How to Navigate the Complicated World of 401(k) Fees
Understanding all of the fees in a 401(k) plan can be a Herculean task for advisors and fiduciaries alike, but especially for the average investor. However, understanding fees and who pays them is paramount to improving their returns. Unfortunately, it is very difficult for investors to truly understand the fees associated with plan administration, investments and individual services.
Recent Employee Retirement Income Security Act (ERISA) regulation from the Department of Labor requires the disclosure of fees from covered service providers, such as investment advisors, record-keepers, brokers and managers of asset allocation models to plan fiduciaries, but it is uncommon that these disclosures are passed on to employees. In order to understand more about the fees of your 401(k) and what service is provided in return, we encourage you to ask your human resources representative or financial advisor the following questions.
Are plan administration costs paid by the participants (employees) or the plan sponsor (employer)? Day-to-day operating expenses of a 401(k) plan involve services such as plan record-keeping, accounting, legal and trustee services, all of which are necessary for the plan to function at a basic level. However, many plans may include services such as educational seminars, retirement planning software and investment planning advice. These fees could be paid for by investment returns, but most often, they are separately charged to either your employer or your assets in the plan.
If paid by the employees, they can be assessed in proportion to the amount of assets in the plan or as a flat fee against each participant's account. By asking this question your aim is to find out: Are you are paying for your ability to invest in a 401(k) by covering the operating expenses involved, or are you only paying for the services you receive and the investments in the plan? If your employer doesn't offer a match, makes you pay administrative expenses and you are not maximizing your contribution to the plan, you may be better off investing in an individual retirement account.
Is there revenue sharing in my plan? Revenue sharing is the practice of adding additional non-investment related fees, including sales and marketing, to the overall cost, or the expense ratio of a mutual fund. These additional fees are then paid out to various service providers, typically record-keepers and brokers, who have no impact on the performance of the fund company managing the mutual fund. Larger 401(k) plans don't have revenue sharing because they have access to managed accounts or institutional share classes.
Often, small businesses have these types of funds within their lineup, even though they may be investing in the same fund as a large company, but at a greater price. This is controversial because mutual fund returns are reported net of fees, but the money collected from investors and paid out to other parties is not explicitly reported to investors.
How are participant forfeitures used? If a participant (employee) terminates employment prior to satisfying the required service years to become fully vested in his or her employer or profit-sharing contributions, then the unvested funds can be used for specific purposes. Some of those uses include to pay plan expenses, reduce employer matching contributions or employer discretionary profit-sharing contributions, or allocate to existing participants on a pro-rata basis.
The use of the funds is described in the plan document. Knowing the use of these funds is important to ensure the proper amount of termination benefit is paid to you upon termination and that the plan administration is properly utilizing forfeitures received.
The 401(k) marketplace continues to evolve and go through common changes that have already taken place in the "retail" investor marketplace. Common sense regulations, such as disclosure of all applicable fees, who they're paid by and for what services rendered, are still being implemented or interpreted in court.
The Department of Labor is going through great lengths to keep up with changes in the marketplace and update regulations to ensure mutual fund companies and plan sponsors comply. The best force for change, however, is from the people who use these products and depend on them to help build a nest egg for a decent standard of living in retirement. If you are uncomfortable with any of the answers you receive, it may be time to consider making changes to your 401(k) plan.
Kelly Campbell, certified financial planner and accredited investment fiduciary, is the founder of Campbell Wealth Management and a registered investment advisor in Alexandria, Va. Campbell is also the author of "Fire Your Broker," a controversial look at the broker industry written as an empathetic response to the trials and tribulations that many investors have faced as the stock market cratered and their advisors abandoned their responsibilities to help them weather the storm.
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