The Shell Game – Some Perspective on Your Plan’s 401(k) Fees

Monday, February 22, 2021

Jim Sampson, Business Conributor

 

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If you’ve read an article about 401(k) plans over the last 10 years, more often than not, it has been about how 401(k) fees are excessive, egregious and ruining the life savings of hard-working Americans.  Many of these articles, however, don’t tell the whole story. It’s time to dispel some of the myths.

First, let’s clear some things up. When looking at ERISA (Employee Retirement Income Security Act of 1974), which governs 401(k) plans, it clearly states that 401(k) fees shall be REASONABLE for the products and services delivered. Nowhere in ERISA does it say that a plan must have the lowest fees. 

While plans with excessive fees still exist, they are not nearly as prevalent as they used to be thanks to fee disclosure regulations and a competitive marketplace that has suppressed many of the bad actors in the industry. While we still have a ways to go to get these costs in line, there are hundreds of thousands of 401(k) plans out there that do a great job following a prudent fiduciary process in managing these fees. So why the bad rap? 

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Providers of 401(k) plans have historically played a lot of games with how they structure plan fees. We call it “the shell game,” you know, the one you see on the Jumbotron where the ball is under one of the shells they move around at lightspeed and you have to guess where the ball is hiding. It’s easy to criticize these fees without a full understanding of what they are and what they cover. This is especially true when comparing 401(k) fees to those in an IRA (individual retirement account) or brokerage account, which can be an apples-to-oranges comparison.  So let’s start with an understanding of the different types of fees in these plans. 

Most 401(k) fees can be boiled down to one of two things: investment costs or operational costs. 

 

Investment Costs

Investment costs come in MANY shapes and sizes but there are three basic components that could make up this fee:

1) Investment management: This covers the cost for the mutual fund manager to research, buy and sell the companies that the fund is going to invest in. Every fund has this cost, whether it’s an actively managed fund or a low-cost index fund.

2) 12b-1 fees: These fees pay commissions to brokers.

3} Sub-Transfer Agent (or sub-TA) fees: These fees offset recordkeeping costs.

These costs are built into the fund as a percentage of the money in the fund, and are deducted on a daily basis, net of returns. These costs are always disclosed, but don’t show up as a line-item deduction on a statement, which is why many refer to these as “hidden fees.”  It’s important to note that not all funds have 12b-1s or sub-TAs, also known as “revenue sharing.”  The share class of each fund determines if revenue sharing is included or not as well as how much. 

 

Operational Costs

Operational costs cover all the components that make the plan run. Most employees don’t know about all the operations that go on behind the scenes of their plan, and those things all have costs. Here’s a sampling of operational costs:

- Recordkeeping costs: These pay for the website and all the tools it offers, the tracking of the daily accounts, statements as well as the support people on the other end of the 800#, among many other things.

- Administration costs: The IRS requires that all 401(k) plans have a legal plan document that must be maintained and updated periodically as well as a litany of discrimination tests and reporting to ensure the plan stays in compliance with all rules and regulations. 

- Investment fiduciary costs: Because employers are managing their employees’ money, they are held to a “fiduciary standard,” which means they must have a rigorous selection and monitoring process to determine what fund choices are offered in the plan. Most companies hire an outside expert to assist with this process as well as educate the employees on their financial choices.

There is no set standard or requirement on how operational costs are charged. Some providers charge a fixed amount while others charge a percentage of assets. There is also no set standard or requirement on who pays these costs – the employer or the employee. Depending on whether the company picks up the tab, some 401(k) fees may appear to be higher than others. Generally speaking, larger companies absorb all of the operational costs and employees have very low fees for their investments. Smaller companies aren’t always able to cover the operational costs and pass them along to the employees, creating the perception of “high fees” since they are added to (or built in) to the investment costs.

401(k) fees are not perfect, but picking up all the shells to find the ball is a good place to start looking to determine if they are indeed high, or if they are actually reasonable – which is, after all, your fiduciary responsibility.

 

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Jim Sampson is the Director of Retirement Advisory Services at Hilb Group Retirement Services in Warwick, supporting retirement plans for companies and their employees for the last 24 years, and is the co-author of the book Save Like a Champion Today, A Winning Game Plan for Retirement.

Investment Advisory services offered through Global Retirement Services (GRP), DBA Hilb Group Retirement Services, a registered investment advisor.

 

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