401(k) Expenses - Understanding and Analyzing 401(k) Plan Fees

Part 2 of 6., R.E.T.I.R.E.® series by Nathan Fisher

Expenses: Understanding and Analyzing 401(k) Plan Fees

People often ask me how much a retirement plan should cost, and it’s a difficult question to answer. It’s sort of like asking how much a car should cost. That depends: do you want a convertible sports car? A luxury SUV? A simple coupe without the frills? In the same way, there’s a lot to consider when thinking about what a 401(k) plan, and service for the plan, costs. It’s all a function of what you’re trying to do with the plan, and what you want to get out of your service providers.

While I can’t say exactly how much you should pay for your plan, I can say that it is vitally important that you understand the expenses associated with it. Under ERISA, you (or any other fiduciary for your plan) are required to ensure that only the services that are needed are being paid for, and that the fees are reasonable. That means you’ll need a practical process for collecting information about your expenses, for comparing and benchmarking that information against other comparable plans in the industry, and for deciding whether or not those expenses are necessary and acceptable.

Let’s explore the fees you are likely to see in your plan, who should be responsible for analyzing those fees, how to best go about that analysis, and how often expenses should be reviewed as part of maintaining a 401(k) plan.

The Types of Fees in a 401(k) Plan

When we talk about expenses in a 401(k) plan, what we’re typically referring to are the fees charged by any service provider handling any aspect of your plan. There are a lot of different kinds of specific fees, but generally, you can expect to pay fees associated with the investments inside your plan, the administration of the plan, and any other individual services your employees may receive from your service providers.

Investment Fees
The largest fees are usually associated with the management of the investments within a plan. Different funds will bring with them fees like the expense ratio, which is a fee based on a fixed percentage of the total assets in a fund designed to cover the management of that fund, sales fees like the front load and back load, which are associated with buying and selling shares in a fund, and 12(b)1 fees, which pay for marketing or distribution of the fund.

Administration Fees
There are also fees designed to pay for the work of different service providers helping to manage a plan. Fees will be paid to your record keeper, third party administrator, and the adviser who recommends your funds or manages your plan for you. Some larger organizations may also pay fees to a third-party auditor for the purposes of evaluating a plan’s expenses.

Individual Service Fees
Finally, there may be fees that are only paid by plan participants who elect certain extra services from service providers. Some employees may choose to take a loan from a plan, or may opt for engaging your service provider in more proactive investing strategies that require additional time and, therefore, cost more to provide.

Keep in mind that most of these expenses are paid by the employees and other participants in a plan, though some may be paid by the employer.

Who Should Analyze Fees?

As a plan sponsor, you can take the time to run the analysis yourself, you can ask one of your service providers to do it for you, or you can pay a third party.

  1. Do it Yourself
    Analyzing your own fees is something you can do as frequently as you’d like, but it isn’t necessarily an easy task. Ask yourself: do you have the time and the expertise to dig into all the fees and understand them? Do you have access to the information you’ll need to get a complete picture of your expenses? If you feel confident that you are able to perform your own analysis, pay special attention to the six steps we outline below for monitoring fees.
  2. Use a Service Provider
    It’s common for employers to rely on their 401(k) service provider to perform some kind of fee analysis. Many providers choose to do this every few years simply in the interest of continuing to prove to you, their client that their fees are reasonable and align well with the service you’re receiving. That said you should be aware of the bias your service provider brings into the equation when analyzing their own fees. If you go this route, make sure your provider leverages a third-party tool, such as Fiduciary Benchmarks, to ensure their analysis is as objective as possible. You should also be aware that some advisers will benchmark fees associated with recordkeeping, third-party administration, and investing, but stop short of analyzing their own fees. Read any benchmarking reports you get closely, and keep in mind that you may need to benchmark the adviser’s fees yourself.
  3. Pay a Third Party
    The third option is to remove yourself and your service provider(s) from the equation and hire an unbiased third party to complete your expense analysis. Larger plans of 100 employees or more often go this route, simply because larger plans can be more difficult to analyze in-house. Third party auditors who perform these kinds of analyses don’t typically offer any other additional services, which means their only interest will be in completing an accurate analysis of your expenses.

How to Monitor Fees

There are six steps to analyzing your fees and determining how reasonable your plan’s expenses are.

  1. Gather required documentation.
    Unless your service provider is performing your analysis, this is a step you will have to take. Typically, you should look for a 408(b)(2) service provider disclosure. This is a document that you would not distribute to your employees and other plan participants, and is only for the plan sponsor. Additionally, you may need an asset statement and documentation on any fees you have paid as an employer to your service providers via an invoice.
  2. Identify all service providers being paid.
    You may think that you have a certain number of service providers maintaining your plan—maybe you have met your record keeper, your adviser, and your third-party administrator—but there may be additional third-party vendors servicing your account that you aren’t aware of. Call all of your known service providers and ask them who else is involved with providing service to your plan—you may be surprised.
  3. Trace the flow of all funds out of the plan.
    Next, make sure you document exactly how money is being taken out of the plan, and how it is being distributed to the different service providers. One common scenario is for your fees to come out of the expense ratios of the mutual funds in your plan, and from there to flow to your record keeper, adviser, and third-party administrator. Think of this as a forensic accounting exercise to see where exactly money is coming from, and where it’s going to.
  4. Calculate fees paid to each service provider.
    Once you understand the flow of funds out of your plan, you can perform some calculations, either in the form of percentage of total plan assets or in a dollar amount, to demonstrate how much of the money flowing out of your plan ended up with each service provider.
  5. Benchmark your fees against the industry.
    Now that you know how much each service provider is charging compare those numbers to other, similar, plans to see how those plans’ fees stack up against yours. This step can be tricky because it’s not always comparing apples to apples. If your provider is doing very little for you, it might make sense that their fees are lower than the industry benchmark you find while comparing expenses. Likewise, a provider that offers an exceptionally high level of service might reasonably charge higher fees. There are tools that can help you compare your fees with those of plans that receive a similar level of service so you get an accurate comparison.
  6. Determine your course of action.
    The last step of this process is to review your findings and decide whether or not the fees in your plan are reasonable. For the service you get, does your plan seem to align with others like it in terms of fees? Going back to our opening metaphor, just because a car is cheap, doesn’t mean the asking price is reasonable. The same can be said for very expensive cars. Make sure you see through the potential biases present in the results of your benchmark; your service provider might argue that their fees are reasonable, but they may not be. It’s just as important for you to document your perception of the fees as it is to document the fees in the first place. Review them and take note of which ones are reasonable, which ones might be lower or higher than the benchmarks you’ve found, and which ones are unacceptable for the service you receive.

When to Monitor Fees

Diving into all of the expenses associated with a 401(k) plan can be an extensive process, and requires a great deal of attention to detail. Depending on the size of your plan and your available resources, you may want to monitor your fees with different frequencies. The largest 401(k) plans will benchmark their fees every year, while smaller plans might only perform analyses every other year. Very small businesses with only a handful of plan participants may only need to monitor fees every three years, which would be reasonable and commensurate with the resources and time they have available to them.

Ultimately, this process is about making sure your employees and other plan participants—which may include you, the employer—pay reasonable fees and keep as much money as possible invested and working hard for a secure retirement.

Part 2 of 6., R.E.T.I.R.E.® series by Nathan Fisher

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