There are few industries where the phrase “you get what you pay for” is less applicable than the 401(k) industry. That’s because equally competent 401(k) providers can charge dramatically different fees for comparable administration services and investments. This variability is a big problem for business owners – who have a fiduciary responsibility to protect the interests of their 401(k) participants by paying only “reasonable” fees from plan assets. If an owner fails to meet their responsibility, they can be personally liable for restoring participant losses due to excessive fee payments.
And yet, few business owners know the cost of their 401(k) plan – even when their personal account earnings are at stake. According to a recent Pew Charitable Trusts survey, only 19% of small to midsize employers are “very familiar” with the fees paid by their 401(k) plan, while 34% were “not at all familiar.” The remaining 47% said they were only “somewhat familiar.”
Why are so many business owners unclear about the cost of their 401(k) plan despite their personal interest in keeping its fees in check? I think a contributing factor is ineffective DOL fee disclosure rules that permit 401(k) providers to bury administration fees paid by revenue sharing and/or a variable annuity wrap in fund expenses ratios. This lack of transparency can make it impossible for business owners to determine the full cost of their 401(k) provider’s administration services.
If you’re a business owner, the stakes are too high to not know the cost of your 401(k) plan. Below is a primer on the two major 401(k) fee categories – administration fees and investment expenses - and the range we found for these fees in our latest small business 401(k) fee study. You can use this information to help determine the cost of your plan and compare your 401(k) provider’s fees to competitors.
401(k) administration fees
401(k) administration services include asset custody, participant recordkeeping, and Third-Party Administration (TPA). A 401(k) provider can charge either “direct” or “indirect” fees for their plan administration services:
- Direct fees – are paid by the plan sponsor or deducted from participant accounts.
- Indirect fees – are paid by plan investments. The two most common forms of indirect fees are revenue sharingand variable annuity wraps.
You have a fiduciary responsibility to ensure these fees are reasonable in total. Direct fees are the most transparent. Their dollar amount should be explicitly reported in your 401(k) provider’s 408b-2 fee disclosure. Indirect fees are a different story. 401(k) providers typically bury them in fund expense ratios – leaving it up to you to determine their dollar amount. This job usually requires the use of a complicated spreadsheet.
401(k) providers can charge either asset-based or headcount-based fees for administration services. I recommend you avoid asset-based administration fees to the extent possible because they can quickly outstretch your provider’s level of service as plan assets grow.
In our 2018 small business 401(k) fee study, we found 401(k) providers charge dramatically different administration fees – ranging from $97.09 to $2,521.81 per participant (direct + indirect) on average. A huge difference!
401(k) investment expenses
401(k) investments are most often mutual funds. Their investment expenses fall into one of two general categories – shareholder fees and operating expenses. Shareholder fees apply to individual investor transactions and account maintenance while operating expenses cover regular and recurring fund expenses. Operating expenses are expressed as an expense ratio in mutual fund prospectuses.
Mutual fund operating expenses lower 401(k) participant investment returns – so the lower the operating expense ratio, the better. Mutual fund companies tend to make their funds - particularly actively-managed funds - available to 401(k) plans in multiple share classes. While all classes hold the same underlying securities, they can have very different expense ratios. Share classes with the highest expense ratios usually pay the most revenue sharing. Insurance companies can increase expense ratios further by adding a variable annuity wrap fee.
Because revenue sharing and wrap fees cover plan administration services - not investment management - you should consider them administration fees - not investment expenses – when they apply.
In our 2018 small business 401(k) fee study, we found the fund lineups of 401(k) providers had dramatically different “net” (minus revenue sharing and annuity wrap fees) expense ratios – ranging from 0.08% to 0.78% of plan assets on average. Another big difference!
Cost matters when saving for retirement!
Cost matters a lot when saving for retirement due to the power of compound interest. Reducing your 401(k) plan’s administration fees and investment expenses can help you and your employees retire years sooner – not to mention, lower your fiduciary liability.
Don’t let your 401(k) provider hide the cost of your plan – the stakes are too high. If they can’t give you a straight answer about the cost of your plan, there’s a good chance your plan is paying too much.