August 2024
The Continuing Freefall of Fees in 401(k) Plans
I recently received my weekly Thursday email from Benefits Pro, which consisted of four or five articles. The headline that grabbed my attention was ICI Report:
Mutual Fund Fees in 401(k)s Show Multi-Decade Decline. This information, though not shocking, is still worth mentioning to clients and participants as it is positive news. Yet, it fails to address the causes of the decline, the distinctions among fund share classes, several types of cost structures, or additional fees associated with 401(k) plans. Here is a quick review of the big three:
1. Investment Fees
The article's title cuts to the chase. To be more specific, “the average equity mutual fund expense ratio paid by 401(k) participants dropped by 60% and their average bond mutual fund expense ratio by 63%” (a mutual fund expense ratio is the annual fee charged by fund managers to cover the operational costs of running the fund). That is a significant amount of savings for 401(k) participants and has contributed to the rise in the number of corporate 401(k)s and participants. Compound that savings for twenty-four years, and that money becomes very meaningful.
The decrease in fees is a result of multiple factors: heightened competition, stricter regulations, more lawsuits related to 401(k) fees, greater adoption of index funds, the shift toward lower cost-no load mutual funds, and improved fee transparency.
Investment fees are inherent to the mutual funds in the plan. Historically, 401(k) participants have been responsible for paying these fees (unfortunately, your 401(k) is not free and never has been). These fees are taken out of your account every quarter to pay for the mutual fund company's research, advertising, sales, marketing, and other related costs. Costs can vary depending on the type of mutual fund share class (examples: A, B, C, I, R shares) and, in some cases, there is a portion of the fee, called revenue sharing, which goes back into the plan to help pay for plan expenses such as administration and investment advisory services.
More information on investment fees can be viewed via your plan participant website or by asking your internal 401(k) contact for a 408(b)(2) fee disclosure.
2. Recordkeeping/Administration Fees
401(k) recordkeeping fees cover a range of essential services necessary for the plan's operation. These include plan administration (maintaining participant records, processing contributions, distributions, loans, participant website, and providing participant account statements), related accounting and legal services, trustee services, compliance, and reporting.
Like investment fees, recordkeeping/administration fees have been going down for years and are one of the main reasons for a rapid decline in the number of recordkeepers. There were approximately 243 recordkeepers in 2023 versus 440 in 2010—a 45% decrease!* Additionally, the decrease can be attributed to fee compression and the escalating costs of technology, particularly in cybersecurity.
3. Advisory Fees
The 401(K) advisor plays a leading role for the plan sponsor, recommending recordkeeping/TPA partners and other third parties. Their primary responsibility is to offer a varied selection of low-cost mutual funds as investment options for 401(k) participants. Additionally, their responsibilities include designing a plan based on company needs, educating participants, conducting regular reviews, and benchmarking investments, fees, and the plan. They also offer guidance on regulations and serve as consultants for the plan.
Advisory fees have also decreased. The practice of mutual funds paying advisors a pre-determined fee or using revenue sharing is declining. In addition, plans are using providers that offer a fixed fee or transparent fee schedules. Plans with $100 million or more in assets are seeing the greatest benefit from fee compression with some experiencing a 20% decrease in fees since 2013.**
Cost Structures
Most plans distribute the cost of plan service providers to the participants by periodically deducting fees. This is done via three methods: 1) pro rata amount to each participant with those with a high percentage of assets paying the most, 2) per capita account debit, where the same flat fee is periodically deducted from each participant’s account, or 3) some combination of both.
A much smaller number of firms pay for one or both the advisory and recordkeeping through the company. This has benefits for everyone, such as:
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- Tax deductibility: all retirement plan service provider fees are tax deductible
- Participant balances will grow and compound faster, as no fees are coming out of their accounts.
- Decreased fee liability: When a plan sponsor pays for plan fees, the plan costs become extremely reasonable for plan participants. No lawyer will be able to sue a plan for excessive fees when all provider costs are paid for by the company.
Paying for one or both fees is a best practice recommended by many 401(k) advisory firms.
Summary
If you hear someone mentioning the high costs of their 401(k) plan, inform them that fees have gone down significantly over the past twenty years. I may not have the same experience as you, but I've noticed that the costs of healthcare, education, automobiles, and other things have been on the rise. Your 401(k) could be the most secure investment you've ever made against inflation.
DISCLAIMER: This newsletter is intended to provide thought-provoking commentary. The information presented herein has been obtained from and is based upon sources and vendors deemed to be reliable, but may be incomplete. Parkside Financial Bank Trust does not itself endorse or guarantee, and assumes no liability for, the accuracy or reliability of any third party data or the financial information contained herein.
Parkside Financial Bank & Trust does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Investments are not insured by the FDIC or any government agency, provide no bank guarantee, are not a deposit and may lose value.
