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4 Questions to Achieve the Ideal 401(k) Plan

Eric Droblyen

February 28, 2024

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An ideal 401(k) plan helps employees and employers meet their respective goals at a low cost. To achieve an ideal plan, employers must avoid conflicted 401(k) providers with overpriced services and investments that put profit ahead of client interests. Given the variety of 401(k) administration and investment options available today, avoiding these providers can seem impossible. In truth, spotting a conflicted 401(k) provider can be easy when you understand the features of an ideal plan.

These features boil down to cost-efficient investment options for employees and an optimized plan design for employers. Conflicted 401(k) providers have little interest in these features. They can earn more profit with expensive investments and one-size-fits-all plan designs. Here are four simple and straightforward questions you can ask to avoid these providers.

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1. How Much Do You Charge?

When 401(k) administration fees are paid from plan assets, they reduce participant returns dollar-for-dollar. Worse yet, 401(k) participant won’t just miss their principal in retirement. They’ll also miss the compound interest the payments would have earned had they remained invested. The “cumulative effect of fees” can cost a 401(k) participant hundreds of thousands of dollars in retirement.

Given the stakes, employers have a fiduciary responsibility to only pay “reasonable” administration fees from plan assets. To meet this responsibility easily, you want to avoid 401(k) providers that charge “hidden” fees like revenue sharing. These asset-based fees can be almost impossible to keep in check due to their lack of transparency.

An ideal plan pays little to no administration fees from plan assets to minimize their drag on participant returns. You can eliminate their drag altogether by paying their amount from a corporate bank account – not plan assets.

2. Do Your Funds Deliver Market Returns?

The Federal Thrift Savings Plan (TSP) is our nation’s largest defined contribution retirement plan with 6.5 million participants and $827.2 billion in assets. Despite the TSP’s mammoth size, it does not use active funds to try to outperform market benchmarks (e.g., the S&P 500 index). Instead, it uses index funds to match market benchmarks.

That choice can seem odd until you know that most active funds underperform “comparable” index funds (i.e., index funds with a similar benchmark). Fees are often the reason. Active funds can cost 1% or more than a comparable index fund. Few have a history of offsetting their higher fees with higher returns - especially over long periods.

In an ideal 401(k) plan, investments deliver no less than index fund returns for participants. Active funds are no problem if they beat this baseline over time, net of fees. A low-cost share class of active funds has the best chance of doing that.

3. Is Your Investment Advice Conflict-Free?

Most 401(k) participants need professional advice to properly invest their account. Fortunately, just about all 401(k) plans today offer at least one of the three forms available today - target-date funds, a financial advisor, or a “robo” advisor (i.e., algorithm-based advice).

Regardless of the form, it should be conflict-free (impartial). Advice is conflicted when the provider can increase their compensation by steering plan participants toward investments with high commissions. In general, investment advisers have a legal obligation to give conflict-free advice, while brokers and insurance agents do not.

In an ideal 401(k) plan, participants receive conflict-free investment advice. Achieving this goal is important. A White House Council of Economic Advisers analysis found conflicted advice lowers investor returns by 1% annually.

4. Is My Plan Design Optimal?

During the plan 401(k) design process, employers choose plan features such as eligibility, compensation, contributions, vesting, and distributions and loans. Employers should choose the features that meet their plan goals at a low cost.

The cost of improper plan design can be steep, including thousands in avoidable contribution expenses, hours of unnecessary administration, and handicapped contribution limits for top employees. Optimizing a plan design can take 30 minutes or less with the help of an expert.

An ideal 401(k) plan has been optimized to meet employer goals at a low cost. If your current provider does not offer plan design consulting, there is a good chance your plan is costing you more than it should.

Ideal 401(k) Plans Lower Fiduciary Liability Too!

An ideal 401(k) plan is a win-win for employers and employees. Such plans help employees save faster while helping employers meet their plan goals at a low price. The kicker? Their cost efficiency can make employer concerns about excessive fees and imprudent investment selection – the top causes of 401(k) fiduciary liability today – a thing of the past.

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