Employers operate 401k plans at a cost. Like other labor expenses (hiring process, salary, vacation pay, etc.) employers have to pay for compliance with labor and employment laws. Benefit plans are somewhat unique. Under ERISA employers can shift the cost of plan administration from the plan sponsor to plan beneficiaries. 401k plan fees often are handled through revenue sharing with the financial institution operating the plan in which the administrator selected funds that would absorb the costs of the plan.
After years of federal litigation challenging whether employers could select higher fee funds to absorb plan costs, many 401k plans moved towards selecting lower fee funds that left the plan sponsor with more fees to pay. Many employers then slid those fees to employees to pay. These fees can gobble up retirement savings so it is important for workers to understand how 401k plan fees work.
Two kinds of fees 401k plans can charge participants – plan-level fees and investment-related fees.
401k plans, like all employee benefits, are expensive to operate. There is a lot of paperwork to make a plan function. ERISA permits plans to share costs through administrative fees in a number of ways. Some plans charge administrative fees through periodic administrative fees. These fees are normally a few dollars or as much as $25 and often charged monthly, quarterly or annually.
Some plans charge fees based upon transactions or particular services elected by participants. For example, it is very common for participants to pay fees to process loans and withdrawals. Participants may even pay a reoccurring, periodic service fee on plan loans.
Plans do this because in addition to the normal operating costs, processing distributions can cost a plan hundreds of dollars through a recordkeeping service provider (such as Fidelity, T. Rowe Price, ACS), especially when paperwork is involved. Participants may pay fees for utilizing an associated investment advisor through the plan, if offered.
Those fees may be a stated dollar amount or a small percentage of what you have in the account (assets under management) depending upon the service agreement between the plan and the advisor. Plans may also charge for specific basic services, such as printing costs to send out plan documents.
Plan administrators may only assess fees from 401k plan assets. They cannot assess fees from your paycheck for the plan. For this reason, any fees collected stay within the plan and may only be used by the administrator for plan expenses, whether they are for specific expenses or general plan expenses. Any plan fees should be clearly outlined in the Summary Plan Description (SPD).
Investment-related fees include fees charged by the investment provider or broker that are paid not to the plan but to the third party provider. These fees may include sales commissions, trading commissions, sales loads and management fees. Plans have a fiduciary duty under ERISA to select investments (and brokers to process transactions) that have reasonable fees – conversely stated, they cannot offer investments that have excessive fees.
(The exception being window investments, such as a brokerage window that allows you to select investments outside of the plan with money you have in the plan. The Supreme Court ruled that plans are not required to review window investments for prudence or fees.)
“Excessive” is not a definitive term and often requires looking at the entire financial industry or the entire sector of similar funds to determine whether the plan is offering funds with excessive fees. Normally plans offer funds with management fees below 3% (and usually below 2%), rarely considered excessive by industry standards.
Fund managers charge periodic management fees for as long as you hold shares of the fund. Excessive investment fees may create claims against the plan. If you believe your 401k plan charges excessive fees then you should speak with an employment lawyer right away.
Although management fees go to the third party fund managers, revenue sharing agreements between fund management and plan administrators receive considerable attention. Revenue sharing agreements form between the funds and the plan so that a portion of the management fee returns to the plan.
The plan then uses the revenue to pay for plan expenses. If the shared revenue exceeds plan expenses, it returns pro rata back to participants. They are particularly common when recordkeeping services are sold by mutual fund companies. They in turn urge the plan administrator to offer the fund company’s funds so that the administrator recovers costs through revenue sharing.
These agreements have come under fire the past few years for several reasons. Plan documents made available to participants or fund prospectuses often do not clearly disclose them. Some people assert that if not for the revenue sharing fund fees would be lower so it is “excessive” to charge participants higher fees for revenue sharing.
Furthermore, plan administrators fail to make independent and neutral decisions about the plan investment options when lured towards choosing investments that make the plan less expensive for them. Excessive management fees can also create claims under ERISA. If you believe your plan charges excessive fees then you should speak with a labor law attorney.
Concerns about revenue sharing
There are definitely some valid concerns about revenue sharing. One reason why revenue sharing is a good for participants is otherwise plans would likely charge fees to the participants. Participants would pay the same management fees to the funds who would just keep the money.
Before the market crashed in 2007 many plans did not assess administrative fees. Revenue sharing paid for most or all plan expenses. When the market crashed, many plans turned to charging administrative fees. Through the 2000s there were many lawsuits against plans brought by employment lawyers around the nation for improper revenue sharing.
Participants continued to pay the same management fees to the funds. As a result, participants pay more now in plan fees than they did pre-crash before revenue sharing came under fire. Many of the complaints alleged against revenue sharing claims it is a kickback. In a sense, it is like a kickback. But if the alternative is participants pay more in fees, the kickback may be cheaper for participants.
The inherent risk in revenue sharing is that participants are not getting the best plan possible. Plan administrators may desire the lowest expense for the plan, which may mean revenue sharing. To get to revenue sharing, plans may have to offer share classes with higher expenses than might be available.
Plan administrators may not even be aware that revenue sharing exists to lower the overall cost of the recordkeeping services. Plan sponsors may select more expensive services than intended and pass along a great deal of expense. Fortunately the Department of Labor’s new disclosure rules require recordkeepers and plans to disclose these relationships.
Plan administration duties to pick investments
Although plans must offer prudent investments, they do not have to offer the cheapest alternative. ERISA rules permit plans to accept revenue sharing so long as it does not violate other rules. This is why many of the revenue sharing lawsuits in the past have failed to survive.
There is a lot of force against doing away with revenue sharing. It helps the big mutual fund companies that control the 401k plan service market keep their market share. It may be several years before new disclosure regulations have a significant impact on plans and 401k service providers.
As a participant you should look carefully at the fees charged in your plan, both plan-level and investment-related. There may be low-fee investment options that can help you avoid paying fees that diminish your account returns. If you are a current employee you may not have an option to remove your money from the plan. However, if you have the option to rollover your money you should compare the fees. You should also consider any administrative fees and what effect that has on your returns. If you believe the plan charges excessive fees then you should speak with an employee benefits attorney right away.
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