specific, answerable question to put to HR.

Revenue sharing, which is why this is confusing

In many plans, particularly smaller ones, the funds pay part of their expense ratio back to the recordkeeper to cover administration. It is called revenue sharing, and the mechanism is usually a 12b-1 fee.

The consequence is that the plan can appear to cost nothing while being expensive. Administration looks free because it is being funded out of inflated fund expenses. So a plan advertising "no administration fees" and holding funds at 0.9% may cost you more than one charging $40 a quarter and holding index funds at 0.04%.

This is also why small employers’ plans tend to cost more. Fixed costs spread across fewer assets, and the shortfall comes out of fund expenses.

What to do about it

Switch to the cheapest equivalent funds on the menu. The single highest-value action, available immediately, requiring nobody’s permission. A broad index fund at a low expense ratio is usually the best option in any plan that offers one.

Still contribute enough to get the full match. An employer match is an immediate return that dwarfs any plausible fee. Even in a bad plan, the matched portion is worth having — see what the match is worth.

Above the match, consider an IRA next. If your plan is expensive, filling an IRA with cheap index funds before contributing beyond the match is often the better order. An IRA has no plan-level fee and an unrestricted fund menu.

Roll over old 401(k)s. Accounts left at former employers are the most expensive money most people own: often a flat administration fee on a small balance, and no match to justify it. Rolling to an IRA usually cuts both layers at once.

Decline the managed account service unless you need it. An optional advice service charging a percentage of assets on top of fund expenses is one of the larger avoidable costs in a modern plan, and for a portfolio that could be a single target-date fund it is buying very little.

Raise it with HR, in writing, with numbers. Employers are fiduciaries and are obliged to monitor plan costs. A specific question — why does the plan hold the retail share class when an institutional class exists — gets traction that a general complaint does not.

One note on target-date funds

Target-date funds are the default in most plans and are a reasonable choice, but their expense ratios vary enormously. Some are funds-of-index-funds charging under a tenth of a percent; others charge well over half a percent for a similar allocation, sometimes with a second layer of fees on the underlying holdings.

If your plan’s target-date option is expensive, building the same allocation from the individual index funds on the menu costs less and takes an hour a year to rebalance. Annual rebalancing covers how.

Frequently asked questions

How do I find out what my 401(k) fees are?

Ask HR for the annual fee disclosure, sometimes called the 404a-5 notice. It lists every investment option with its expense ratio plus all plan-level charges. Your plan is required to provide it every year.

What is a reasonable total 401(k) fee?

For a large plan holding index funds, all-in costs well under half a percent a year are achievable. Small-employer plans are typically more expensive because fixed costs are spread over fewer assets. Above about 1% all-in, it is worth contributing only up to the match and using an IRA above that.

Can I avoid 401(k) fees?

Not the plan-level ones while you are in the plan. You can cut the investment layer by choosing the cheapest funds on the menu, avoid service fees by not taking loans or optional advice services, and remove old-employer account fees entirely by rolling those balances into an IRA.

Should I stop contributing if my plan has high fees?

No — contribute at least enough to capture the full employer match, which outweighs any realistic fee. Above the match, an IRA with low-cost index funds is often the better destination if your plan is expensive.

What is revenue sharing in a 401(k)?

An arrangement where the funds in the plan pay part of their expense ratio back to the recordkeeper to cover administration. It makes the plan look free while the cost sits inside inflated fund expenses.

Are target-date funds expensive?

It depends entirely on the fund. Some are built from index funds and charge very little; others charge several times as much for a comparable allocation. Check the expense ratio rather than assuming the default option is the cheap one.