The increasingly diverse investment options and new investment services, such as daily valuation of a participant's account, carry costs. Those costs are imposed increasingly on the employee participant alone. In addition, expenses of operating and maintaining an investment portfolio that are charged against an employee's account exact an "opportunity cost" in the form of foregone investment in every contribution period. A small reduction in an employee's potential investment, because account assets are used to pay an investment or administrative fee, can result in a large loss over the period in which the employee participates in the plan.
Joshua participates in ABC Company's 401(k) plan. He is 35 years from retirement and has an account balance of $25,000. Over the next 35 years, returns on the investments in Joshua's account average 7 percent a year. Fees and expenses over that period reduce average returns by 0.5 percent. Joshua will have an account balance at retirement of $227,000, even if no further contributions are made to the account. But if fees and expenses were assessed at a rate of 1.5 percent over the 35-year period, Joshua's account balance at retirement would be reduced to $163,000.
Employer duty as fiduciary to evaluate fees.
Both 401(k) plan sponsors and participants may be paying higher fees and expenses because plan administrators didn’t exercise sufficient care in selecting and monitoring service providers. One reason is that plan sponsors and participants don’t have enough information about the structure and extent of fees and expenses in the 401(k) industry to make informed decisions about service providers and investment options. It’s possible that, because 401(k) fees are ultimately passed on to employees, employers don’t have the same financial incentive to aggressively negotiate 401(k) plan fees as they do to negotiate defined benefit plan fees that the employer must pay.
The Department of Labor (DOL), however, cautions employers that they have a specific and ongoing fiduciary obligation under ERISA to evaluate and understand the fees and expenses paid by the plan. Accordingly, employers must:
- Establish a prudent process for selecting investment alternatives and service providers;
- Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided;
- Select prudent and adequately diversified investment alternatives; and
- Monitor investment alternatives and service providers once they have been selected to assure that they continue to be appropriate.
How to evaluate fees and expenses incurred by the plan.
DOL has provided employers with questions designed to help evaluate fees and expenses incurred by the plan. Among the questions the DOL recommends that employers ask themselves are:
- Do you know what features you want to provide (e.g., loans, number of investment options, types of investments, Internet trading)?
- Have you decided which fees and expenses you, as plan sponsor, will pay, which your employees will pay, and/or which you will share?
- Do you know which fees and expenses are charged directly to the plan and which are deducted from investment returns?
- Do you know what services are covered under the base fee and what services incur an extra charge?
- Do you understand that some investment options have higher fees than other because of the nature of the investment?
- Does the prospective service arrangement have any restrictions, such as charges for early termination of your relationship with the provider?
- Does the prospective arrangement assist your employees in making informed investment decisions for their individual accounts (e.g., providing investment education, information on fees, and the like), and how are you charged for this service?
401(k) Plan Fee Disclosure Form.
DOL suggests that an employer ask each prospective service provider for specific information regarding the services for which fees are to be paid. Employers may wish to use the same format for each prospective provider in gathering information and making equivalent comparisons. In order to facilitate this undertaking, the Pension and Welfare Benefits Administration (PWBA) and other industry groups have developed an optional 401(k) plan fee disclosure form that may be used by employers in evaluating and comparing investment fees and administrative costs charged by competing service providers.
The form enables an employer to calculate total plan fees and expenses, and features schedules that are designed to help the employer compile information on investment product fees and estimates, plan administration expenses, one-time start up and conversion expenses, and service provider termination expenses. In addition, the form outlines the manner in which fees are generally calculated and provides a list of standardized definitions that employers may consult in comparing fees assessed by vendors offering varying products.
Cites: "Study of 401(k) Plan Fees and Expenses," prepared for the PWBA by Economic Systems, Inc., and The Hay Group; Pension and Welfare Benefits Administration, "A Look at 401(k) Plan Fees"; Fred Reish, Reish & Luftman, CCH Benefit Plan Compliance, October 1998; Pension and Welfare Benefits Administration, "A Look at 401(k) Plan Fees"; Department of Labor, "A Look at 401(k) Fees for Employers."
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The information contained in this article is intended to provide useful information on the topic covered, but should not be construed as legal advice or a legal opinion.