Uncovering 401(k) Fees

By Mary E. Medland Aug 1, 2004

HR Magazine, August 2004

Questions of who pays what for the companys 401(k) plan are typically HRs to answer.

Overseeing a company’s 401(k) retirement plans can be a complex responsibility, particularly since it demands a thorough understanding of mutual funds’ often-obscure fees and expenses.

Plan sponsors, including HR professionals responsible for retirement plans, are required by the Employee Retirement Income Security Act (ERISA) to find out how plan fees are calculated and charged to participants and to make sure the costs are not exorbitant. It’s part of their obligation under ERISA to act prudently and foremost for the benefit of plan participants.

Failure to be diligent about that fiduciary responsibility can be costly—to both employees and employers.

If a plan’s expenses are unreasonably high, they can depress an employee’s account value by tens of thousands of dollars over the course of 20 or 30 years. That, in turn, can prompt employees to sue, alleging that the employer failed to meet its fiduciary obligation because it did not discover and curtail the excessive fees.

Such sentiment was rare in the financially heady days of the late 1990s, when 401(k) balances were soaring in tandem with stock values overall; the impact of fees didn’t draw widespread notice outside the ranks of fiduciaries.

Moreover, it was a period of heightened merger and acquisition activity, and the restructuring of benefits packages sometimes didn’t command the priority it deserved, says David Huntley, a principal with HR Investment Consultants Inc., a Towson, Md., firm that focuses on retirement plans. Sometimes the result, he says, was failure to negotiate fee reductions for smaller plans when they were merged with larger plans that already had lower fees.

New Concerns

Besides the long-standing reasons for vigilance about 401(k) fees, there are newer factors linked to the headlines. Retirement plan fiduciaries now need to stay current on federal and state agencies’ widely reported investigations into apparent trading irregularities—variously referred to as market-timing and late-trading practices—involving some mutual funds, which are a staple of 401(k) plans. Agencies are also looking into the propriety of some transaction fees.

The fiduciary interest in mutual fund issues has been spelled out by Ann L. Combs, assistant secretary of the U.S. Department of Labor’s Employee Benefits Security Administration. Noting that retirement plans “hold more than $1.1 trillion of assets invested in mutual funds and similar pooled investment vehicles, representing more than 30 percent of all pension plan investments,” Combs has said: “Although investors generally could not anticipate the late-trading and market-timing problems identified by federal and state regulators, plan fiduciaries nonetheless are now faced with the difficult task of assessing the impact of these problems on their plans’ investments and on investment options made available to the plans’ participants and beneficiaries.”

Benefits managers who have questions about funds’ management and possible trading irregularities should start asking questions, says David Wolfe, a partner and HR law specialist in the Chicago law firm of Gardner, Carton & Douglas.

He suggests the following possible lines of questioning:

  • Has the fund been approached by state or federal regulators?
  • If so, what is the status of the regulatory investigation?
  • What trading irregularities, if any, have been identified?
  • To what extent are investors negatively affected by such activities?
  • What steps are being taken to make certain that any such irregularities do not continue at the fund level?
  • What steps are being considered to make up for any resulting losses in participants’ accounts?

Finding The Facts and Figures

While plan providers have the right to be compensated for their work and to make a profit, retirement plan experts say benefits managers have rights, too—namely, to acquire plan providers’ full disclosure about fees.

And the experts admit it’s not easy. Don Stone, president of Chicago-based Plan Sponsor Advisors LLC, says, “There is so much to know, and plan sponsors really struggle with that.” He adds that “asymmetry” in the ways that facts are presented can make it difficult to compare them, and that “vendors have all the data, which can be hard for HR to access.”

Nonetheless, many experts say, although fees are not uniform from fund to fund and many fees and expenses seem to be hidden, the information is there to be found.

“Anyone who cares to look can find out how much they are paying in fees and expenses,” Huntley says. “The only reason fees and expenses are hidden is because managers choose not to look deeply enough at them.”

And while alarm bells should go off for HR professionals if they suspect providers are dragging their feet on disclosing fees, Huntley recommends persistence: Benefits managers should ask—and keep asking—until they get the information they want.

Says Wolfe: “You have to look at a plan’s prospectus and ask: How much are you being charged? How much of your fees are asset-based? What are your arrangements with related parties? Who is paying whom for what? What dollar arrangements are involved?”

John Blossom, president and CEO of Peoria-based Alliance Benefit Group of Illinois, which administers retirement plans, says: “Full disclosure should be requested and received in written form and should be maintained as a permanent record of the plan operation. When individual mutual funds are included in the plan, the benefits managers should compare the expense ratios of each fund’s peer group.

“Disclosure should enable the benefits manager to determine annual base fees, per capita fees, asset-based fees, revenue sharing payments to the provider, any commissions paid by the plan, 12b-1 fees and the internal expense ratios for each fund.” (The term “12b-1 fees” refers to expenses charged to shareholders to cover a mutual fund’s shareholder servicing, distribution and marketing costs.)

Blossom adds that “national surveys of 401(k) plan providers indicate that the annual service cost per participant per plan is in the $90 to $110 range.”

Stone concurs that a reasonable cost for a plan that includes 200 employees would be about $90 per participant per year. And yet, he says, it could turn out to be an unusually high figure, perhaps “$900 annually” per participant. “In that case, you really have to dig into the fees and negotiate with the vendor for a reduction.” An expanding fee category that benefits managers should explore in their research consists of legal fees, such as those for routine annual filings with regulatory agencies. “Each fund pays about $5,000 to $20,000 a year for legal work,” says Stone. “That’s pretty typical.”

In addition, however, there are skyrocketing legal fees being paid to defend lawsuits revolving around unacceptable 401(k) fees, Stone says. “I’ve seen legal fees go from $10,000 to more than $1 million. And those legal fees are in turn buried and passed on to the participant.” Such fees would be rolled into the “other expenses” portion of the fund’s expenses, and, in effect, fund investors, including 401(k) plan participants, would foot the bill.

David Wray, president of the Chicago-based Profit Sharing/401(k) Council of America, advises benefits managers to ask the plan provider for a spreadsheet that lists the types of fees for each investment option and to apply those fees to the overall plan balances in each of those funds.

Wray adds that a Summary of Additional Information for each fund is available upon request. It’s a report, he says, that “lists the transaction-related fees that a mutual fund pays that are not included in the management fee or 12b-1 fee.”

Noting that the payment of fees from fund assets affects a fund’s overall performance, Wray says funds with high fees typically underperform equivalent funds with low fees. With that in mind, retirement plan managers “who carefully benchmark fund performance over time,” he says, can then “either avoid or drop consistently underperforming funds from their plan.”

As always in any investing arrangement, you should be wary of a free lunch, Stone says. If, for example, a vendor tells you that there is no fee for keeping your records, it means the vendor is making a lot of money somewhere else, he cautions.

Spreading the Message

After getting responses from plan providers about fees and expenses—and negotiating reductions if necessary—benefits managers “need to openly communicate the responses with plan participants, explaining the potential impact to investment returns,” says Connie Rank-Smith, vice president of HR and administration for Jewelers Mutual Insurance Co. in Neenah, Wis.

Such communication can help all employees—from those who are in the dark about retirement plans to those who are savvy about investing—and it also helps benefits managers demonstrate that they take their fiduciary responsibilities seriously. Telling employees about 401(k) fees also fits into the wider responsibility of benefits managers to educate employees about their retirement plans, says Rank-Smith. “Now, more than ever, employers should be providing nonbiased educational information to plan participants to help them to be well-versed in a valuable benefit,” she says. “This is part of all benefit managers’ fiduciary responsibility.”

One way to keep employees informed, Rank-Smith says, is to simply hold meetings in which both the employer and a representative from the investment company participate.

“In most cases,” says attorney Antoinette Pilzner, an ERISA specialist with the Butzel Long law firm in Ann Arbor, Mich., “these education sessions are very helpful to plan participants. The service provider will generally have more expertise in understanding and explaining mutual fund expenses and plan fees than the benefits manager.”

Pilzner adds: “If the benefits manager does not have the required expertise or skills, fiduciary duty requires the benefits manager to engage an expert for assistance.”

Wray notes that benefits managers increasingly are turning to third-party advisers to help with managing their fiduciary responsibilities, and Wolfe adds a note of caution: Make sure that any third-party adviser who is consulted is completely independent of, for instance, all of the mutual funds that might be involved. “Some of these independent third parties,” he says, “are not as independent as they should be.”

Matters of Timing

How often should employees be informed about 401(k) plan fees and expenses? Consider not just holding annual sessions but also giving quarterly updates—and immediate updates when something surfaces that could impact plan participants—Rank-Smith says. She acknowledges that communicating fees to employees is easier when investment returns are good than when they are poor.

Plan administrator Blossom recommends that benefits managers come down on the side of disclosing more rather than less information to participants.

Says Wolfe: “You simply cannot communicate too much.” Bear in mind, for example, that plan participants are reading and hearing news accounts of irregularities in mutual fund practices, he says, so it’s imperative that providers make it known that they are doing everything possible to protect participants’ assets.

“If you have bad news to give, give it early,” Wolfe advises. “Explain to participants what your process for protecting them is. This is such a public issue that a good HR person can give a lot of comfort to employees.”

Overall, Wolfe says, most benefits managers probably don’t know “the full extent of what they are paying.” But by digging for the facts, they’ll get a clearer picture. And if, as a result, “they realize they are paying an unreasonable amount,” he continues, they “will need to negotiate with the vendor to get a reasonable package.

“In the long run, plan participants will be the ones who benefit.”

Mary E. Medland is a freelance business writer based in Baltimore.


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