Thanks to the Labor Department's 408(b)2 and 404(a)5 regulations, greater clarity now exists concerning the often complex fee structures embedded in many 401(k) plans. For example, fee-sharing arrangements between record-keepers and asset managers are now easier to identify and question. In addition, other basic data about asset management charges, while previously available, is now generally presented in a more comprehensive manner (although it is potentially overwhelming).

 

"Research has shown that paying just 1 percent more in fees can lead to a 28 percent decrease in a 401(k) account balance over the course of a career."

-- The U.S Department of Labor

 

But the current task at hand is to determine whether the costs are reasonable and competitive. Technically, the individuals in your organization who have legal responsibility for the welfare of 401(k) plan participants (plan fiduciaries) have always been charged with making sure that employees weren't being over charged, directly or indirectly, for plan services. With the more detailed information available, it will be harder to claim ignorance as an excuse for over paying.

 

Asleep at the Switch?

In the past, there was litigation against large employers, which accused them of being asleep at the switch while participants were ripped off. This involved class-action lawsuits by high-powered plaintiffs' attorneys. Today, many smaller employers could be vulnerable to lawsuits.

It can be very easy for small employers to settle for, say, $25,000 rather than to go to arbitration or trial and risk paying a lot more.

Many small 401(k) plans and employers could have problems if they haven't taken all the necessary steps to meet their fiduciary obligations. But even if an employer is handling retirement plan management requirements, there may be room for improvement.

The importance of making sure that fees are competitive is illustrated by this calculation provided by Jerry Huggins of Innovest Portfolio Solutions. He notes that for plans with between $10 million and $100 million in assets, combined fees (as a percentage of plan assets) of .5 percent would be at the lowest end of the spectrum, 1.15 percent would be average, and the highest would be 1.7 percent.

Impact of High Fees

Huggins determined the long-term impact of these differences as follows. An employee starting with a $50,000 account balance, after 35 years earning an average return of 7 percent (before fees), would wind up with about $1.3 million in the low-cost plan, $1.1 million in the average cost plan and only $900,000 in the high cost plan. If accumulated assets are withdrawn at a 5 percent rate over a 35-year period of the employee's retirement, the employee in the low-cost plan would be able to take out about $24,000 more annually than his counterpart in the high-cost plan.

Such comparisons are only possible when you take the detailed fees data that is now being supplied and put it into context by benchmarking. You can get that data yourself, or more likely, get it from your retirement plan advisor. Research firms like Fiduciary Benchmarks and Fiduciary Risk Assessment Plan Tools are among those that supply benchmark data. Be sure benchmark data is providing the most current survey information, and not using potentially stale data from government filings. That's important because some fees are coming down fast.

Experts stress, however, not to assume that "low-cost" means "good," especially without examining fee categories individually. You may make a wise determination that some "bells and whistles" are worth paying more for. Ask questions including:

  • What services are actually included in the fees the plan is paying? For example, what does "participant education" actually mean?
  • Do plan participants benefit from all of these services?
  • Are employees actually using them?

Index Funds and ETFs

When it comes to asset management costs, the cheapest way to go generally is with index-based mutual funds and exchange-traded funds (ETFs). Yet some index funds might cost vastly more than others -- so apples-to-apples cost comparisons even within these categories are essential.

Because index funds and ETFs are cheaper, some employers might think about abandoning other fund types. Yet more expensive actively managed funds may still have a very legitimate place in your 401(k). The key is making sure employees understand the costs and trade-offs involved.

With the growing attention to plan fees, you might think a lot of employers are dumping high-cost vendors in favor of less expensive ones. It turns out that isn't always necessary. Many high-cost providers now accept the competitive necessity of cutting their fees in order to maintain existing relationships.

© Bizactions LLC.