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Fees, Fees, and more fees…

The rent in your 401(k) plan is likely too high.  Even worse, a lot of the time neither employers nor employees know just how much they’re paying, to whom, or even that they’re paying at all.

Focusing on the fees in your 401(k) is critical.  Fees reduce your overall return and affect your bottom line.  Research has shown that paying just 1% more in annual fees can lead to a 28% decrease in 401(k) balance over the course of a career.

The U.S. Department of Labor knows this and wants to protect plan participants from high fees.  It has created rules requiring employers to determine the reasonableness of the costs being charged, and to provide plan, investment, and fee information to employees.

As a result, informed employees and their attorneys, are now following up with lawsuits.  Since the DOL rules were enacted, attorneys have filed over 400 suits against employers.  The three most common complaints, according to a recent report from the Center for Retirement Research, were: excessive fees, inappropriate investment choices, and self-dealing.

One of the inherent problems with having a 401(k) plan is that it can be complex.  There are many different components to be mindful of, including recordkeeping, administration, employee education, and regulatory filings. The vast majority of employers hire external providers to handle these processes, however, hiring these providers does not release the fiduciary or legal burden of the employer.  At the end of the day, the DOL still puts the final responsibility on the employer. Recent lawsuits suggest employers may not be doing a good enough job making sure that the service providers are charging reasonable fees, including comparing their fund fees to those with similar characteristics.

The first step in analyzing your fee structure, and improving performance potential, is to look at your mutual funds’ expense ratios.   Each fund has a prospectus which discloses the annual fee charged, but you can also look them up on Morningstar or Yahoo Finance.   According to the Investment Company Institute, the average stock mutual fund annual expense ratio for 401(k) plans was 0.53% as of 2015.  Determining if the funds you’re using charge a sales load is also very important.  Many mutual fund share classes will charge you when you purchase or sell a share of their fund.  Also noted by the Investment Company Institute’s “fact book”, the average equity mutual fund sales load is a hefty 5.4%.

The next place to look is at recordkeeping costs.  The recordkeeper is essentially the bookkeeper and is in charge of tracking who is in the plan, the investments, and all transactions.  A  recent “Defined Contribution/401(k) Fee Study” conducted by Deloitte found the average fee paid for all-in services was 0.72% annually.

Advisory service fees also contribute to overall costs.  Good advisors not only take work off your plate but also share in your fiduciary role. They are generally responsible for being the plan’s consultant, investment manager, and employee educator. Plan advisors typically charge anywhere from 0.15% to 1% annually.  However, many advisors also collect 12b-1 fees from the mutual fund companies. Many consider 12b-1 fees to be a form of a “kickback”, since the advisor is being incentivized by the mutual fund company to select their funds.  Unfortunately, as the owner of the fund, you end up paying this fee.  Typical 12b-1 fees can range from 0.10% to 0.20% annually. Using an advisor who is set up to be conflict-free is important.

In addition, a plan can have miscellaneous charges for processing transactions, such as loans, redemptions, and rollovers.  All these fees, plus the time your company spends administering your plan, can add up and hurt long term performance.  When you consider all the different layers of fees, many plans are paying more than 2% a year when it’s often possible to do it for half as much.

Using a low-cost solution, with service providers who have transparent and conflict-free structures, will maximize the benefits and minimize the risk for you and your employees.