What is an appropriate level of 401k fees or expenses in a typical plan?

Question

I am aware that there are fees involved in a company 401(k) plan. These can vary widely depending on where you work and the particulars of a plan.

What would be an appropriate amount of fees and expenses in a typical 401(k) plan? Maybe a guideline to follow. Or would this threshold be too dependent on the individual's situation to properly define generally?

This seems to be a very important factor when it comes to deciding if it is worth upping a 401(k) contribution for the tax benefit when going beyond the employer match, or if your money would be better off elsewhere.

BrightScope seems to be a very useful website for finding out fees. They also give information on how to find your own if they don't already have them on record. (I am in no way associated with this, BTW.)

Edit: I have found my expense ratio on my 401(k) is around 1.2% throughout most of my funds. If I can take the 6% I am putting into my 401(k) unmatched and put it somewhere with a very a low expense ratio like an ETF which can be less than 0.1%, I could very well come out ahead regardless of the tax perks since I am in a lower tax bracket anyways and have already maxed my Roth.

Answer 1

To answer, I'm going to make a few assumptions. First, the ideal scenario for a pre-tax 401(k) is the deposit goes in at a 25% tax rate (i.e. the employee is in that bracket) but withdrawn at 15%. This may be true for many, but not all. It's to illustrate a point.

The SPY (S&P 500 index ETF) has a cost of .09% per year. If your 401(k) fees are anywhere near 1% per year total, over 10 years you've paid nearly 10% in fees, vs less than 1% for the ETF. Above, I suggest the ideal is that the 401(k) saves you 10% on your taxes, but if you pay 10% over the decade, the benefit is completely negated.

I can add to the above that funds outside the retirement accounts give off dividends which are tax favored, and if you were to sell ETFs held over a year, they receive favorable cap-gains rates.

The "deposit to get the matching funds" should always be good advice, it would take many years of high fees to destroy that. But even that seemingly reasonable 1% fee can make any other deposits a bad approach.

Keep in mind, when retired you will have a zero bracket (in 2011, the combined standard deduction and exemption) adding to $9500, as well as a 10% bracket (the next $8500), so having some pretax money to take advantage of those brackets will help. Last, the average person changes jobs now and then. The ability to transfer the funds from the (bad) 401(k) to an IRA where you can control the investments is an option I'd not ignore in the analysis.

I arbitrarily picked 1% to illustrate my thoughts. The same math will show a long time employee will get hurt by even .5%/yr if enough time passes. What are the fees in your 401(k)?

Edit - Study of 401(k) fees - put out by the Dept of Labor. Unfortunately, it's over 10 years old, but it speaks to my point. Back then, even a 2000 participant plan with $60M in assets had 110 basis points (this is 1.1%) in fees on average. Whatever the distribution is, those above this average shouldn't even participate in their plans (except for matching) and those on the other side should look at their expenses. As Radix07 points out below, yes, for those just shy of retirement, the fee has less impact, and of course, they have a better idea if they will retire in a lower bracket. Those who have some catching up to do, may benefit despite the fees.

Answer 2

I'd argue that you should be focusing on avoiding taxation and maximizing employer matching funds as your first objective.

Over a longer period, quality of investment options and fees will both drive your account value. A personal IRA account is usually a better value over time -- so contribute as much as possible to your IRA, and rollover 401k accounts whenever you have an opportunity to do so.