401(k) Fee Transparency
Clear up your 401(k) fees and uncover what you and your employees are paying for your 401(k) plan. Unfortunately, complex fee structures make that easier said than done. This paper explains why it’s crucial to take the time to review and understand your company’s fees, what the three main “fee buckets” are, who actually pays these costs, and how the types of funds you have in your 401(k) plan can affect your fees.
If you don’t know your 401(k) fees, you may be throwing money away
As a business owner, you may have seen your company’s 401(k) fees when it was first started, but it’s worth another review (and periodic reviews thereafter) to see if they’re still reasonable or there’s room to trim. With so many different fee structures and hidden investment fees in the market place today, determining what your business is paying for its 401(k) is no easy feat. But knowing what you and your employees are paying for your 401(k) plan is important. Fees matter for a couple main reasons.
- Excessive fees eat into retirement savings over time. Unless employers absorb the expenses, the majority of fees are often paid for out of plan assets. This means they’re paid by those employees participating in a 401(k) plan. According to the Department of Labor (DOL), one percent difference in fees can potentially reduce an account balance by 28 percent at retirement. With so much on the line, it’s important to keep fees under control to help your employees achieve their retirement savings goals
- The law requires reasonable 401(k) fees, or you may be held liable. ERISA, the law that requires private retirement plan sponsors to meet certain standards, calls for businesses that provide 401(k) plans to make sure their fees are reasonable. This does not mean that the fees need to be the least expensive but that they are in the range of what is paid by 401(k) plans receiving similar service promises. If it’s determined that the fees are not reasonable, employers offering a 401(k) plan can be held personally liable for the losses. And recent lawsuits for excessive fees are no longer only against large plans but smaller ones as well, such as the Damberg v. LaMettry’s Collision, Inc. lawsuit. The plaintiffs claim that the plan fiduciaries of the $9 million dollar 401(k) plan breached their fiduciary responsibility by selecting investment options that were unnecessarily expensive and by failing to actively monitor them and replace them with similar, lower cost options.
Who gets paid what, and for what service?
Retirement plan costs can be sliced and diced in many different ways but we find that they typically fall into three main fee categories. Let’s call them “fee buckets.
- Administrative fees cover the cost of running the plan. The two major components are recordkeeping and administration. For many plans, these services are “bundled,” and performed by the same party. For others, going “unbundled” by hiring a separate Third Party Administrator (TPA) may make more sense. Core recordkeeping functions include maintaining internet access and reporting for the plan sponsor and participants, investment access, transaction activity and investment disclosures. Plan administration includes plan document management, annual IRS 5500 preparation, compliance testing, loans and distributions, and disclosures. Administrative fees may also include any additional legal and accounting costs. Administrative fees may be paid for by the employer or the employees.
- Fund expenses are costs associated with managing the investments, which can include mutual funds, collective investment funds, variable annuities and other investments available in a 401(k).
- Financial partner fees are charged by a broker, investment manager, financial adviser, or plan consultant, and may cover fund line-up management, investment advice, plan fiduciary support and education, employee education and enrollment, plan design consulting, fee benchmarking and analysis.
So who actually pays these costs?
Determining who pays and who receives plan fees can be complicated. Fund expenses are always paid for by employees. Administrative and financial partner fees can be paid by the employer or passed on to the employees. But in many cases, fees in the fund expenses bucket end up being diverted to administrative and financial partners buckets. Although buried in complex fee arrangements, the practical effect is that the fund expenses bucket can be used to make employees pay additional administrative and financial partner fees.
What are fund “share classes” and how do they affect your 401(k) plan?
Most mutual funds have multiple share classes. A share class is identified by a letter, and each share class can have different expenses. Fund share classes can be A, Z, T, R, I—and that’s not all of them. These letters can mean a whole lot for expenses. Many share classes pay “revenue sharing” or additional fees. It is called revenue sharing because additional fees can be “shared” with the administrative service provider or financial partner. These fees also create incentives for the people receiving them to recommend a particular fund.
So how do you know what each 401(k) service provider is getting paid, and if their service is reasonable?
Fee transparency is possible
As of 2012, all 401(k) service providers are required to disclose their compensation, direct and indirect, through a document called a 408(b)(2) disclosure. This document, however, may vary in format and name from one provider to the next. If revenue sharing exists, it can also be difficult to determine the flow of fees and expenses from one fee bucket to the next. In an ideal scenario, fees and expenses would not flow among the different fee buckets. And it would be clear how each 401(k) service is paid for. Large corporations have greater negotiating power and professional staff to oversee their plans, so they have a better chance of keeping costs in check than small businesses. But without transparency, you and your employees could end up paying higher fees than necessary for your retirement plan.
Transparent Fee Solution
Seek a 401(k) service provider that offers:
- A fair, transparent fee structure that’s easy to understand. The fee should be easy to see and monitor through quarterly statements. For example, a good fee structure could include one asset-based fee for the financial adviser’s services and another flat fee for administrative services and does not include revenue sharing arrangements. A fee based solely on the amount of assets in your plan will align your plan goals with the goals of the service provider.
- A fee overview that illustrates your current fees, proposed fees with the new service provider, and the industry average fees for plans similar to yours. Request any revenue sharing arrangements or other hidden fees to be included in the calculations. This allows you to see how your plan stacks up and empowers you to make informed decisions about your 401(k) plan costs
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