Recently, there has been much in the news about employees suing their employer over the high cost of fees in their 401K plans. This liability exposure is due to an employers obligations under the Employee Retirement Income Security Act of 1974 (ERISA). ERISA requires those who operate 401K plans to act as fiduciaries for the plan. Which means they have a duty to put the employees interest above all other concerns. Monitoring fees is a large part of the responsibility.
In conflict with the fee obligation is a financial industry that sells 401K plans to employers with the administrative and adviser fees built into the mutual fund fee ratio. This means that the fees are taken from the returns of the mutual funds and diverted to the plan provider. The fee is invisible to the employee, because they only see the net return of the mutual funds they own. And, the fee is painless to the employer because they are not writing a check to the providers.
Currently, the fees for a medium sized plan ($10,000,000 in assets) may average around .50% . This means that each participant has an invisible reduction of their mutual fund returns of .50% . In addition, the participant with higher balances pay the larger share of the total plan fees (ie an employee with a $10,000 balance will pay $50/year in fees, while an employee with a $100,000 balance will pay $500).
In many cases, as the employees account balances grow, the participants continue to pay the same percentage fee. The providers earn more with no additional work involved. An argument can be made that a down market negatively effect the providers. But in an environment, where employees are making weekly contributions and markets trend up, the risk for providers is low.
In summary, the current fee structure, in which the employees pay the plan expenses, does not provide an incentive for the employer to monitor the expenses.
My proposal: Employers should simply pay fees directly to the administrative and investment advisers. This would eliminate much of the employer liability. When the administrative fees are broken down, the cost to a small/medium sized could run about $100/year per employee* The cost of $100/year per employee is minimal compared to what an employer pays for health, workers comp and disability insurance.
If employers broke the paradigm of employee pay 401K expenses, the benefits could be as follows:
- The employee earns a higher return on their investments. With reports showing that most savers are ill prepared for retirement any additional return is critical.
- The employees with the higher balances no longer pay the disproportionate amount of the expenses.
- Fees will come down when the employer starts paying the bill.
- The potential for litigation due to high fees is reduced.
Seems like a no brainer, but change is difficult.
* I am involved with a 400 employee, $10,000,000 plan that has a low combined administrative and adviser fee of $40,000. The fees were once over $100,000. They were reduced through a strategy that unbundled and directly paid the service functions of administration, compliance, record keeping and investment advisers.
- There are some plans that directly pay the providers. In my experience they are the minority.
- Some employers may argue that by paying 401K fees the employer may have to reduce contributions to health insurance or other benefits that could result in an unintended consequence of employees reducing their 401K contributions to make up the increase in other benefit costs. This is a potential effect, but unlikely, if the cost is $100/employee as mentioned above.