If you’re like most people, your company retirement account ranks right up there with your home as your biggest asset. Most of you who have a 401k understand the basic mechanics of how they work. You make contributions to your account, your employer typically offers a matching contribution, and then you invest these monies using the 15 to 20 fund choices in the plan. But beyond this knowledge, 401k plans have some black box qualities; they’re not very transparent.
At P&A, we have the unique vantage point of seeing a lot of 401k plans and the investments offered inside them. In the last month, we reviewed several large plans with total expenses of 1.2% to 1.4% per year, when competitive rates are roughly half as much. The reason plans have high fees is almost always due to the plan advisor or administrator being paid by the investments in the plan.
All mutual funds have a management fee (aka an expense ratio); there’s no getting around this. In theory, it’s the cost of operating the fund (paying the managers and research team as well as trading costs). But even in the same mutual fund, expense ratios can vary significantly. It’s common practice for a mutual fund company to share a portion of their management fee with the 401k plan advisor or administrator. For example, if a mutual fund charges 1.25%, they might give 0.25% to the plan’s advisor. This is known as revenue sharing or a 12b-1 fee.
There are several problems with this business model. First, it creates a conflict of interest, as there’s no incentive for the plan advisor/administrator to use lower cost investments because these typically don’t pay revenue sharing. Second, it unnecessarily increases the cost of the investments in the plan. The same mutual fund offers a lower cost version of their fund. And lastly, higher fee investments are detrimental to your financial future, which we wrote about in early April.
So how can you control your own fate?
—If you’re a participant in a 401k plan and under the age of 59 ½, we’d be happy to review your investment options with you and make sure you have your monies allocated appropriately within the plan.
—If you’re a participant over the age of 59 ½ and are unhappy with your plan’s investment options, you might be able to take what’s called an in-service distribution. This allows you to roll over to an IRA a portion (or all) of your current 401k balance without any tax implications or affecting your status in the plan.*
—Finally, if you are a business owner or sit on your company’s retirement plan committee, the first thing you should do is determine how your current plan advisor is being paid. It’s possible to reduce your plan expenses and allow your employees to keep more of their hard-earned money if your vendors aren’t paid by the investments in your plan. And if you’re interested in seeing how a fee-only advisor handles 401k plans, you can read more about P&A’s offering here.*
Whether you’re an employee participating in a plan or a company owner providing the plan to your staff, be sure to pay attention to the fees you are paying.
*Our compliance attorney has suggested I point out under these scenarios P&A stands to gain, which represents a conflict of interest. For more on conflicts in our business model, check out this article.