Are Your 401K Costs Too High?

While mutual fund expenses and brokerage commissions receive plenty of attention in the financial press, 401k plan fees are a much less frequently discussed topic. However, both the employers who sponsor 401ks and plan participants can benefit from a review of the topic. This note presents some key information, and then an example of how one firm with a $2.5 million plan could save $16,650 per year, and at the same time add potentailly valuable advice from a fiduciary for the plan participants.

The Department of Labor Weighs In

The United State Department of Labor offers a booklet that provides a detailed look at the fees and expenses paid by 401k plans. This booklet is a worthwhile read for 401k plan sponsors, and may also be of interest to plan participants who would like to better understand various details of their company’s program. Fees and expenses are a particularly relevant topic for plan sponsors since they hold a fiduciary duty to the plans. For plan participants, fees and expenses are one of the factors that will affect their investment performance and impact their retirement income.

As the Department of Labor website points out, fees should not be the only consideration in choosing a plan provider, though they can provide a meaningful drag on investment performance. Employers who are the plan sponsors should recognize this.

The Reality

Particularly at businesses where 401k plan assets are less than $10 million, one finds expensive programs. Employers who sponsor these smaller plans often elect an off-the-shelf, bundled solution where the 401k provider is either a mutual fund or insurance company. These “closed” or “semi-closed architecture” offerings provide one stop shopping for plan design, custody, and investment choices. However, this typically comes at the cost of higher fees and more limited investment options than would be available to participants in a well-designed “open architecture” 401k plan. Such a plan would feature a separate plan administrator, custodian, and mutual fund managers.

The Data Supports the Value of Advice

There is often very little advice provided to 401k plan participants about their investment options and appropriate asset allocation. This is unfortunate because there can be significant improvements to investment performance when employees receive investment advice.

Consultants at Hewitt Associates Inc., Lincolnshire, Illinois, and Financial Engines Inc., Palo Alto, Calif., have published data supporting that conclusion in an analysis of data on 400,000 401(k) plan participants.

The consultants at Hewitt and Financial Engines, both active players in the 401(k) plan services market, found that, on average, the median annual return for participants using investment help was 1.86 percentage points higher, net of fees, than the median annual return for participants who did not use professional help (Life and Health National Underwriter, 1/28/10).

The Numbers Can Be Compelling

An industry record keeper recently provided the following numbers. They illustrate how 401k fees might differ between a broker provided 401k program and one structured in an open architecture with advice provided by a fee-based RIA firm. These numbers are for a 40 participant plan with $2.5 million in plan assets.

Broker Sponsored 401k Sample Cost Breakdown

Administration/Compliance…………………………8.6 bps
Custodian Contract Fee…………………….…….…50.0 bps
Broker Fee – current advisor…………………………………Paid via 12b-1 fees
Net Mutual Fund Expense Ratio…..........…....149.0 bps avg.
Net Cost to Client…………………………..…...…..207.6 bps

Open Architecture 401k with RIA Co-Fiduciary Sample Cost Breakdown

Administration/Compliance………………......……3.0 bps
Custodian Contract Fee………………………..……..0.0 bps
RIA/Co-Fiduciary………………………………....….50.0 bps
Net Mutual Fund Expense Ratio……..…………..58.0 bps avg.
Net Cost to Client…………………………….........…141.0 bps

Savings to Client = 207.6 bps – 141.0 bps = 66.6 bps x $2.5 million = $16,650/yr.

In this instance the plan would save $16,650/year and plan participants would obtain advice from an independent RIA that is a co-fiduciary to the plan along with the plan sponsor.

Conclusion

At a minimum this data about plan costs and the potential benefit that advice can provide should make plan sponsors take a look at their plan expenses relative to the alternatives. Independent fee-based Registered Investment Advisors can play an instrumental role in helping small and medium sized businesses improve their 401k offering; assistance with the creation of a cost effective, open architecture 401k plan and the provision of investment advice being the two most obvious areas.