Hidden & Confusing Fees
Fees can be "packaged" into your company's retirement plan in a number of ways making it difficult for even the most experienced CFO or HR Director to know exactly what their employees are paying. No bills are sent and the fee disclosures can be difficult to find and understand. But make no mistake, the fees are there and they take a big bite out of your employee's retirement accounts.
Top Five Hidden & Confusing Fees in Retirement Plans
The following are common ways service providers (record keepers and/or administrators) "package" fees into retirement plans. Those charged with overseeing their company's retirement plan have a fiduciary responsibility to understand the fees their employees pay and determine if they are "fair and reasonable."
1. Asset Management Charges (AMC)
Asset Management Charges (AMC), sometimes called Mortality & Expense Fees (M&E), and can go by a few other names. are a percentage of assets taken from plan assets in addition to fund management fees. Some service providers do a good job of disclosing these fees, however many do not. Since they already hold plan assets, these fees are taken from employee accounts automatically without a bill or invoice. AMC's go largely unnoticed by employees and many employers/fiduciaries.
AMC's can be 10X more than the fund management expense and can add up to $150k+ over the career of an average employee.
Key Fiduciary Action: Plan fiduciaries need to know if their plan has an AMC, M&E or other asset based fee above and beyond the fund expense ratios in their plan. These fees, as with all participant paid fees, need to be evaluated regularly and determined if they are "fair and reasonable."
2. Loaded Mutual Funds
As many retirement service providers try to lower their AMC's, they have looked for other ways to generate revenue from plan assets. Many have shifted some or all of their AMC's to the fund management expense. Record keepers have been working with fund families for 20+ years to create new share classes of funds for the primary purpose of packaging fees inside of the fund expense ratio so they can be passed back to the service providers.
Many mutual fund companies have come out with "R" (R=Retirement, or can use other letters) share classes, that offer multiple versions of the same underlying fund. For example, ABC Growth Fund might offer six share classes, R1, R2, R3, R4, R5 and R6. The only difference between the ABC Growth R1 and ABC Growth R6 might be that the R1 version has an additional 1% in fees that are passed back to the record keeper.
Key Fiduciary Action: Knowing which share class your plan offers and who is getting what fees from the fund managers is an important (and required) step for employers to understand total plan fees.
3. Stable Value Subsidation
A growing trend of fee packaging is the use of the Stable Value (cash/fixed/money market equivalents) to subsidize plan pricing. If you have received a quote from a service provider recently and the fee appears too good to be true, it's possibly because they are subsidizing record keeping and administration fees by adding extra fees to the Stable Value fund that they manage.
The issues with this practice are, #1: it's often not fully understood by the employer and almost never by the participants who pay the fees. And #2: employees with a higher allocation to the Stable Value account end up paying (subsidizing) a disproportionate amount of fees for the entire plan. This isn't good for their retirement accounts and it creates a potential liability for fiduciaries.
Key Fiduciary Action: Understand the Stable Value or Fixed Account option your plan uses and if it subsidizes plan administrative fees. Most record keepers offer a Stable Value option that does not disproportionately subsidize plan fees versus other plan investments, which would be considered a fiduciary "best practice." If participants are paying for administrative fees, they should be fairly allocated across participants.
Many record keepers also manage mutual funds. Some are in the record keeping business in large part to distribute their own mutual funds, as the profit margins for managing funds is typically significantly higher than for providing record keeping services. Record keepers may offer a low cost or apparently "free" 401k plan, but in exchange require the plan to use some or all of their "proprietary" mutual funds.
Using funds for reasons other than their merits as investments (performance, risk, management, expense, etc.) can put fiduciaries in a bad liability position. Additionally, you often find that when record keepers offer outside or competing fund families on their platform, they offer more expensive share classes than their own funds, creating an unlevel playing field for participants.
Key Fiduciary Action: When choosing investment options for your plan, best practice is to consider the funds based upon their merits and not whether their use will reduce administrative fees. When the lines are blurred on why funds are selected, fiduciaries can be exposing themselves to additional liability.
5. Managed Accounts
As record keepers look for a way to generate more fees, their preferred method is to package them into the assets. The main reason is because they go largely unnoticed by employers and the participants paying these fees. Managed accounts are another way to add asset based charges to the plan, largely going under the "fee evaluation" radar.
Managed accounts are commonly an automated investment portfolio that takes into account the participant's age (like a target date fund would), and then uses an algorithm to factor in other participant data like income, plan assets and risk tolerance to create a more customized portfolio. While these portfolios can be an improvement over one-size-fits-all target date funds, their use comes into question when they are used to add fees that subsidize overall plan administration.
Managed accounts often have fees that range from 0.30% to 0.70%, which may be 3X-5X the total administrative cost for the plan.
Record keepers often give discounts to their administrative fees when plan sponsors offer these managed accounts to participants. Even bigger discounts are offered when managed accounts are made the default (QDIA) investment option. This again can create a scenario where participants who are in the managed accounts paying the extra fees are subsidizing the administrative costs for the employer and the participants not using these accounts. This is not a good fiduciary position to be in for those making buying decisions.
Key Fiduciary Action: Understand the fees within the managed accounts offered in your plan and how they impact the overall administrative costs for the plan. Generally speaking, it's not a good fiduciary practice to create a scenario where some participants are subsidizing the administrative costs of the plan for other participants.