We recently worked with a small business to help them identify and understand their company sponsored 401k fees.
The 401k plan was actually an insurance product that was put into place prior to working with us. And in case you don’t know, insurance products typically involve lengthy, confusing contracts. In fact there were 170 pages within the contract. It took us quite a while to determine what the fees were and even then we weren’t totally sure we knew all the fees.
There was a lot of language within the contract that said “there may be fees for …….” or “certain charges may be deducted from plan assets”. Another part of the contract said “Program and Administrative Charges will never exceed 2.00% per year”. What??? This tells us nothing about what the fees are; just that they are on some kind of sliding scale. Do you see all the vagueness here?
A 2012 Ruling from the Department of Labor (DOL) requires that all vendors providing services to a 401k (more on this in a minute) fully disclose their fees to employers. Yet as you just saw, some vendors, mainly insurance companies, still continue to find ways to make it difficult for you to figure out what the 401k is costing you and your employees.
The Legal Responsibility of Business Owners
The Employee Retirement Income Security Act (ERISA), requires that the employer “pay only reasonable expenses from plan assets”. In other words, it is the business owner’s legal responsibility to make sure that all vendors within the 401k are charging reasonable amounts. But how can an employer begin to understand what is reasonable if the fees are vague and not fully disclosed?
An employer should not judge a 401k based solely on fees, but they should have an idea of whether or not the fees are reasonable. But before we get into the reasonableness of fees, let me first discuss the different types of fees typically found within 401k plans.
5 Types of 401k Fees
In total, there are typically 5 different types of fees within a 401k plan. My guess is that this is a surprise to you because our industry has historically done a poor job of laying it all on the table.
The 5 types of fees are for the custodian, investments, investment manager, recordkeeper, and third party administrator.
Custodian – this is where the employees’ money is physically held. Our firm uses TD Ameritrade.
Investments – each investment will carry its own expense. And the costs can vary widely. In fact, many mutual fund companies, for example, will have several different versions (called share classes) of the same mutual fund with each having a different fee. I have seen as many as 10 different versions of the same mutual fund. And you may or may not be receiving the cheapest version. Our firm doesn’t use investments like this. Instead we use Exchange Traded Funds which are much more transparent and much less costly.
Investment Manager – an investment manager will typically help with investment selection, investment monitoring, and employee guidance. At our firm not only do we help with these things, but we also provide services intended to protect the business owner(s) and employees.
Recordkeeper – this is the company that provides the website for employees to log into so that they can make investment elections, choose how much they wish to contribute, view statements, view historical transactions, etc. The Recordkeeper also keeps a record of all transactions into and out of the 401k plan (hence the term recordkeeper). And they provide statements to employees at least on a quarterly basis.
Third Party Administrator (TPA) – they are responsible for handling all legal aspects of the 401k plan such as vesting, testing, employee eligibility, sending out required disclosures and plan documents, and filing IRS Form 5500 annually. In many cases the Recordkeeping and TPA duties are bundled together by one company. At our firm we outsource to a combined Recordkeeper / TPA.
You should receive a fee disclosure notice each year (called a 408(b)(2) Fee Disclosure Notice) from your TPA. This notice should clearly outline all fees within your plan. Once you have become familiar with the fees then you can begin to determine whether or not they are reasonable.
What are “reasonable” 401k fees?
Unfortunately, the DOL does not come out and state what is “reasonable”. It would be nice if they provided a range, but they do not.
In my opinion, total fees (including all the vendors listed above) should generally be under 1.50% per year for plans with $1.0 million or more in assets. At our firm total fees are generally much less than 1.50%, but 1.50% should be a good guide for you when evaluating your plan. Start up plans and smaller plans (under $1.0 million) tend to be more pricey from a % standpoint simply because there aren’t many assets in the 401k plan. But as the 401k plan grows the fee % should drop.
As mentioned above, a 401k should not be judged solely on fees. It is equally important to look at the services and value being provided. For example, if you are using the cheapest provider around, you may not be getting the fiduciary guidance that you need in order to satisfy your legal responsibility to your employees.
With all that said, 401k fees cannot be astronomical; they have to be “reasonable”. One of the ways that we help to determine reasonableness is through an annual benchmarking process. What this means is that we will annually compare the fees of our client’s 401k plan to other plans of similar size to make sure that we are in the ballpark of averages.
If you aren’t sure what your company sponsored 401k fees are and would like some help identifying and understanding them, then feel free to contact us. To learn more visit our Company Sponsored Retirement Plan section on our website.
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Brad E.S. Tinnon
CERTIFIED FINANCIAL PLANNER™