401(k) Corner – No Free Lunch

401(k) Corner – No Free Lunch

While most plan sponsors understand the underlying investment expenses of their mutual funds, many have an erroneous belief that they don’t pay administrative costs. Somebody is paying for the expense; they probably don’t know it.

Bundled vs. Unbundled Providers
There are three separate services that all 401(k) and Profit Sharing plans require: 1.) Custody & trading of securities 2.) Investment Advice to determine investment options as a “prudent expert” would, and #3) Administration- to handle the compliance and testing that a plan requires for DOL and IRS testing. A “bundled” product is where one firm provides all of the solutions-usually in a very standard way. An “unbundled” plan has a separate provider for custody & trading, investment advice, and administration.

Bundled Plans
The belief in “Free 401(k)’s” seems to be a byproduct of insurance companies. Insurance companies typically bundle the investment, custody, and administrative component into one product. The investments have underlying fees, and an additional “wrapper” is then placed on top to compensate the provider for administrative duties. These fees are taken from the performance of the investments and are therefore paid by the participants. This isn’t necessarily bad, many plans would likely never get off the ground if the company had to foot the entire bill. For a small plan, say $200,000, 2.5% “all in fees” are not abnormal for a total annual cost of $5,000.

Unbundled Providers
An “unbundled” plan will have a separate Administrator, Investment Advisor, and Custodian. The administrator will likely have some base fee and smaller asset based fee on top. The investment advisor will also likely have a reduction in their fees as plan assets grow. Different custodians charge differently and each plan requires a review of the most competitive custodian for their situation. In essence, a portion of the unbundled providers’ costs are fixed, and a portion are variable to the asset base.

When Bundled gets Bulky
The problem arises when the plan grows in value. Under the bundled approach, your fees as a percent stay the same, but the dollar value of the fee grows rapidly. Once the plan referenced above grows to $1.5M, the bundled approach yields a total cost of $37,500! In other words; once your plan grows, a bundled provider is likely not the best value! Many people think that their broker or insurance company will automatically switch them into a more competitive plan; this rarely happens.

What to do
You have a legal duty to ensure the plan is paying reasonable expenses. Most experts recommend benchmarking your plan with an independent source or bidding every 3 years. Have you reviewed your plan recently to ensure you and your employees have the most competitive option?