As a small business owner, it’s natural for you to want to take care of your employees. After all, your employees are like family—and, in some cases, are family. Which means looking out for their retirement is more than simply checking a human resources box.
Obligations aside, you probably also realize that offering generous benefits to your employees is an excellent way to help them feel valued and to prevent them from looking for work elsewhere.
Deciding to offer your employees a company-sponsored 401(k) is a great means of ensuring your workers are taken care of in their retirement while also ensuring that your business is able to attract and retain the best possible talent. But it also isn’t a decision you should take lightly: Selecting the wrong plan can cost you, and your employees, a lot of money over the years in the form of fees and other costs—money you could use to offer your employees additional benefits, and money that they can use to get more out of their retirement.
Below, we explore the most common small business 401(k) costs, how these fees are determined, and who pays for these fees, so that you can choose the best possible plan for your employees.
What Is a 401(k)?
Before diving into specifics about small business 401(k) costs and fees, it can be helpful to first review some of the basics: Namely, what is a 401(k)?
A 401(k) is a tax-advantaged, employer-sponsored retirement account. It’s named after subsection 401(k) of the Internal Revenue Code, which allows employees to avoid taxes on deferred compensation.
Types of 401(k)s
401(k)s come in two varieties: traditional and Roth.
With a traditional 401(k), contributions are made with pre-tax funds, which allows the money to grow tax-deferred. This lowers an individual’s tax liabilities in the year that contributions are made. When withdrawals are made during retirement, the principal (and any investment growth) is taxed as ordinary income.
With a Roth 401(k), contributions are made with post-tax funds. This means that taxes are paid on the contributions during the year that contributions are made—but when withdrawals are made in retirement, they are tax-free.
As of 2020, the maximum amount that an individual can contribute to either a traditional or Roth 401(k) is $19,500. Individuals who are older than 50 years old are allowed to make “catch-up contributions” of $6,500 each year, which brings their maximum annual contribution limits to $26,000.
Major Types of 401(k) Fees
Exactly how your small business’s 401(k) plan fees are determined will depend on a number of factors, including the specific plan that you select and the amount of assets that you have under management.
401(k) fees typically fall into four buckets, as defined by the U.S. Department of Labor (DOL): plan administration fees, investment fees, individual service fees, and transaction-based fees. Before selecting any retirement plan for yourself or your employees, it’s important that you understand which fees will apply to your plan and how substantial those fees are; without this understanding, it will be impossible to know whether you’re getting a good deal or not.
Plan Administration Fees
Plan administration fees are the fees charged to pay for the day-to-day operation and administration of your 401(k) plan. They are used to cover costs such as recordkeeping and accounting, trustee services, and legal fees. Depending on the features offered by your specific plan, these fees may also be used to cover additional benefits, features, or services, such as:
- Customer support (telephone and online)
- Participant education (workshops, seminars, webinars, etc.)
- Retirement planning software
- Investment advice
- Online transactions
- Website/web portal management
- And more
These fees are often assessed on a per-person or per-participant basis. Generally speaking, larger businesses or those with more assets under management in their 401(k) plan enjoy lower overall costs and fees; smaller businesses or those with fewer assets under management in their plan can expect to pay higher overall costs and fees. Certain flat-rate fees will remain the same regardless of how many participants a plan has.
Investment fees are the fees charged to cover expenses associated with directly managing a 401(k) plan’s investments. They are also known as management, custodial, or investment advisory fees.
Because these fees are typically calculated as a percentage of the total amount of assets under management in the plan, they are also known as asset-based fees. These can range from a fraction of a percent to more than 5% of the plan’s total assets. They tend to be higher in actively managed plans and lower in passively managed plans, due to the nature of each.
Individual Service Fees
While administration fees and investment fees tend to be split evenly amongst all of the participants in a 401(k) plan, individual service fees are charged directly to participants who make use of optional features offered by the plan. These might, for example, include fees associated with:
- Taking a loan from your 401(k)
- Seeking advisory services
- Rolling a 401(k) investment over into an IRA
Transaction-based fees, also known as sales charges, loads, or commissions, are exactly what they sound like—fees associated with completing a transaction. When it comes to 401(k)s, this typically means buying or selling shares or other investment items. They are typically charged as a flat fee, but can be calculated in a number of different ways based on the type of investment.
While the four groupings outlined above likely account for all of the different 401(k) fees that you’re likely to encounter, there are some additional fees which you should also be aware of because they are so common. These include recordkeeping fees, potential revenue sharing agreements, and ERISA bond fees.
Additionally, different kinds of investment vehicles (such as mutual funds, target date funds, and variable annuities, amongst others) may carry their own unique fees.
It’s also important to remember that there may be certain in-house costs associated with offering a 401(k) plan to your employees. These will come in the form of salary and benefits that you pay to your human resources and/or accounting professionals, who are typically responsible for ensuring 401(k) compliance, tax obligations, investment advising, and other tasks related to administering your 401(k) plan. If you don’t currently employ such professionals, it may be possible to find a plan which offers these services at added cost.
Who Pays These Fees?
Any savvy business owner will want to know what the 401(k) cost to the employer will be. After all, you need to make sure you can afford this fringe benefit before you offer it. The answer to this question is: It depends.
Generally speaking, the majority of fees associated with a 401(k) plan are related to investment options—which investment products or funds a participant selects. The fees, in turn, are used to pay for the asset management fees and operating expenses associated with each individual fund. As such, these fees are typically paid by the participant, your employee.
Similarly, per-participant fees are often bundled into your employees’ annual 401(k) fees, and deducted from the balance of their account.
There are certain fees, though, that you will likely need to pay as the employer. Some costs of a 401(k) for a small business include startup expenses associated with getting your company enrolled in a plan to begin with.
But again, it depends. Sometimes, if the employer is generous, they will cover all fees associated with the 401(k). Sometimes, the fees are paid entirely by the employees. But more often than not, these fees are shared by both the employer and employees.
The Bottom Line
If you’re considering offering your employees access to a company-sponsored 401(k) plan as a part of their benefits package, you need to keep a number of factors in mind.
In addition to meeting the needs of your employees, it’s critical that you select a plan that fits your company’s budget and that your employees will actually want to participate in. Selecting a plan that offers the functions and features your employees desire—while also limiting the costs and fees that both you and your employees will need to pay—is crucial to making this a reality.
One way to make it easier for yourself in choosing a 401(k) provider is to ask each provider you are considering to fill out a 401(k) Plan Fee Disclosure Form. (You can find an excellent sample form from the Department of Labor here.) This form will help you understand all of the potential 401(k) fees associated with each plan you are considering, so that you can make helpful side-by-side comparisons and choose the plan that best suits your budget and your needs.
- Payscale.com. “Why They ‘Quit You:’ Top Reasons an Employee Leaves”
- IRS.gov. “401(k) Plan Overview”
- DOL.gov. “A Look at 401(k) Plan Fees”