In a recent study, we found 79% of our small business clients pay 100% of their 401(k) administration fees from a corporate bank account – not plan assets. This approach is popular because it can mutually benefit plan sponsors and participants. While the plan sponsor can deduct these fees as a business expense, plan participants can keep their amount invested – where they can grow until retirement.
However, not all 401(k) plan sponsors want to pay their 401(k) administration fees themselves. Instead, they want the participants benefiting from their plan to pay them. This is perfectly fine as long as the fees paid by the plan are “reasonable.”
If you’re a 401(k) plan sponsor, you have a fiduciary responsibility to pay only reasonable fees from plan assets. Meeting this responsibility is important because paying excessive fees reduce plan participant returns unnecessarily – potentially making you personally liable for restoring the excessive losses.
A prudent way to evaluate 401(k) plan fees for reasonableness is by benchmarking (comparing) them to fees charged by competing 401(k) providers. However, when undertaking this process, I recommend you evaluate fees for administration services and investment management separately – because each should scale based on different factors. If you don’t, fees that seem reasonable today can spiral out of control tomorrow. Below are some guidelines.
Evaluating 401(k) provider fees for administration services
401(k) plan administration services include:
- Asset custody – holding plan assets in a trust and execute trades
- Participant recordkeeping – tracking contributions, earnings and investments on a participant-level and direct the custodian to execute trades
- Third-Party Administration (TPA) – Performing plan design and annual ERISA compliance (testing, Form 5500, plan document maintenance, participant notices)
Except for asset custody, the level of administration services delivered by a 401(k) provider scale with employee headcount – not assets. That means it's most reasonable to evaluate 401(k) administration fees on a per capita basis. Otherwise, it can be easy to overpay a 401(k) provider for administration services when your plan has a lot of assets.
The problem is that many 401(k) providers charge asset-based administration fees. In fact, many providers lock you into paying them by limiting your plan investment options to expensive funds that pay revenue sharing and/or wrap fees. Because these “hidden” 401(k) fees are paid from fund expense ratios, there is no way avoid paying them on an asset basis.
Evaluating 401(k) provider fees for investment management
401(k) investment management services include:
- Fund management – Managing the underlying portfolio of each plan fund according to a specific investment objective (e.g., tracking the S&P 500 index).
- Financial advice – Giving professional investment advice to the plan sponsor and/or plan participants.
Unlike administration services, you want to evaluate 401(k) provider fees for investment management on an asset basis. I recommend using a fund lineup of index funds and Target-Date Index Funds (TDIFs) that’s modeled after the Federal government’s Thrift Savings Plan (TSP) as a baseline for this evaluation. Such a fund lineup offers diversified market returns and professional investment advice to participants that invest 100% of their account in the TDIF that best matches their estimated retirement date for less than 0.20% of assets annually.
You only want to pay more than the TSP baseline when plan participants receive more valuable services - like one-on-one coaching or personalized investment advice - in return.
Ensure your 401(k) fees are reasonable today and tomorrow!
You want to ensure that all fees paid by your 401(k) plan are reasonable to protect the interests of plan participant and limit your fiduciary liability. An acceptable way to do that is by benchmarking your 401(k) fees to fees charged by competing 401(k) providers.
When completing this process, I recommend you evaluate fees for administration services and investment management separately. Doing so will best ensure that the 401(k) fees you found reasonable today will stay reasonable as plan assets grow.