Cost to Set Up a 401(k) Plan
While 401(k) plans offer key benefits to both employers and employees, one factor that is often overlooked-at least by many employees-is the various costs and fees that the plan charges to both the plan sponsor (employer) and its participants.
It is important to know how much you are paying in fees to your 401(k) plan provider whether you are an employer or employee. These fees can have a material impact on both the employer’s bottom line and a plan participant’s rate of return over time.
A breakdown of the various fees that a 401(k) plan usually charges includes:
Plan administration fees:
The day-to-day operation of a 401(k) plan involves expenses for basic and necessary administrative services, such as plan record-keeping, accounting, legal, and trustee services.
A 401(k) plan also may offer a host of additional services, such as telephone voice-response systems, access to customer service representatives, educational seminars, retirement planning software, investment advice, electronic access to plan information, daily valuation, and online transactions.
In some instances, administrative service costs are covered by investment fees that are deducted directly from investment returns.
Otherwise, if administrative costs are separately charged, they will be borne either by your employer or charged directly against the assets of the plan.
When paid directly by the plan, administrative fees are either allocated among participants’ individual accounts in proportion to each account balance (i.e., participants with larger account balances pay more of the allocated expenses) or passed through as a flat fee against each participant’s account.
Either way, generally the more services provided, the higher the fees.
By far the largest component of 401(k) plan fees and expenses is associated with managing plan investments.
Fees for investment management and other investment-related services generally are assessed as a percentage of assets invested.
You should pay attention to these fees.
You pay for them in the form of an indirect charge against your account because they are deducted directly from your investment returns.
Your net total return is your return after these fees have been deducted.
Individual service fees:
In addition to overall administrative expenses, there may be individual service fees associated with optional features offered under a 401(k) plan.
Individual service fees are charged separately to the accounts of participants who choose to take advantage of a particular plan feature.
For example, individual service fees may be charged to a participant for taking a loan from the plan or for executing participant investment directions.
Other 401(k) Fees
Apart from plan administration fees, there are three basic types of fees that may be charged in connection with 401(k) plan investment options.
These fees, which can be referred to by different terms, include:
Sales charges (also known as loads or commissions):
These are transaction costs for buying and selling of shares.
They may be computed in different ways, depending upon the investment product.
Management fees (also known as investment advisory fees or account maintenance fees):
These are ongoing charges for managing the assets of the investment fund.
They are generally stated as a percentage of the amount of assets invested in the fund.
Sometimes management fees may be used to cover administrative expenses.
The level of management fees can vary widely, depending on the investment manager and the nature of the investment product.
Investment products that require significant management, research, and monitoring services generally will have higher fees.
This category covers services, such as recordkeeping, furnishing statements, toll-free telephone numbers, and investment advice, involved in the day-to-day management of investment products.
They may be stated either as a flat fee or as a percentage of the amount of assets invested in the fund.
Special investment fees:
These fees are charged by specific types of investments.
For example, most variable valuation that are used inside 401(k) plans charge an annual maintenance fee (that is often waived for balances above a certain amount) as well as mortality and expense fees for the insurance-based element of the annuity.
Target-date funds are funds that reallocate the balance of funds within the larger fund to a more conservative mix over time as the fund’s target date approaches.
This type of fund may assess an additional fee on top of the fees assessed by each of the individual funds within the larger fund.
Statistics show that smaller plans often charge much higher fees than large plans.
Plans with more than $100 million in assets often charge fees in the half-percent per year range, while funds with less than $50 million in assets may charge at least 2% per year in total fees and expenses.
Plan participants can easily find out how much they are paying by looking in their plan prospectus, which must be furnished by their plan sponsor or administrator at least once a year.
Cost to Set Up a 401(K) Plan FAQs
What Is a 401(k) Plan?
The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k).
Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.
Traditional 401(k) vs Roth 401(k)
The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978.
With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn.
Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006.
Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free.
Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings.
Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.
Contributing to Your 401(k) Retirement Plan
Contributing to a 401(k) plan is traditionally done through one’s employer.
Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion.
If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade.
If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion.
To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn.
With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them.
Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire.
If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term.
You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket.
On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true.
In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up.
Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change.
A smart move may be to hedge your bets and divide your contributions between the two types of IRAs.
If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each.
In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other.
When you do decide which avenue to take, make sure to thoroughly evaluate your decision.
Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible.
Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky.
You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.
Pension vs 401(k)
If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement.
There is typically no option to grow this amount, but it also does not require any financial investment from the employee.
Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer.
401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.
How Much Should I Contribute to My 401(k)?
Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k).
There are limits on how much you can contribute to it that are outlined in detail below.
There are two methods of contributing funds to your 401(k).
The main way of adding new funds to your account is to contribute a portion of your own income directly.
This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)).
The system mandates that the majority of direct financial contributions will come from your own pocket.
It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return.
The second method comes from deposits that an employer matches.
Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee.
However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan.
This is especially important to keep in mind if you want to utilize both types of plans.
A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year.
For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000.
If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions.
The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.
Plan in Advance
401(k) Plan FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.