No matter what your company’s 401(k) looks like, it costs money. This topic—401(k) costs—represents a big part of an employer’s duties in managing a 401(k). I often hear questions from employers about the costs associated with their 401(k) plan. Below, I’ll go through three of the most common questions and share some answers that can help you better understand and manage the costs of your 401(k) plan.
What types of small business 401(k) costs are there?
There are several kinds of fees associated with a 401(k) plan paid by employees and occasionally by the employer directly. Some are associated with the investments your employees choose, and others are administrative fees. Here’s a quick breakdown of the expenses your 401(k) may feature:
• Investment: These expenses are paid by your employees and go to the firms managing the funds your employees invest in with their savings. They cover those funds’ operating expenses, and also cover asset management fees.
• Administrative: Other service providers—like your record keeper or third party administrator—also collect fees. Sometimes these expenses are paid directly by the employer, but most often they are deducted from employee accounts.
• Fiduciary and consulting: If you work with a specialized 401(k) adviser, your plan may also have expenses that cover costs like fund lineup management, investment advice, fiduciary support, enrollment, and employee education.
Sometimes, your employees may also pay indirect fees to fiduciaries and consultants. This is referred to as “revenue sharing.” These expenses are often categorized as investment fees, so they can sometimes be difficult to identify as a distinct cost of your plan.
Who is responsible for monitoring 401(k) fees?
I’ve heard employers say, “Aren’t expenses paid by my employees? They choose their own investments, and most of the fees are tied to investment. Don’t they review the fees?” While it’s true that employees do pay a majority of the fees in a 401(k) plan, employers have a very real responsibility to make sure expenses are reasonable.
The Employee Retirement Income Security Act of 1974 (ERISA), which outlines the rules associated with defined contribution plans like a 401(k), says that employers act as fiduciaries for the plans they offer. A fiduciary is someone who takes a legal responsibility to make reasonable decisions in the best interest of their employees participating in the plan. That includes regularly monitoring 401(k) fees to ensure that employees aren’t spending more than they should to keep the plan running.
Secondarily, many business owners are themselves participants in their 401(k) plan. You are your own best advocate to make sure your retirement savings are kept intact, and that the benefit you are offering to yourself and your employees is a quality one.
How much should my company’s 401(k) plan cost?
If employers have a responsibility to keep 401(k) fees reasonable, what does “reasonable” even mean? Sometimes employers will ask, “How much should a retirement plan cost?” This is a tough question to answer. It’s like asking how much a car should cost—it depends. Do you want a used coupe, or are you looking for a brand-new, four-wheel-drive European import? A big part of understanding how reasonable your plan’s fees are is to examine the level of service you’re receiving. Compared to other, similar plans belonging to businesses similar to yours, paying fees similar to yours, how much service are you receiving? Running this kind of comparison is called “benchmarking”—more on that below.
One quick way to spot opportunities for saving money on 401(k) fees is to take a look at the expense ratios I mentioned earlier. For most small business 401(k) plans I encounter between $1 million and $10 million in assets, a common cause for unreasonable expenses has to do with something called “share classes.” There are different versions of each fund you include in your plan’s investment lineup (different “share classes”), and many smaller plans overpay for investments by using a more expensive share class. It’s a bit like paying more money at one dealer for a car when another dealer can get you a better deal on the same car. By speaking with your service providers and finding a less expensive share class for your funds, you could uncover some immediate savings. That, in turn, could lower the plan’s total cost or help you reinvest in additional retirement services for your employees, like increased education or on-site visits with retirement counselors.
How do I know if my employees and I are getting a fair deal?
I recommend looking at your 401(k) expenses every three years as a best practice. If you’re ready to examine your plan’s expenses, my blog post on monitoring and understanding 401(k) fees is a great place to start. In order to accurately compare your 401(k) plan to other companies’ plans, you’ll want to do a full 401(k) plan review, documenting the fees you pay and the services you receive from your provider. Recently, we published a webinar series introducing the framework you need to adopt in order to assess your 401(k) plan. Access the recorded webinars anytime if you’re interested in taking a look at your responsibilities as an employer who offers a 401(k) plan.
Remember: It’s critical that you monitor your expenses to ensure you and your employees are getting the best price for the level of service you’re receiving. When you do find those opportunities to lower your plan’s costs, that means either more money for your employees to save, or more resources to get your employees the service they need to make the most of the plan. In either case, I believe that’s a reward very much worth the effort.