401(k) plans may contain many different provisions, which often require considerable work to administer. And the more difficult a plan is to administer, the costlier it can be.
A 401(k) plan has a third-party administrator who conducts testing to ensure that the plan meets and follows IRS and DOL compliance standards as well as preparing annual reports and returns for the plan. The plan also needs a platform which consists of websites and reporting to allow plan to access their accounts for viewing or making changes in their investment choices or other details. Additionally, the plan needs an advisor to assist the participants in making the right choices for their situation.
These various services can be sourced separately or bundled together within a plan. Since there are obviously costs involved with bringing these components together, it is important to drill down and determine the total cost of a plan. Many times, there are different levels of fees which can be hidden and moved about within the plan to appear that the costs are much lower than they actually are. This is where the shell game analogy comes into play.
Sometimes a plan may be represented to a company as having a very low administrative cost. The line-up of mutual funds within the plan however may have high fees or other added costs to the funds to pay for the administration of the plan. With the cost of these fees generally hidden, it can appear that the plan is a low-cost plan while actually having significant fees inside the plan. The result is that the plan provider is still getting paid but it comes at the expense of the participants in the plan. These costs drag on the performance of the funds, thus keeping the retirement savings from growing as fast as they should.
Unfortunately, it is difficult to dig through the fine print and follow the fee structure to determine how the plan providers are compensated. Fees may be shown outright or they may be shuffled through one or more categories. As an example, a provider may offer a line-up of low cost or well-known funds but the internal expense ratio charged by the fund is much higher than if you purchased those funds outside the retirement plan or through another retirement plan. Many times, plan providers shuffle these expenses throughout the plan so it is difficult to determine exactly what you are paying and to whom.
As an example of how this could play out, let’s assume you have $100,000 in a 401k or 403(b) plan. If one plan has a .05 % average fee on the funds it offers and another has a .75 % fee, that may not sound like a lot. And remember, these fees are not always obvious so most times, investors only see how their fund grows or falls. But that small .7% difference can add up. On $100,000, that equates to an extra $700 of fees … every year. On a $500,000 portfolio, that’s $3,500 more a year and at $1,000,000, that’s a whopping $7,000 more each and every year. So, understanding fees and ‘administrative costs’ is very important indeed.
Sometimes plans will use what are known as proprietary mutual funds or ‘house funds’ that are owned and managed by the brokerage firm or plan provider. These funds are generally more expensive than other alternatives but may make up a majority of the options in the plan.
Finally, in all the shuffling around, you want to make sure your plan and advisor have a fiduciary duty. An ERISA Code Section 3(38) Investment Manager is the type of advisor that assumes sole fiduciary liability for the investment selection and monitoring. When a Section 3(38) advisor is hired, the trustee or owner of the plan is relieved of the fiduciary responsibilities. Other advisors aren’t held to this standard and their compensation can depend upon the advice they give, creating a conflict of interest.
There are lots of moving parts in a 401(k) plan but by becoming familiar with the ins and outs, you can avoid the shell game and develop the best plan for your company and employees.