RSM Resources

Long hailed as the foundation of a smart retirement savingsstrategy, 401(k) plans are an essential component of many employers’total compensation offerings. These retirement vehicles have grown at astaggering pace, reaching about 47 million participants and more than$2 trillion in assets. Yet many midsized businesses and their employeesare seeing hidden fees and undisclosed costs whittle down their 401(k)plan balances.

Fees for 401(k) plans cover services such asinvestment management and other financial advice, hiring and managingplan vendors, telephone or Web-based customer service for planparticipants, and record-keeping, custodial or trustee services forplan assets. Generally, services are either "bundled," where a plansponsor hires one company to provide the full range of servicesdirectly or through subcontractors, or "unbundled," where the sponsoruses a combination of service providers hired independently of eachother.

These fees can influence the long-term performance of anemployee savings plan. According to a November 2006 study published bythe U.S. Government Accountability Office (GAO), even a smalldifference in 401(k) fees can significantly decrease an employee’sretirement savings over the course of a career.

"Assume anemployee of 45 years of age with 20 years until retirement changesemployers and leaves $20,000 in a 401(k) account," writes report authorBarbara Bovbjerg, director of Education, Workforce and Income SecurityIssues for the GAO. "If the average annual net return is 6.5 percent —a 7 percent investment return minus a 0.5 percent charge for fees — the$20,000 will grow to about $70,500 at retirement. However, if fees areinstead 1.5 percent annually, the average net return is reduced to 5.5percent, and the $20,000 will grow to only about $58,400. Theadditional 1 percent annual charge for fees would reduce the accountbalance at retirement by about 17 percent."

Many employers andplan participants are not aware of these charges or service providers’undisclosed business arrangements that can negatively affect planperformance. In addition, fees can mask a potential conflict ofinterest — for example, where one service provider to a 401(k) planpays a third-party provider for services, such as record-keeping, butdoes not disclose this compensation to the plan sponsor.

Tocompound the problem, not all companies review their 401(k) fees asoften as they should. Transamerica Retirement Services, a retirementplan provider, reported in a 2005 survey that 17 percent of companiesnever evaluate their retirement benefits. Of those that do, smallcompanies are less likely than large companies to conduct reviews atleast once a year. At the same time, many employees don’t understandthere is a cost for their 401(k) investment services. In a nationalsurvey conducted by AARP, more than 80 percent of 401(k) participantsreported not knowing how much they pay in fees.

Managing 401(k) fees

Sinceinvestment services account for the bulk of plan fees, many 401(k) plansponsors are looking to institutional funds to help lower their planexpenses. Institutional mutual funds resemble funds available in theconsumer market but are typically available only to 401(k) plans withassets above a certain threshold, such as $1 million. Similarly,indexed funds charge lower management fees than actively managed funds.These funds closely track a market performance indicator, such as theStandard & Poor’s 500, which largely eliminates expendituresassociated with research, investment selection, and buying and selling.

Newfederal initiatives that address 401(k) fees should help manage plancosts and improve understanding of a plan’s expense structure. The U.S.Department of Labor is proposing changes to the regulations that governarrangements between plan sponsors and their service providers, with afocus on fee transparency. Under this proposal, plan administratorswould be required to disclose indirect fees, including revenue-sharingpayments, on the plan’s annual report. Plan service providers wouldalso be required to provide a summary of all fees that plan assetscover or that participants pay directly.

Employers can alsoreduce 401(k) costs and liability concerns by taking an active role inplan management. Attorney Gregory Ash, a partner with Spencer FaneBritt & Browne and a specialist in employee benefits law andlitigation avoidance, explains that class-action lawsuits are croppingup in response to 401(k) fees. In 10 lawsuits filed recently, planparticipants argued that even small reductions in the return of their401(k) investments are devastating, and that the most certain means ofprotecting plan returns — and the factor most within employer control —is to reduce fees and expenses.

"The plaintiffs in these casesare arguing that the fee structures used by third-party administrators,recordkeepers, investment consultants and other 401(k) serviceproviders are complex, excessive, undisclosed and illegal. Theymaintain that by adhering to those fee structures, plan fiduciaries arebreaching their obligations to participants," Ash says. "According tothe plaintiffs, by failing to provide adequate information about planexpenses, the fiduciaries are responsible for any investment losses theparticipants may have suffered. This is likely to be just the first ina wave of similar suits which could have a tremendous effect on the401(k) industry as a whole."

Ash recommends these tactics to reduce your liability risk and promote a well-managed 401(k) fee structure:

• Calculate current plan costs and ask service providers to explain the expense- and revenue-sharing arrangements for each fund in the plan.
• Periodically reviewthe performance of the investment funds the plan offers, includingtheir expenses, to determine whether those funds continue to beappropriate.
• Aggressively negotiate your plan fees,including conducting formal or informal requests for proposals withexisting or new providers, to ensure you provide the most competitive401(k) offering.
• Offer a diverse selection of funds and investment options to ensure choice and flexibility for plan participants.
• Inform participants about the fees and expenses associated with the plan and thoroughly document the employee communication process.

"AsAmerican workers take increasing responsibility for the adequacy oftheir retirement savings through 401(k) plans, they need to be moreaware of the fees that they pay," says the GAO’s Bovbjerg. "Givingparticipants key information on fees for each of the plan’s investmentoptions in a simple format — including fees, historical performance,and risk — will help participants make informed investment decisionswithin their 401(k) plan."