Small businesses that sponsor a 401(k) plan have a fiduciary responsibility to only pay necessary and reasonable fees from plan assets. Keeping 401(k) fees in check is one of the most important fiduciary responsibilities because excessive fees reduce investment returns unnecessarily, making a comfortable retirement for plan participants less affordable. Not meeting this responsibility can also mean severe consequences for plan fiduciaries – including personal liability.

However, many (if not most) 401(k) fiduciaries don’t know how to meet this important responsibility. This is unsurprising when you consider that DOL-mandated fee disclosures do not obligate 401(k) providers to explicitly disclose the dollar amount of fees they receive from plan investment funds.

If you’re a 401(k) fiduciary, you don’t want to be in the dark about your plan fees - the potential consequences for paying excessive 401(k) fees are too great.

401(k) Fee Basics

There are 3 basic types of 401(k) fees and expenses:

  • Administration fees – these are fees paid to 401(k) providers for the following services:
    • Asset custody – includes safekeeping plan assets and executing trades
    • Participant recordkeeping – includes tracking plan contributions, earnings and investments on a participant-level and directing the custodian to execute trades
    • Third-Party Administration (TPA) – includes plan design consulting and annual ERISA compliance (testing, Form 5500, plan document maintenance, participant notices)
  • Investment management fees – these are fees paid to 401(k) providers for the following services:
    • Fund selection – includes the selection and monitoring of the investment funds a 401(k) plan offers its participants.
    • Asset allocation – includes participant investment advice.
    • Education/coaching - includes participant savings rate advice and retirement readiness analysis.
  • Fund operating expenses – these are the sum of the administrative and operating expenses of a 401(k) investment fund - usually a mutual fund or ETF today. They are usually expressed as a percentage of assets (i.e., an expense ratio).

401(k) administration and investment management fees may be paid to 401(k) providers from three sources today – the plan sponsor, participant accounts or plan investments. 401(k) fees paid by the plan sponsor or participant account deduction are considered “direct compensation,” while fees paid by plan investments are considered “indirect compensation.” Both types of compensation reduce participant returns, so you have a fiduciary responsibility to keep these fees in check.

  • Direct compensation is the most transparent type of 401(k) fees. It’s explicitly reported in provider invoices, ERISA 408(b)(2) and 404a-5 fee disclosures, and plan statements.
  • Indirect compensation is a different story. It can be estimated in 408b-2 disclosures, buried in the investment expense ratios of 404a-5 disclosures, and not appear in plan statements. For these reasons, indirect compensation is often called “hidden” compensation. There are two basic types:
    • Wrap fees. Insurance company providers often use variable annuities as 401(k) plan investments. Variable annuities are basically mutual funds wrapped in a thin layer of insurance with additional fees and redemption restrictions.
      • Wrap fees can dramatically increase the expenses of the underlying mutual fund. Sometimes by more than 1% per year!
    • Revenue sharing. Some mutual fund companies compensate the 401(k) providers that use their funds. “12b-1” payments and sub-transfer agency (sub-TA) fees are the two most common types of revenue sharing. 12b-1 fees can be found in fund prospectuses, while sub-TA fees cannot.

Because all 401(k) fees and expenses reduce participant returns, each type must be evaluated by 401(k) fiduciaries for reasonableness. My advice to 401(k) fiduciaries? Make this job as easy as possible by only hiring 401(k) providers that charge transparent direct fees. It’s much more difficult to evaluate indirect fees and you’re risking personal liability when you’re unclear regarding your 401(k) plan’s fees.

Evaluating 401(k) plan fees

Proving the reasonableness of 401(k) fees can be one of the most complicated obligations of a 401(k) fiduciary. This job is made more difficult when providers charge hidden indirect fees. Regardless of how your plan compensates its 401(k) provider(s), the process for evaluating their fees involves the same 3 step process.

1. Confirm receipt of a 408(b)(2) disclosure for each “covered” service provider

The DOL’s Section 408(b)(2) rules require 401(k) providers to provide 401(k) fiduciaries with the information they need to assess the reasonableness of provider compensation and identify potential conflicts of interest.

For purposes of the 408(b)(2) regulation, a Covered Service Provider (CSP) is a person or entity who enters into a contract or arrangement with a plan and reasonably expects to receive $1,000 or more in compensation for providing services to a plan. There are four categories of CSP. These categories are described on the DOL website.

If a CSP fails to provide the required 408(b)(2) information, the contract or arrangement between the plan and the CSP is prohibited by ERISA, and the responsible plan fiduciary will have engaged in a prohibited transaction. In other words, while CSPs are required to provide a 408(b)(2) disclosure, it’s the plan sponsor’s responsibility to ensure it’s received.

2. Examine each 408(b)(2) disclosure for adequacy

CSPs must include the following information in their 408(b)(2) disclosure to the 401(k) sponsor:

  • A description of the services to be provided to the plan pursuant to the contract or arrangement.
  • Whether or not the CSP serves the plan in a fiduciary capacity
  • All “direct” and “indirect” compensation the CSP, affiliate, or a subcontractor reasonably expects to receive in connection with the covered services. Direct compensation means fees paid directly from the plan. Indirect compensation means fees paid from any source other than the plan or the plan sponsor (e.g., “revenue sharing”).
  • A description of any compensation paid between the CSP and related parties.

3. Prove fees for plan services are reasonable

For 401(k) fiduciaries to prove fees are reasonable, they need to be benchmarked. Benchmarking is done by comparing 401(k) provider fees to competitors or averages. To compare competitor fees, fiduciaries should take the following steps:

  • Request a proposal from at least three different 401(k) providers
  • Identify all compensation paid to each provider, including any “hidden” indirect compensation paid by plan investments. Fees charged by each provider should be totaled to determine their “all in” fee for services.
  • Identify all services offered by each provider to determine any differences.
  • Evaluate experience of each provider and any conflicts of interest.
  • Compare fees and services in an “apples-to-apples” standardized format. Our 401(k) Shopping Companion can help you complete this step.

The DOL also offers tips for selecting and monitoring 401(k) service providers on its website. This list can also be helpful in comparing the fees and service of competing providers.

Bottom line, it doesn’t need to be difficult to evaluate 401(k) plan fees. Once the process is over, it should be crystal clear whether fees are reasonable or if service provider changes are in order. Regardless of either outcome, participant interests are protected and fiduciaries have reduced their liability.

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