Financial Opinion and Insights

Do You Know Your 401(k) Costs?

Jim Lorenzen, CFP®
Jim Lorenzen, CFP®



Believe it or not, many experts estimate 85% of retirement industry revenue is never billed directly or even disclosed.      

This is because most 401(k) plan distribution and record-keeping costs are subsidized by the funds themselves in the form of fund-marketing fees, shareholder-servicing fees, sub-transfer agent fees, and finder’s fees that compensate the sales and distribution effort.  Many of these costs are unknown to a great many employers who provide retirement plans for their employees.  In some cases, these costs are paid by the employer; but, in many – if not most – cases, they’re paid by the plan participants themselves through hidden deductions.    


Revenue Sharing    

Ever hear of it?  It’s quite common.  Many legitimate plan expenses are paid through revenue sharing arrangements, but often they’re hidden.   Many providers ‘bury’ costs in the investment side in order to reduce costs on the administration side.  It makes the plan look less expensive – or even `free’ – to the employer.  In some cases providers overpay for brokerage services so that they can receive ‘research’ and other services from the brokerage firms, which is legal as long as it benefits the plan.  But, few employers sponsoring plans know what those fees are or how to account for them.     

Are You Paying Too Much in Fees?    

Here’s a little checklist of ‘Warning Signs’ your company should be looking for:    

>  Low plan administration fee.   If that fee is low, or even ‘zero’, just remember that nothing is free and a ‘zero’ hard-dollar fee means the plan is paying for administration based on plan assets (either through an asset-based charge or higher fund expense ratios that subsidize the record keeper – or both).  Fees that don’t cover the cost of administration obscure the cost of the service – and, asset-based fees result in substantially higher fees as assets grow.    

>  Average participant balance is over $25,000.   Since over 80% of vendor revenue is asset-based, high average balance plans are more profitable.  The economics of the industry make plans with average balances below $20,000 not very profitable for the vendors, while plans with average balances over $25,000 become attractive.  If the average plan balance is over $50,000 it’s a virtual certainty the vendor is being overpaid and you can negotiate a lower fee.    

>  Vendor compensation from funds is unknown.   Most mutual funds pay compensation to record keepers because they do the accounting work the fund would otherwise have to do.  These fees are asset-based.   Many employers have no idea how much the plan vendor is earning in these sub-transfer agent fees or shareholder service fees.    

>  Heavy reliance on proprietary funds.   A good rule of thumb is that service providers make 0.70% (70 basis-points) or more on equity funds they manage.   Requiring proprietary funds may be good for the vendor, but may not be prudent from either a fee or investment perspective for your plan.    

>  12-(b)(1) fees are kept by the vendor.  12b-1 fees pay account representatives to service the plan.  If your plan doesn’t have an advisor providing services, either the vendor or the fund manager is keeping those fees.  Consider either getting an advisor to help with the plan or ask the vendor to offer lower expense ratio funds to the plan without this fee.    

>  Unknown stable-value management fee.  Stable value funds are a favorite place to bury additional fees.  Insurance companies often minimize more visible fees by raising the management fee of the stable value product.  The management fee for the same product can vary from as little as 0.30% to 1.25%.  Since assets in this type of fund are typically high, it can be very profitable for the service provider and practically invisible to the employer/sponsor and plan participants.    

>  Unknown advisor fees.  In the small to mid-market (plans between $2-50 million), advisor fees can have a major impact on fees.  Advisors often choose the fee they want and the vendor builds it into the total fees the client is charged.  Some vendors even tie additional fees for themselves to advisor compensation.   There are even some plans that are paying the advisor more than twice as much as similar plans.  If you don’t know what compensation your advisor is getting, you may be overpaying.    

It pays to watch your pennies.   Like mom said, they grow to nickels, dimes, ….. well, you know. 

Written by Jim Lorenzen, CFP®, AIF®

July 6, 2010 at 8:00 am