Paying 401(k) Admin Fees from Plan Assets Hurt Business Owners Most Blog Feature
Eric Droblyen

By: Eric Droblyen on August 19th, 2020

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Paying 401(k) Admin Fees from Plan Assets Hurt Business Owners Most

401(k) Fees | Retirement Planning | Provider Shopping

When a 401(k) provider’s administration fees are paid from plan assets, they're typically allocated among plan participants pro rata based on account balance. That means the plan participants with largest account balances pay the highest fees. In most small business 401(k) plans, that group usually includes the business owner.

In my experience, most small business owners know they have a fiduciary responsibility to pay only “reasonable” 401(k) fees. What far fewer seem to realize, however, is their personal stake in minimizing the 401(k) administration fees paid by their plan as much as possible.

If you’re a small business owner, there is a good chance your 401(k) account is paying the lion’s share of any 401(k) administration fees paid from plan assets. And if your 401(k) provider is overpriced, that share could cost you hundreds of thousands of dollars by the time you retire.

Not sure how much your 401(k) provider’s administration fees are costing you personally? I can help you find out.

Administration fees paid from plan assets reduce 401(k) investment returns

401(k) plans are never free. All 401(k) providers charge fees in return for plan services such as asset custody, participant recordkeeping, Third-Party Administration (TPA), and professional investment advice. These 401(k) administration fees can either “direct” or “indirect” in nature: 

  • Direct fees – these fees can be paid from either 1) plan assets or 2) a corporate bank account. They are highly transparent. Their dollar amount must be explicitly reported in invoices in 408b-2 and 404a-5 fee disclosures, participant statements, and invoices. 
  • Indirect fees – these fees are paid by plan investments. They’re often called “hidden fees” because they lack the transparency of direct fees. Their dollar amount can be buried in the fund expense ratios of 408b-2 and 404a-5 disclosures, and not appear at all in participant statements or invoices. The two most common forms are revenue sharing and variable annuity “wrap” fees.

Indirect fees and the direct fees paid from plan assets reduce the investment returns of plan participants - including you - on a dollar-for-dollar basis so you want to minimize their amount as much as possible.

Direct fees paid from a corporate bank account have no effect on 401(k) investment returns.

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Your 401(k) account’s share of administration fees paid from plan assets

When 401(k) administration fees are paid from plan assets, they’re usually allocated among plan participants pro rata based on account balance.  In general, this is true for both “direct” or “indirect” fees. This is also true for direct fees that are calculated based on a flat (headcount-based) formula at the plan-level.

Below are 3 pro rata allocations for hypothetical $1 million, 10-participant plan. Each allocation is based on a different total fee amount. In all cases, the business owner pays 60% of the total because their account balance is 60% of plan assets. That 60% can be a bitter pill to swallow if your 401(k) provider charges steep administration fees 

Participant

Account balance

$2,500

(0.25% of Assets)

$5,000

(0.50% of Assets)

$10,000

(1.00% of Assets)

Owner 1

$600,000.00

$1,500.00

$3,000.00

$6,000.00

Participant 2

$100,000.00

$250.00

$500.00

$1,000.00

Participant 3

$7,500.00

$18.75

$37.50

$75.00

Participant 4

$40,000.00

$100.00

$200.00

$400.00

Participant 5

$75,000.00

$187.50

$375.00

$750.00

Participant 6

$25,000.00

$62.50

$125.00

$250.00

Participant 7

$50,000.00

$125.00

$250.00

$500.00

Participant 8

$40,000.00

$100.00

$200.00

$400.00

Participant 9

$60,000.00

$150.00

$300.00

$600.00

Participant 10

$2,500.00

$6.25

$12.50

$25.00

 

$1,000,000.00

$2,500.00

$5,000.00

$10,000.00

The long-term cost of 401(k) administration fees can be brutal

The big problem with 401(k) administration fees paid from plan assets? Once they’re paid out, they stop accruing compound interest. That means you won’t just miss out on their amount in retirement – you’ll also miss out on their future earnings. These losses can add up to hundreds of thousands depending upon the amount and timing of the payments.

The table below demonstrates the problem. It shows how much Owner 1’s account balance would be reduced by the fees from our earlier example after 20 years (assuming $20,000 in annual contributions and a 7% annual return).

Owner 1

No Annual Fee

$1,500 Annually

$3,000 Annually

$6,000 Annually

Future Balance

3,305,719.55 

3,240,250.09 

3,174,780.63 

3,043,841.71 

Principal Loss

0.00 

(30,000.00)

(60,000.00)

(120,000.00)

Earnings Loss

0.00 

(35,469.46)

(70,938.92)

(141,877.84)

Total Loss

0.00 

(65,469.46)

(130,938.92)

(261,877.84)

After 25 years, the losses are even more dramatic.

Owner 1

No Annual Fee

$1,500 Annually

$3,000 Annually

$6,000 Annually

Account Balance

4,810,624.86 

4,708,741.67 

4,606,858.48 

4,403,092.10 

Principal Loss

0.00 

(37,500.00)

(75,000.00)

(150,000.00)

Earnings Loss

0.00 

(64,383.19)

(128,766.38)

(257,532.76)

Total Loss

0.00 

(101,883.19)

(203,766.38)

(407,532.76)

Just pay 100% of your 401(k) administration fees from a corporate account!

Approximately 80% of our small business clients pay none of their 401(k) administration fees from plan assets – they pay them from a corporate bank account instead.  This high rate is hardly surprising when you consider the approach is usually a win-win for the business owner.  They can deduct all of the administration fees as a business expense, while keeping the portion that would been paid from their personal account working for them until retirement.  

The kicker – other participants will benefit too!

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About Eric Droblyen

Eric Droblyen began his career as an ERISA compliance specialist with Charles Schwab in the mid-1990s. His keen grasp on 401k plan administration and compliance matters has made Eric a sought after speaker. He has delivered presentations at a number of events, including the American Society of Pension Professionals and Actuaries (ASPPA) Annual Conference. As President and CEO of Employee Fiduciary, Eric is responsible for all aspects of the company’s operations and service delivery.

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