401(k) Plan Fee Disclosure
The types and amounts of fees that are charged by a 401(k) plan can impact on the total return earned by plan participants, particularly over long periods of time.
For this reason, it is vitally important for plan participants to know how much they are paying in fees each year (or quarter or month) so that they can make informed investment decisions.
The Department of Labor requires all 401(k) plan sponsors to furnish their participants with a prospectus at least once every 14 months that provides a comprehensive breakdown of all fees that are charged by the plan, and when they are charged for non-recurring events, such as moving money from one fund to another.
This is fulfilled in the form of a 404(a)(5) participant fee disclosure.
The plan administrator will create this document and then pass it on to the plan sponsor.
The sponsor then has the responsibility of sending this to each employee in the plan.
The disclosure can be sent via email or snail mail.
Email is usually the preferred method, but all plan participants have to have either access to a computer or have opted in for email notification.
401(k) Fee Disclosure Form
The fee disclosure form is sent to all new participants when they first join the plan and all current participants about once a year.
This form must break down three types of fees that are charged within the plan, which are listed as follows:
- General plan information – breaks down the basic information about the plan and its general features, such as matching contributions, vesting schedules, loan provisions and other similar features.
- Administrative fees – These are the fees that are charged for record-keeping, accounting, plan statements, the customer telephone service center, etc.
- Participant fees – This includes fees such as an annual plan administration fee, fees that are charged for taking out a loan, moving money from one investment choice to another, and other miscellaneous plan services.
- Investment fees – These fees can differ widely from one plan to another, depending upon the types of investment choices that they offer. Many plans offer traditional mutual funds as their primary investment options, and these funds may assess a sales charge at the time of purchase or redemption. There are also annual 12b-1 fees that are charged for the funds’ operations and management. Some plans may instead charge a flat fee or percentage instead of transaction-based fees such as sales charges or commissions.
It is relatively easy to find the actual breakdown of all fees that are charged within the plan prospectus.
All fees are generally listed in boldface type so that they are easy to find and understand.
This allows employees to make more informed investment choices and minimize plan expenses so that their savings balances can grow at a faster rate over time.
In fact, the DoL has estimated $14 billion in savings to participants in 10 years as a result of fee disclosure rules.
Information is power (or in this case, money)!
Fee disclosure rules may be relatively new – but they’re in place because of a greater need for transparency.
Transparent fees show employees exactly what they’re taking home, and ultimately help plan sponsors fulfill their fiduciary duty to act in the financial best interests of their plan participants.
That means, first and foremost, reasonable fees for 401(k) services.
Employers therefore need to be cognizant of the fees that their investments are charging and monitor whether they are reasonable or not on an ongoing basis.
401(k) Plan Design Options 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.