Small businesses that sponsor a 401k plan have a fiduciary responsibility to only pay necessary and reasonable fees from plan assets. Keeping 401k plan 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) 401k fiduciaries don’t know how to meet this important responsibility. This is unsurprising when you consider that DOL-mandated fee disclosures do not obligate 401k providers to explicitly disclose the dollar amount of 401k fees they are paid from plan investment funds.
If you’re a 401k fiduciary, you don’t want to be in the dark about your plan fees - the potential consequences for paying excessive 401k fees are too great. Need help understanding your 401k plan fees? Check out our FAQ below for answers to some of the most common 401k fee questions.
Q1: What are the basic types of 401k fees?
A1: There are 3 basic types of 401k plan fees:
- Administration fees – these are fees paid to 401k 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 401k providers for the following services:
- Fund selection – includes the selection and monitoring of the investment funds a 401k 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 expenses are expressed as a percentage of assets (i.e., an expense ratio). They represent the sum of the administrative and operating expenses of a 401k investment fund - usually a mutual fund or ETF today.
Q2: How are 401k providers compensated today?
A2: 401k providers can be compensated from three sources today – the plan sponsor, participant accounts or plan investments. 401k fees paid by the plan sponsor or participant account deduction are considered “direct compensation,” while fees paid by plan investments are considered “indirect compensation.”
- Direct compensation is the most transparent type of 401k fees. It’s explicitly reported in provider invoices, ERISA section 408b-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 401k plan investments. Variable annuities are basically mutual funds wrapped in a thin layer of insurance with additional fees and redemption restrictions.
- Revenue sharing. Some mutual fund companies compensate the 401k providers that use their funds. “12b-1” payments and sub-transfer agency (sub-TA) fees are the two most common types of revenue sharing.
Q3: What’s the best resource for finding my 401k provider’s fees?
A3: When 401k fiduciaries have questions about a 401k provider’s fees, their go-to resource should be the provider’s ERISA 408b-2 fee disclosure. 401k providers are obligated by the DOL to outline their services and fees in this disclosure.
Q4: What’s the process for totaling my 401k plan fees?
A4: I recommend a 3 step process that includes confirming all plan service providers, determining their compensation sources, and totaling their direct and indirect fees.
Q5: How do I benchmark my 401k plan fees?
A5: For 401k fiduciaries to prove their plan fees are reasonable, they need to benchmark them. Benchmarking is done by comparing service provider fees to competitors or averages. To compare competitor fees, you can take the following steps:
- Request a proposal from at least three different service 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. The DOL offers a 401k fee disclosure worksheet on their website.
Understanding your 401k fees is time well spent!
Given the consequences of paying excessive 401k fees, 401k fiduciaries need to be sure their plan fees are reasonable. Meeting this fiduciary responsibility can be easy or difficult based on the fees charged by plan service providers.
My recommendation to 401k fiduciaries? Only hire providers with easy-to-calculate fees that are easily comparable to competitors.