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3 Questions for Calculating Small Business 401(k) Provider Fees

Eric Droblyen

December 28, 2022


Small businesses have a fiduciary responsibility to pay only reasonable 401(k) plan fees. The problem? Too many 401(k) providers bury their fees in complex disclosure documents. When 401(k) fees are hard to find, it can be easy for 401(k) fiduciaries to pay too much for 401(k) services. When this happens, participant returns are handicapped unnecessarily and fiduciary liability is increased.

To show 401(k) fiduciaries the “all-in” fee their 401(k) plan pays annually - and how much they could save by using our firm - we launched a no-cost 401(k) fee comparison service two years ago. Since launching this service, we have gotten pretty good at finding 401(k) fees – even the hidden ones.

I’d like to share the 3 questions we ask to calculate 401k service provider fees. If you are a 401(k) fiduciary, you can use these questions to easily find out how much your plan pays on your own.

Question #1 – Who provides services to my 401(k) plan?

The answer to this question may seem obvious, but it’s often more complicated than you know. 401(k) providers can use a “bundled” or “unbundled” approach to deliver 401(k) plan services. Under the bundled approach, one provider delivers all plan services. Under the unbundled approach, a lead provider partners with independent, subordinate providers to deliver services.

Before you start your 401(k) fee search, I recommend you first confirm your plan service provider(s). For help, speak to your day-to-day provider contact. You might be surprised to learn your plan has multiple service providers with separate fees.

Question #2 – Are my service provider(s) paid from plan investments?

401(k) fees may be paid 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, 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 401(k) plan investments. Variable annuities are basically mutual funds wrapped in a thin layer of insurance with additional fees and redemption restrictions.
      • Variable annuity “wrap” fees increase the investment expense 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.

It can be easy to overlook indirect compensation due to its lack of transparency, but you can’t do that as a 401(k) fiduciary - 401(k) fees paid by indirect compensation reduce participant returns just like fees paid by direct compensation.

Question #3 – How much are my 401(k) service provider(s) paid?

Once you’ve confirmed all plan service providers and whether or not they receive indirect compensation from plan investments, you’re ready to calculate how much your 401(k) plan pays its service providers.

If your plan does not pay any indirect compensation, you are lucky – totaling your 401(k) fees should be straight-forward because the amount of direct compensation must be explicitly reported in provider 408b-2 fee disclosures. To confirm your total, you can cross-reference provider invoices.

If your plan pays indirect compensation to any provider, you have a lot more work to do. Indirect compensation can only be estimated in 408b-2 disclosures because it can vary based on plan fund balances. To calculate the dollar amount of indirect compensation, you need to use a fairly complicated spreadsheet. To make this job easier, I would just ask the provider for fund-level breakdown of the annual wrap fees and revenue sharing (as applicable) they would receive from your plan given today’s fund balances. Don’t settle for a total, insist on the fund-level detail – you need to know.

The stakes are high! Don’t settle until you know your 401(k) fees!

401(k) service providers are not monolithic in the way they deliver 401(k) services or get paid. Regardless of this variability, you have a fiduciary responsibility to ensure the amount your 401k plan pays its service provider(s) is reasonable.

For this reason, I recommend you only choose service providers that don’t receive indirect compensation. You don’t want to be surprised to learn your plan pays excessive hidden fees down the road that can result in personal liability.

Not sure if your plan pays indirect compensation today? Answer our three questions.