In 2010, the Department of Labor released multiple sets of regulations regarding 401(k) fee disclosure rules. In addition to helping plan fiduciaries fulfill their duty to make informed decisions about the reasonableness of fees, the regulations require plan administrators to disclose investment-related expenses and information, as well as various administrative and individual expenses. Under these new rules, plan administrators must lay out—at least quarterly—all administrative expenses, including accounting and recordkeeping fees. Administrators that fail to meet this new disclosure could have liability for investment losses that participants incur when they self-direct their accounts. In addition, administrators that willfully violate their obligations could be subject to fines and injunctive relief.
For self-directed 401(k) plans—which offer individual participants a broader universe of investment options—fee information is often confusing and difficult to understand. While the new disclosure rules will increase access to cost information, actually interpreting that data may still be difficult.
Understanding and Monitoring the Fees
In many plans, administrative and fund management fees are bundled together and assessed as a percentage of the assets in the plan–not the actual services performed. With bundled arrangements, it is important to understand the dizzying array of fees that may be charged against a participant's 401(k) account for investment advisory, recordkeeping, administration, brokerage and management services.
What follows are the three main categories of 401(k) expenses:
Investment Management Fees
Attributable to the management of a plan's assets, these costs are typically netted out of assets in the account and, therefore, invisible to participants. They are also by far the largest cost item, generally representing between 60% and 80% of total expenses related to a 401(k) account. Investment management fees vary based on the fund type, with foreign funds being the most expensive and generally followed by stock funds and bond funds. In addition, retail mutual funds are more expensive than institutional funds, and actively managed funds are more expensive than indexed funds.
Cost of Advice Fees
These fees are paid to financial advisers who provide advice on the selection and monitoring of the investments. In addition, financial advisers may provide services such as participant education, enrollment meetings and assistance with plan design. Fees to the financial adviser typically range from 0.25% to 1%. Fees for plans with smaller assets are generally assessed according to the higher end of this range. For example, a 0.75% fee on a $500,000 plan is only $3,750. However, this fee would grow to $75,000 if plan assets reached $10 million, even though there may not be any additional services provided.
Cost of Administration and Trustee Fees
Administrative fees subsidize services such as processing the daily investment transactions, maintenance of account balances, the website and customer service telephone lines.
Asset-based fees can grow quickly as the trust assets increase over time. Therefore, it is important for sponsors to monitor the costs associated with their 401(k) plans by taking the steps outlined below.
Review the fee paid to the financial adviser. As plan assets increase in size, it may be appropriate for the basis point fee to be reduced.
Review whether lower-cost institutional funds are available in lieu of retail mutual funds. Institutional fund options generally have higher asset requirements and are often not available to smaller plans.
Review whether the selected mutual fund share class is appropriate. Mutual funds have different share classes. While the gross investment return is the same for all investors, the net return depends on the costs associated with the different share classes. The management fees charged for each share class are generally the same. The distribution and service fees, however, are different and can range between zero and 1%.
Examine the role of revenue sharing. There is a wide variance in revenue-sharing funds and depending on the mutual fund, the revenue-sharing rebates from the mutual funds can range from 0.05% to 0.25%. The service agreement between the plan sponsor and its service provider will disclose whether these funds are used to offset administrative expenses charged by your recordkeeper or whether the recordkeeper is entitled to these fees.
Examine whether an unbundled arrangement will reduce total fees paid. Assessing fees on a flat, per participant (or per capita) basis—rather than as a percentage of plan assets—generally increases transparency and flexibility.
- Benchmark your costs with industry data and/or by obtaining other proposals.
Fees are only one factor in selecting and evaluating appropriate investment options for a plan fiduciary, as well as for participants. For a plan fiduciary, payments for advice, monitoring investments, participant education and other services are necessary expenses. In this context, the plan fiduciary's objective is to make sure that these payments are reasonable. For a plan participant, fees are important but should not be the only investment criteria. For example, a high investment percentage in the plan's lowest cost investments (i.e., the stable value funds) is generally counter-productive and too conservative for most plan participants. By identifying and managing fees, plan sponsors and participants can better control these expenses.© 2013 Much Shelist, P.C.