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A Guide to 401k Fees and Fee-Related Liabilities for Retirement Plans

 401k Fees


The topic of 401k fees has dominated the headlines for the better part of this decade. Running a company 401k plan is an arduous task. Navigating fiduciary responsibilities is also a potential minefield of liability as ambitious law firms aggressively attempt to exploit the subjective regulatory frameworks of the IRS and the Department of Labor. Nowhere within a 401k plan is there more potential liability than with regard to the subject of fees. Excessive fees litigation is by far the most common law suit brought against 401k plans.

401k Fees litigation is not without merit. Considering the profound impact of fees on an individual’s retirement plan balance, even a small error in fees selection could have a large impact on the participant balance at retirement. Keep in mind also, the regulations do not say that fees have to be the cheapest, they need to be reasonable for the services being offered. This may require benchmarking against similar services.

So what are 401k fees, what is reasonable and who should pay?

Let’s start with some basic concepts related to the responsibilities of a plan sponsor when it comes to paying fees from plan funds. The first thing to understand is that the plan sponsor has a fiduciary responsibility to pay only necessary and reasonable fees from plan assets. Herein lays one of the biggest potential trap-doors for a sponsor. While “necessary” may be somewhat objective in nature…the issue of reasonableness is certainly a gray area in the courts. Keep in mind, as a plan fiduciary, you have personal liability as well.

401(k) plan fees and expenses generally fall into three categories:

Department of Labor whitepaper (the following are excerpts from the on defined contribution plan fees)

Plan administration fees. The day-to-day operation of a 401(k) plan involves expenses for basic administrative services – such as plan recordkeeping, accounting, legal and trustee services – that are necessary for administering the plan as a whole. Today, a 401(k) plan also may offer a host of additional services, such as telephone voice-response systems, access to a customer service representative, educational seminars, retirement planning software, and investment advice, electronic access to plan information, daily valuation and online transactions.

In some instances, the costs of administrative services will be covered by investment fees that are deducted directly from investment returns. Otherwise, if administrative costs are separately charged, they will be borne either by your employer or charged directly against the assets of the plan. When paid directly by the plan, administrative fees are either allocated among participant’s individual accounts in proportion to each account balance (i.e., participants with larger account balances pay more of the allocated expenses) or passed through as a fl at fee against each participant’s account. Either way, generally the more services provided, the higher the fees.

Investment fees. By far the largest component of 401(k) plan fees and expenses is associated with managing plan investments. Fees for investment management and other investment-related services generally are assessed as a percentage of assets invested. You should pay attention to these fees. You pay for them in the form of an indirect charge against your account because they are deducted directly from your investment returns. Your net total return is your return after these fees have been deducted. (See pages 4-6 for more information on investment-related fees.)

Individual service fees. In addition to overall administrative expenses, there may be individual service fees associated with optional features offered under a 401(k) plan. Individual service fees are charged separately to the accounts of participants who choose to take advantage of a particular plan feature. For example, individual service fees may be charged to a participant for taking a loan from the plan or for executing participant investment directions.

401(k) plan investments and services may be provided through a variety of arrangements: Employers may directly provide, or separately negotiate with and hire different providers for, some or all of the various services and investment alternatives offered under their 401(k) plans (sometimes referred to as an unbundled arrangement). The expenses of each provider (i.e., investment manager, trustee, recordkeeper, communications fi rm) are charged separately.

In many plans, some or all of the various services and investment options may be offered by one provider for a fee paid to that provider (sometimes referred to as a bundled arrangement). The provider will then pay out of that fee any other service providers that it contracts with to provide the services.

Some plans may use an arrangement that combines a single provider for certain services, such as administrative services, with a number of providers for investment options.

Regardless of the arrangement used, fees need to be evaluated, keeping in mind the cost of all covered services.

What fees are associated with investment choices in a 401(k) plan?

Apart from fees charged for administration of the plan itself, there are three basic types of fees that may be charged in connection with investment options in a 401(k) plan. These fees, which can be referred to by different terms, include:

Sales charges (also known as loads or commissions). These are transaction costs for buying and selling of shares. They may be computed in different ways, depending upon the particular investment product.

Management fees (also known as investment advisory fees or account maintenance fees). These are ongoing charges for managing the assets of the investment fund. They are generally stated as a percentage of the amount of assets invested in the fund. Sometimes management fees may be used to cover administrative expenses. You should know that the level of management fees can vary widely, depending on the investment manager and the nature of the investment product. Investment products that require significant management, research and monitoring services generally will have higher fees.

Other fees. This category covers services, such as recordkeeping, furnishing statements, toll-free telephone numbers and investment advice, involved in the day-to-day management of investment products. They may be stated either as a flat fee or as a percentage of the amount of assets invested in the fund.

In addition, there are some fees that are unique to specific types of investments. Following are brief descriptions of some of the more common investments offered under 401(k) plans and explanations of some of the different terminology and unique fees associated with them.

Some Common Investments and Related Fees

Most investments offered under 401(k) plans today pool the money of a large number of individual investors. Pooling money makes it possible for individual participants to diversify investments, to benefit from economies of scale and to lower their transaction costs. These funds may invest in stocks, bonds, real estate and other investments. Larger plans, by virtue of their size, are more likely to pool investments on their own – for example, by using a separate account held with a financial institution. Smaller plans generally invest in commingled pooled investment vehicles offered by financial institutions. Generally, investment-related fees, usually charged as a percentage of assets invested, are paid by the participant.

Mutual funds. Mutual funds pool and invest the money of many people. Each investor owns shares in the mutual fund that represent a part of the mutual fund’s holdings. The portfolio of securities held by a mutual fund is managed by a professional investment adviser following a specific investment policy. In addition to investment management and administration fees, you may fi nd these fees:

  • Some mutual funds assess sales charges . These charges may be paid when you invest in a fund (known as a front-end load) or when you sell (known as a back-end load, deferred sales charge or redemption fee). A frontend load is deducted up front and, therefore, reduces the amount of your initial investment. A back-end load is determined by how long you keep your investment. There are various types of back-end loads, including some which decrease and eventually disappear over time. A back-end load is paid when the shares are sold (i.e., if you decide to sell a fund share when a back-end load is in effect, you will be charged the load).
  • Mutual funds also may charge what are known as Rule 12b-1 fees, which are ongoing fees paid out of fund assets. Rule 12b-1 fees may be used to pay for commissions to brokers and other salespersons, to pay for advertising and other costs of promoting the fund to investors and to pay various service providers of a 401(k) plan pursuant to a bundled services arrangement. Some mutual funds may be advertised as “no-load” funds. This can mean that there is no front- or backend load. However, there may be a 12b-1 fee.
  • Target date retirement funds, which are often mutual funds, hold stocks, bonds, and cash investments. These funds are designed to make investing for retirement more convenient by automatically changing your investment mix or asset allocation over time. Target date funds may charge different fees even with the same target date. If a target date fund invests in other mutual funds (often called a “fund-of-funds”), fees may be charged by both the target date fund and the other funds.

Collective investment funds. A collective investment fund is a trust fund managed by a bank or trust company that pools investments of 401(k) plans and other similar investors. Each investor has a proportionate interest in the trust fund assets. For example, if a collective investment fund holds $10 million in assets and your investment in the fund is $10,000, you have a 0.1 percent interest in the fund. Like mutual funds, collective investment funds may have different investment objectives. There are investment management and administrative fees associated with a collective investment fund.

Variable annuities. Insurance companies frequently offer a range of investment options for 401(k) plans through a group variable annuity contract between an insurance company and an employer on behalf of a plan. The variable annuity contract “wraps” around investment options, often a number of mutual funds. Participants select from among the investment options offered, and the returns to their individual accounts vary with their choice of investments. Variable annuities also include one or more insurance elements, which are not present in other investment options. Generally, these elements include an annuity feature, interest and expense guarantees, and any death benefi t provided during the term of the contract. In addition to investment management fees and administration fees, you may fi nd these fees:

  • Insurance-related charges are associated with investment options that include an insurance component. They include items such as sales expenses, mortality risk charges and the cost of issuing and administering contracts.
  • Surrender and transfer charges are fees an insurance company may charge when an employer terminates a contract (in other words, withdraws the plan’s investment) before the term of the contract expires or if you withdraw an amount from the contract. This fee may be imposed if these events occur before the expiration of a stated period, and commonly decrease and disappear over time. It is similar to an early withdrawal penalty on a bank certificate of deposit or to a back-end load or redemption fee charged by some mutual funds.

Stable value funds. A common investment option that generally includes fixed income securities and one or more contracts issued by banks or insurance companies that provide protection of contributions invested (the principal) and accumulated interest, as well as a rate of return that may be fixed, linked to an index, or reset periodically based on the performance of the fund’s investments. These funds may have investment management and other administrative fees associated with their operation. While the investments described above are common, 401(k) plans also may offer other investments which are not described here (such as employer securities).

Timothy Kelly
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