To make sound investment decisions, it’s important to be informed. Yet one of the more impactful components of any retirement plan is the area where employers and participants feel least clear: retirement account fees. While fees are not the only consideration, high retirement account fees can erode retirement savings and create fiduciary liability for you, the plan sponsors.
Despite the risks, many employers/sponsors don’t carefully examine their plan fees. Worse yet, they needlessly increase their risk when they overpay providers via “hidden” fees. What you don’t see can hurt you, but what questions should you ask to avoid pitfalls?
First, let’s understand what services are provided to a typical retirement plan. There are three categories:
A successfully operated retirement plan requires all of these services. There is nothing wrong with getting paid, but you must understand how providers get paid, the fee’s reasonableness, and whether it is disclosed. Unfortunately, it is not as simple as asking the service providers. These fees can be embedded in the expense ratios of the mutual funds offered in the investment lineup.
Given all this, how can you get to the bottom of what you’re actually paying and what you’re getting in exchange for those mutual fund fees?
You should receive year-end fee disclosures that list all plan-paid expenses. Those notices and the plan’s benefits statements help you understand the total fees. The plan administrator should provide a list of all direct service charges. All expenses paid by the plan or individual participants should be clearly itemized; if not, ask why.
Share classes are classifications of different stocks or mutual funds with their own rules and benefits. Large employers may invest in institutional share classes, which often have lower costs. Some mutual funds create a share class specifically for smaller retirement plans. These may include Sub-TA fees which, in turn, include fees paid to recordkeepers, plan administrators, or other providers. In other words, the providers’ fees are aggregated with the mutual fund’s expenses and so become impossible for plan sponsors to identify. However, you can ask for a separate itemization.
Find out what your share class is. If you are in a class with a high cost, insist on one with lower expenses.
If your plan provider is an insurance company, there is a good chance your plan’s investments are variable annuities – mutual funds wrapped or protected by an insurance policy. You pay fees, surrender charges, or sales commissions that turn a low-cost mutual fund into an expensive and illiquid investment.
The same could be true of plans supported by a mutual fund provider, which has a built-in incentive to use its funds in the investment lineup. Conflicts of interest are not wrong but must be disclosed so the plan sponsor can make informed decisions.
The word “kickback” may make you cringe. Revenue sharing is a kickback— a perk to service providers that use a particular fund. There are often finder fees for bringing new business to the mutual funds, or salespeople, brokers, and insurance agents may receive negotiated loyalty incentive compensation. Regardless of the type of fee, they are all revenue sharing, increasing the investment’s expenses, and reducing returns.
Sometimes mutual fund fees are disclosed as 12(b)-1 fees – distribution fees paid for marketing and distributing fund shares. But fund companies sometimes pay different fees through multiple share classes.
Ask your investment advisor or read the prospectus. Don’t overlook footnotes about how your plan expenses “may not include any contract-level or participant record-keeping charges.” Therefore, such charges may reduce the value of your account.”
That is a red flag pointing to hidden fees. Ask your investment advisor whether your plan receives 12(b)-1 fees, the annual value of those fees, and whether you can buy the same mutual funds for a different share class with lower fees.
Transaction fees can be hard to understand, yet they are one of the most significant expenses a participant can bear. Every time a mutual fund manager buys or sells the underlying securities within a mutual fund, there is a cost.
Actively managed funds have higher transaction costs than passive funds like index-based funds. Those costs reduce the participant’s returns. You cannot entirely avoid transaction costs in actively managed funds; they can include hidden commissions and other compensation. Note that you can find transaction fees, but not easily, in the fund’s Statement of Additional Information (SAI) and annual report.
So how are the fees justified? Again, there is nothing wrong with compensating service providers. They perform the necessary services to operate a qualified retirement plan. However, sponsors must ask what services justify these fees and whether the provider yields material results for participants and beneficiaries.
In short, ask: Do these fees pay for reasonable, legitimate, and valuable services that benefit participants and enhance their retirement security? Or do they exist to support the financial services industry at the participant’s expense?
You can avoid these issues by investing in lower-cost mutual funds, like Exchange Traded Funds (ETF) or Target Date Funds (TDF). ETFs let you invest in a collection of stocks or other securities. TDFs are lifecycle funds using “professionally determined investment mixes” that grow assets over time, typically becoming more conservative.
Consider using service providers not financially incentivized to use certain mutual funds. Regularly, ask yourself: Am I paying only appropriate and reasonable retirement account fees? Hopefully, your answer will be “yes.”
[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can listen to at your leisure and each includes a comprehensive customer PowerPoint about the topic):
This is an updated version of an article originally published on June 28, 2019.]
©2022. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
Allison Brecher is general counsel at Vestwell, a fintech startup innovating the retirement plan market. She brings over 15 years of legal and regulatory experience to Vestwell, having handled high profile and complex litigation involving employee benefits, ERISA, regulatory matters, data privacy, and electronic discovery. Previously, Allison was Senior Assistant General Counsel and Director of…
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