A 401k plan generally involves four parties: the contributing employees, the sponsoring employer, a plan administrator, and various investment advisors.
A 401k plan aims to grow employees’ contributions through investments for retirement. To better manage a plan’s ongoing operation, once the plan has been set up by the employer for employee participation, the employer will usually appoint a plan administrator to take care of the plan with tasks such as recording keeping and accounting, providing customer service, giving educational seminars, etc…
But the actual investment of the plan contributions are managed by a group of investment companies, such as mutual fund brokerages (Vanguard, Fidelity, and ShareBuilder are a few), that the plan administrator has contracted with.
There are two major 401k fees in connection with plan administration and investment management.
Plan Administration Fees
The plan administrator is a separate entity hired by the employer and it charges plan administration fees for providing its services. The plan administration fees cover the expenses of the day-to-day operation of a 401k plan. In addition to providing basic administrative services, the plan administrator also serves as the contact agent between plan participants and investment managers. Therefore the fees are also paid for services like online trade transactions, daily investment account valuation, investment advice, and other online access to plan’s investment information.
Plan administration fees may be deducted against plan assets. Depending on the a person’s account size, the fees are charged to the account accordingly. Generally, the more services a plan administrator provides, the higher fees it charges. Some plans also offer individual services beyond the overall administrative services and a fee called individual service fees is charged separately to the accounts of the individuals who request such services, for example, taking out a 401k loan.
A 401k plan’s Summary Plan Description, or SPD, describes how administrative fees are spread out over all accounts. A person’s annual account statement may show the administrative expenses charged to his account. The plan’s annual report also lists the aggregate administrative fees paid by the plan.
Investment Fees
Investment fees are expenses of managing plan investments by investment advisors and assessed as a percentage of the total assets invested. Investment fees are further classified as sales charges and management fees.
Sales charges, also known as loads or commissions, are transaction costs of buying or selling, say, mutual fund shares. A typical 401k plan offers a number of investment choices featuring, for example, mutual funds from different fund companies. From time to time, participants may self-direct their investments by shifting account balances among available mutual funds in the plan. Each fund may have different kinds of sales charges such as front-end load, back-end load, or no load.
Management fees are the investment advisory fees, and they also cover the investment manager’s administrative expenses. Management fees vary among different investment companies and the kind of products they offer. Investment products that require active management and research by investment advisors will have higher fees.
Investment fees are normally deducted from an account’s investment returns and thus are an indirect charge against a person’s account in that the fees may not be separately identified in account statements. Even though no investment fees are shown, a person’s total investment returns are reduced after the fees. The plan administrator should provide information about management fees in connection with each investment alternative and transaction fees each time a person directs investment transactions.
Yes, you have to keep track of, and know these fees. Your fund(s) may have one return but your actual return may be lower due to fees.
A person should pay attention to fees of a 401k plan, both the plan administration fees and investment fees.
A small difference in the fees charged can result in substantial losses in total investment returns over the years.
Yes, it is a way for investment managers to make more money. They are expensive because they take the work off of you to manage your own portfolio, and for that a higher fee is considered to be paying for this extra service. This does not mean these funds will do better than you could, but at least you won’t have to worry about re-balancing and adjusting your allocations every 6-12 months.
Good explanation of the various fees that are generally paid by plan participants. As you are likely aware, as of July 1, 2012 (unless they move the date again) plan sponsors (via their outside plan administrators in most cases) are required to provide plan participants with reporting about the fees that they pay via the plan. I’ve seen a couple of examples of what this will look like via some of the plan providers I deal with, but I imagine some versions will be better than others. In any case plan participants should review and do their best to understand this data. In some cases this will be an eye opener. I’ve already seen some companies make adjustments to the plan in anticipation of this new era or disclosure.
Hopefully the new rules on plan fees will open up some awareness for employees and HR folks. As great as 401(k)s are, there are many that are laden with fees and poor fund choices.