What’s Going On “Under The Hood” of your 401(k) Plan
There are a number of different entities involved in the operation of a retirement plan:
- The Administrator, or Third Party Administrator (TPA), which drafts the plan document, performs the compliance testing and prepares the annual IRS Forms 5500 (that’s us…);
- The Investment Advisor, who provides advice and guidance on investment selection and allocation to the trustees and participants; and,
- The Recordkeeper, which maintains the participant records, trades the shares when contributions are deposited and when participants reallocate their portfolios, provides the web site and call center for the participants, plan sponsors and investment consultants, and generates and mails the participant statements. The Recordkeeper often works in partnership with at least two other entites: the Custodian, a bank or trust company that initially accepts the contributions, processes loan- and distribution checks and prepares 1099’s for former participants; and, the Trading Partner, the company that actually executes the trades in the marketplace based on participant’s or plan sponsor’s instructions to the Recordkeeper. (We have included the Custodian’s and Trading Partner’s services here since they are part-and-parcel to the Recordkeepers services and typically don’t stand alone.)
That’s a lot of moving parts…how do all these people get paid??
Now that’s an excellent question! There are, in fact, 3 questions every plan sponsor should be asking:
- How much am I paying?
- To whom am I paying it?
- What am I getting for my (or my participants’) money?
The TPA typically charges a flat dollar fee, often an annual base fee plus a per-participant charge.
The Investment Advisor is generally either a broker who receives commissions from the investments in the plan or a Registered Investment Advisor (RIA) who charges the plan or the employer a fee (usually a percentage of the assets).
Recordkeeping fees are often the most difficult to identify and are becoming the most controversial. They are described as the “hidden” costs of operating a retirement plan, primarily because a major portion of them are buried in the mutual fund fees and are rarely disclosed in any fund fact sheet or online resource.
Mutual fund expenses can be broken down into 3 basic categories:
1. Operating Expenses, the fundamental cost of operating the fund, including paying the fund’s portfolio manager(s);
2. 12b-1 fees, the commissions paid to brokers; and,
3. Sub-transfer agency (“sub-ta”) fees, often also referred to as “revenue sharing”. These are fees paid to recordkeepers to reimburse them for providing services that the mutual fund company would otherwise be responsible for were the participants to go directly to the fund company for their investment (account balances, web site, statements, call center, trading, custodial, etc., etc.)
Revenue sharing may include 12b-1 fees if there is no commissioned broker-of-record working with the plan (which includes plans contracted with an RIA). Both sub-ta and 12b-1 fees can range from 0% to as high as 1%.
“But our plan is FREE – we don’t pay anything!” Not exactly… let’s take a look under the hood
It’s truly remarkable how often we hear this phrase. Polite professionals like ourselves will not say it the client’s faces, but we are astounded at how naive that statement is. While it’s true that some providers will claim that their program is available with no out-of-pocket cost to the employer, no one works for free. The providers are paid out of the participants accounts – the sub-ta revenue sharing from the funds they’re invested in. It’s not unusual for a $5 million plan, for example, to be paying .50% in sub-ta and/or 12b-1 fees – that’s $25,000. That doesn’t sound like “free” to us – and the cost continues to rise as the plan assets grow!
Problems arise when trustees don’t completely understand the components of their plans and as a result are not in a position to evaluate their options. Worse, they cannot effectively answer participants’ questions about fees they’re paying. Worse yet, they may fail to meet fiduciary standards and are subject to participants’ lawsuits.
The good news: there are a number of recordkeepers who are changing the paradigm. They are charging a fee, of course, but are then crediting the revenue sharing against those fees. If the amount of revenue sharing exceeds the recordkeeping fee, the difference is deposited into an “ERISA expense” or “ERISA reimbursement” account within the plan and can be used to pay other plan-related expenses (TPA or RIA fees, for example). Some recordkeepers are even crediting the revenue sharing back to the participants’ accounts. This approach can reduce plan fees by thousands of dollars in some cases, year after year.
Important note: even if your plan’s recordkeeper already uses this type of arrangement you’re not off the hook. You MUST insist on a breakdown of the individual components (recordkeeping/trading/administration/investment advice) so you can determine how much you – or more accurately, your participants – are paying for each. It’s still very easy for a provider to “bundle” everything together without full disclosure and continue to hide excessive fees.
If you’re a plan trustee or an interested participant here are several resources that address the issues of 401(k) fees:
COLLECTED WISDOM™ On Revenue Sharing Within 401k Plans from the 401khelpcenter.com: http://www.401khelpcenter.com/cw/cw_revenue_sharing.html
Dirty Little Secrets of 401(k) Plan Fees by Ken Weber, from the May 2007 American Institute of Certified Public Accountants’ Journal of Accountancy: http://www.journalofaccountancy.com/Issues/2007/May/DirtyLittleSecretsOf401KPlanFees
An Interview with Fred Reish, by Ryan Alfred, posted November 5, 2009 on the BrightScope blog: http://www.brightscope.com/blog/
If you’d like to “lift the hood” on your company’s retirement plan, please contact us at (908) 450-7170 or Info@PathwayRetirement.com. There is no charge for the initial consultation.