There has been a lot of buzz around investment management fees lately, even in the 401(k) plan space. The mantra of the day—“The lower the investment fees, the better the return.” However, like sponsoring any benefit, there are fees associated with the administration and management of a 401(k) plan. You, as an employer, can choose to pass on some or even all of these fees to participants. This decision must be weighed seriously before implementation. How will the decision be perceived by employees? Is it more appropriate for the company to cover the cost? If the cost is split, what fees should be passed through to the participants?
What are our options?
You can guess that the easiest solution is to have the company absorb the administrative and advisory fees completely. That generally leaves the participant to only cover their funds’ operating expenses (we’ll talk about that in a second), just as they would in the open market. If taking on all the plan management fees is too much for the company, then the cost can be shared between the company and the participants.
This is very common with earlier stage companies that have a tight budget, but still want to offer this crucial benefit to their team. 401(k) plans have an average cost anywhere between 0.50% – 1.25% of annual plan assets. That cost may sound large to some and small to others, but fees paid out of participant accounts can definitely impact retirement savings when viewed in the long term. Compounded over the long haul, you can see how reducing fees paid in participant account can really help out your employees. Employers that absorb the fees or at least equitably share the cost with the participants tend to have better participation, which ultimately lowers fiduciary exposure. And it’s like any other benefit…the more the company covers the plan costs, the more competitive the 401(k) becomes.
So what about those fund expenses?
Employers share plan costs in a couple different ways::
- They bill a flat dollar amount to each participant, or
- They use revenue that is generated from the fund expenses
Most of the companies that have been making the news for “fiduciary neglect” tend to have unwarranted higher plan fees and additionally pass on all or some of those fees to their participants. A best practice to make your 401(k) more competitive and reduce fiduciary exposure is to use lower cost fund options. To satisfy your employees’ varying investment styles, there are low cost Index (aka “Passive”) fund options and “Institutional” share classes of actively managed fund options that have stripped out some or all of the revenue sharing that a recordkeeper uses to reduce company cost. Participants who are offered these Index and Institutional options are then left with just their funds’ operating expenses.
As a fiduciary, it is your responsibility to make sure that you are offering reasonably priced fund options to your employees. To make sure you’re in compliance, consult your 401(k) advisor.