401(k) Fees: You'll Pay Now or Pay Later, But You Will Pay

401k
For most people, a 401(k) is almost an ideal investment. Simply by filling out the paperwork for a typical plan, you get:
  • Autopilot investing with every paycheck
  • An immediate tax deduction
  • The possibility of an employer match
  • Tax-deferred compounding
  • Decent diversification
Plus, it's all in one convenient package, administered by your employer.

The only problem is the costs. 401(k) plans are not cheap to manage. Unlike with a typical brokerage account or even an IRA, there are some fairly complicated rules your employer has to follow to assure the 401(k) plan stays in compliance with the law.

That costs money -- money that's above and beyond typical investing fees like mutual fund management fees and trading commissions. And guess who frequently gets stuck with the tab for compliance and other administrative costs?

How Do You Prefer to Pay?

While employers are allowed to pass on administrative costs to participants, the big question is how they pass them on. There are generally two methods employers follow. Both methods have advantages and disadvantages, and depending on your personal situation, you'll likely strongly prefer one method over the other.

1. Everyone pays the same amount: The biggest advantages of this method are that it more closely matches what's driving the costs -- the number of people in the plan -- and that it's far simpler to calculate each person's fee. In essence, the statement mailings and the regulatory compliance testing just care if you're participating and how much you're contributing, not what your balance is.

The effort to comply is essentially the same whether you've got $1,000 or $1,000,000 in the plan.

The key disadvantage of that method? It can be an incredible disincentive to a person who's just getting started in the plan.

Say you're just out of college with a $40,000-a-year salary, and you want to put away 5 percent of your paycheck. That's $2,000 -- of your hard-earned cash -- going toward your retirement. If your employer charges each participant $100 a year, you lose 5 percent of your first year's contribution to that administrative fee. A charge that large might make you reconsider getting started at all.

2. Everyone pays in proportion to his or her balance: The biggest advantage of this method is that it doesn't discourage new investors from participating. If you're just getting started, using the same assumptions as above, your charge might wind up at $4 for the year on a $2,000 balance (0.2 percent of your balance), rather than the $100 price tag from charging everyone the same.

Of course, on the flip side, the disadvantage is that the proportional charge can get downright painful near the end of your career. Say you've amassed a cool $1,000,000 balance near the time you're ready to retire. Using the same 0.2 percent proportional allocation method, you'd be paying $2,000 a year for the privilege of keeping your money in your 401(k). That's a pretty big chunk of change -- even for a millionaire -- to pay for what amounts to some basic recordkeeping and compliance testing.

Go Big or Go Home

For any investor with a long-term perspective, the first option is clearly the better choice. Even a $100-per-person-per-year fee is less than 1 percent of the first-year maximum contribution that person can make (the limits are $17,000 in 2012 and $17,500 in 2013). If you're at all fee-conscious, a flat charge like that would likely encourage you to put as much away as you possibly can, so that a bigger share of your money stays working for you -- rather than getting eaten up by fees.

In many respects, when it comes to your financial well-being in retirement, the act of investing matters as much as the rate of return you earn on your investments. The more money you regularly put away, and the longer you let that cash compound, the better off you'll likely be in retirement, virtually no matter what the market does along the way.

In the end, regardless of how your company's 401(k) charges its fees, it's hard to beat the tax benefits, potential of a company match, and just plain direct-from-the-paycheck convenience of participating in the plan. Because of those benefits, in spite of the fees, your 401(k) remains a great place to amass a retirement nest egg to take you through your golden years.

Chuck Saletta is a contributing writer to The Motley Fool.

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42 Comments

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anthony_rogers33

Steidle Pension Solutions has been handling my 401k Plan for 3 years. They help me keep the cost low and charge much less than other third party administrators. I would highly recommend them to other small business owners.

December 05 2012 at 2:41 PM Report abuse rate up rate down Reply
1 reply to anthony_rogers33's comment
jr42coburgsomar

Thank you for the news, are you being compensated for your comment??, no one care as one should do their own homework rather than having an advertisement used in this section for a company.

January 12 2013 at 7:51 AM Report abuse rate up rate down Reply
jposhea1

This is not always true. Many employers absorb the cost and do not pass expenses on to the employees!!

December 03 2012 at 10:07 PM Report abuse rate up rate down Reply
pdbliz

In the old days,,,,people put money in a tin can or a fruit jar,,,buried it in the back yard,,,,,IT WAS SAFE FROM THE GOVERMENT.!!!
May be,,the old folks had a good idea.!!!!!

December 03 2012 at 8:55 AM Report abuse +3 rate up rate down Reply
fuss1

There is actually talk going on in our Government about confiscating everyone's 401k money and putting it into Government pooled funds that invest in our treasuries and pay a whopping 3% annual interest rate. This is no joke.
Is this what you want, America? Demand that gov't keep their mitts off your hard earned and saved money! Restore freedom and liberty before it's too late!

December 03 2012 at 7:43 AM Report abuse rate up rate down Reply
2 replies to fuss1's comment
pdbliz

fuss1,,,,,,THIS is not just talk,,,it has been written in the Health Care Law..........There are so mush in the Obama Care Law that has in the open...
PEOPLE,,OPEN YOUR EYES BEFORE IT IS TOO LATE.!!!!!!!! STOP THIS GOVERMENT TAKE OVER.!!!!!

December 03 2012 at 8:53 AM Report abuse -2 rate up rate down Reply
tj1108

Look at the election we just had. Of course thats what america wants, 100% Goverment and thats what we are going to get. I lost all hope in the country on Nov 6th. No one under 40 seems have any confidense in themselves and want the Govt to reinforce their safety net. there used to be a phrase " its a free country" but I think thats long gone.

December 03 2012 at 10:43 AM Report abuse -1 rate up rate down Reply
HELLO TOMMY

401-k plans are good but when you close it out the gov. laughs and you cry

December 02 2012 at 10:10 PM Report abuse +1 rate up rate down Reply
Jim

This information wasn't worth the paper it was printed on. What's the point?

December 02 2012 at 9:50 PM Report abuse rate up rate down Reply
Mikerat42

Guess what, we put $18,000 away in a 401K every year and it has been gaining 15% If we lose a little because of taxes or fees, we will still have money left. What will all of the smart mouths who save nothing but complain anyway have??

December 02 2012 at 5:10 PM Report abuse -2 rate up rate down Reply
1 reply to Mikerat42's comment
Phillip

If you had put that money in a fixed annuity, you probably would have almost twice as much w/ no fees.

December 02 2012 at 11:53 PM Report abuse rate up rate down Reply
trucker9635

you must understand that the libs are ok with oboma care ,they do not care because it will not affect the majority of them,they have government insuance that is paid with the tax dollars

December 02 2012 at 3:09 PM Report abuse -2 rate up rate down Reply
1 reply to trucker9635's comment
billybuttlooker

that crap started under bush quit crying

December 02 2012 at 4:03 PM Report abuse rate up rate down Reply
fisherdude47

Don't wait till your in your mid 60's and want to take some money out of your 401k after you say retired, be prepared to pay a nice percentage of money for taxes. Pay the gov now or later they stil lget your money

December 02 2012 at 1:23 PM Report abuse rate up rate down Reply
1 reply to fisherdude47's comment
abziegler

When you take it out later you will be paying a lower tax bracket. I pay 18% instead of 33% and no state tax on the 1st 20,000. Plus you are putting away $100 but only paying 66 for all those years as the interest grows tax free. The payoff is better than a small fixed rate. The longer you can wait to take the money the less the tax rate and if you are a vet you get a bigger break!

December 03 2012 at 10:10 AM Report abuse rate up rate down Reply
1 reply to abziegler's comment
pozboys

When you take out money from a 401k, you must pay, up front, 20% taxes! Its only after you file income for the year, adding the whole amount, of what you withdrew, to your yearly income, that you find, what you a getting "nailed for", by the IRS! Believe it, it is not in your favour, no matter, what your age!!!

December 03 2012 at 10:45 AM Report abuse rate up rate down
Iselin007

We all need some help so remember this song " I got you babe" :)

December 02 2012 at 11:53 AM Report abuse +1 rate up rate down Reply