Additional non-profit websites that include relevant unbiased information about 401k plans include: www.401k-providers.com and www.iraeasy.com

 

Is your company's 401(k) plan a good deal? Don't be too quick to say yes. Sure, the 401(k) has become one of the crown jewels of employee benefits. Nearly two-thirds of Americans are counting on them, along with other employer-sponsored retirement programs, to serve as their primary source of retirement funds, according to the Certified Financial Planner Board of Standards in Denver.

But just because your employees appreciate their 401(k) plan doesn't mean it's a bargain. According to HR Investment Consultants in Towson, Md., publisher of the 401k Provider Directory, the cost of running a 401(k) plan with 25 participants and $750,000 in assets can range from as little as $6,750 per year to as much as $20,000, depending on which 401(k) vendor you select.

401k Tips:  

The tremendous variation in plan costs reflects the fact that there are many types of 401(k) vendors, including mutual-fund companies, insurance companies, commercial banks, investment banks, and independent third-party administrators.

Each structures its fees somewhat differently, and each can be competitive in certain niches of the market. But employers who choose their provider haphazardly from this melange of vendors often wind up paying more than they should.

Creative Computer Solutions Inc., a Pleasanton, Calif., software company, is a good example. The company didn't realize that it was paying too much for its $1.5 million 401(k) plan until dissatisfaction with the service it was receiving prompted it to look for a new vendor. It found one and, effective July 1, is saving itself and its employees more than $16,000 per year in administrative and investment-management costs combined.

"The financial advantage [of the new plan] was a very happy, big surprise," says Bruce Jones, the company's vice president for finance and administration.

How The Products Are Priced

To understand where Creative Computer is saving money, it helps to know how 401(k) vendors price their products.

There are two primary components to every 401(k) fee schedule. The first, and the one that most employers focus on because typically they pay for it, consists of administrative costs. This covers items such as record keeping and communicating with plan participants.

The second, more-critical component is the investment-management fee, which is levied as a percentage of the plan's assets and is paid by plan participants. According to HR Investment Consultants, these asset-based fees account for almost 75 percent of total plan costs for the average 25-person plan and 85 percent of the costs for the average 100-person plan.

"If the investment-management services are being provided by the mutual-fund industry, the investment-management fee is embodied in the expense ratio of the mutual funds available to the plan participants," says Stephen Butler, president of Pension Dynamics Corp., a 401(k) plan administrator in Lafayette, Calif.

"If the investment-management services are being provided by the insurance industry, it's the expense ratio of the funds plus some kind of annuity wrap fee." Insurance companies sell 401(k) plans "wrapped" by an annuity, which adds administrative expenses.

For Creative Computer's 401(k) plan, investment-management services had been provided by a major insurance company. Today, it uses First Data Corp., a Rockville, Md., financial-services firm, to provide its plan participants with an array of mutual funds as investment options. Those funds carry investment fees nearly a percentage point lower than those charged by the previous vendor, says Jones.

Pension Dynamics, meanwhile, acts as the administrator of the plan, a move that is saving the company about $2,500 a year in administrative costs. (While Creative Computer chose to have a separate administrator and investment adviser, it is possible to buy both services in a bundled package from mutual-fund companies, insurance companies, and banks.)

Despite the disproportionate role that investment fees play in determining total 401(k) costs, plan sponsors often pay scant attention to them, for several reasons:

* The investment fees are charged to plan participants rather than to plan sponsors, so there's no hit to the employer's bottom line.

* The investment fees are obscure. Plan sponsors aren't required to report them, and some don't.

* Even among sponsors who report the fees, not all do so the same way, and they rarely provide a line item on participant statements showing what the investment fees are in dollars and cents.

Instead, the fees--which vary from one investment option to the next--are simply deducted from the plan's earnings before its performance figures are reported. Thus, a mutual fund with a 1 percent investment-management fee that earned 10 percent before expenses last year would simply report that it earned 9 percent.

Addressing The Cost Issue

Concerned that investors don't understand all this, the U.S. Department of Labor earlier this year hosted hearings at which it solicited suggestions for improving the way plan sponsors communicate cost information to 401(k) participants.

Thus far, the department has not issued any new regulations, but in July, Labor Secretary Alexis Herman introduced a new consumer publication, A Look at 401(k) Plan Fees. The publication is available free by calling the Labor Department at 1-800-998-7542 or by visiting its Web site at www.dol.gov/dol/pwba.

Investors haven't raised much ruckus over the cost issue, in part because so many of them don't understand how much they're paying. Their seeming lack of interest has been compounded by the fact that the stock market has been on a heady bull run for three years. With their account values soaring, few 401(k) participants have been inclined to worry about costs.

That could change if the Labor Department initiative keeps media attention focused on the topic, or when the bull market finally stalls. After all, money spent on needlessly high investment fees is money that otherwise would have been compounding, tax-deferred, for the benefit of plan participants.

"Even an extra half percent charged against [plan] earnings can turn into a huge amount of money over a period of, say, 20 years," says Butler.

Because investment-management companies' earnings through asset-based fees grow as their customers' 401(k) accounts grow, some are starting to reduce or even waive the other component of their charges--administrative fees--for plans approaching $1 million or more in assets.

These apparent price breaks appeal to penny-conscious business owners, but over the long haul the waivers may not make sense for them individually or for their companies.

"I don't think you should consider [a waiver of administrative fees] a break," says Guy Patton, senior vice president of Boston-based Fidelity Institutional Retirement Services, a subsidiary of Fidelity Investments. "You have to look at the total costs associated with a program. The axiom that there's no free lunch holds true in this case."

Moreover, administrative fees paid by the company are tax-deductible to the business, while asset-based investment-management fees are paid by participants with after-tax dollars. Often the largest account balances in a 401(k) plan are those of the firm's owners and managers, so when investment fees are exorbitant, the owners and managers feel the pinch just as their employees do.

Linda Wauson, a consultant with Watson Wyatt & Co. in Houston and its central-region practice leader for defined-contribution services, recommends that employers look at administrative and investment-management fees together when evaluating 401(k) plans to get the whole picture. In addition, she suggests weighing a in carte fees that might be charged to plan participants on a per-use basis, such as fees for taking a loan against their 401(k) account.

Wauson also says employers should beware of hidden costs that never show up as a hard expense. For example, some 401(k) vendors pay below-market returns on the money-market funds they offer as an investment option to plan participants. While this doesn't cost the employer anything, each participant who puts money into one of those low-yielding funds loses earning power.

Determining What You Pay

Given that there's no standard method for presenting the costs of 401(k) plans, figuring out what you're paying for your plan--or what a competing vendor might charge you--can be difficult. But there are some rules of thumb that can help you.

If your plan is just getting started and doesn't have much in the way of assets, you may benefit from such a pricing structure. But watch out for plans that levy surrender charges when you terminate them. Those costs, and the hassle of changing providers, could outweigh the short-term benefits of an insurance company's fee structure.

As your plan approaches the $1 million plateau, Huntley says, you may find good values at mutual-fund companies that charge upfront sales loads to individual investors. That's because they'll typically waive the sales loads for large-volume 401(k) customers while still allowing you to benefit from the low-cost administrative structure made possible by the sales loads paid by other customers.

Here are two more suggestions for savvy 40 1(k) shopping:

Pay close attention to investment management fees. Mutual funds are by far the most popular investment option in 401(k) plans. The average domestic stock fund carries an expense ratio of 1.4 percent, according to data compiled by Morningstar Inc., a Chicago-based fund-research company.

But Butler says you should be wary of paying more than 1 percent in your 401(k) plan. You should pay even less for stockindex funds, which mimic the performance of popular benchmarks such as the Standard & Poor's 500-stock index. Their expense ratios typically range between 0.25 and 0.5 percent.

Expect to pay a little more than the domestic stock-fund expense ratio for international stock funds (the average expense ratio is 1.84 percent, according to Morningstar) and a little less for bond funds (the industry average is 1.07 percent).

Keep in mind, of course, that a low expense ratio may be no bargain if the fund hasn't performed well. Real value comes from funds that combine low expenses with solid performance.

Keep it simple. Fancy extras such as Internet access, paperless loan services, and large numbers of investment options can drive a plan's costs higher. Turnkey 401(k) plans from mutual-fund companies and other big providers often provide all of the basics and more, including niceties such as daily valuation of account balances, for one low fee. rrp

"To the extent that you can attract and retain employees with relatively simple features in your plan, go with simple features," says Fidelity's Patton. "Our experience is that you can have a very competitive plan and still keep it relatively simple."

                Why 401(k) Management Fees Matter

Each plan started with a zero balance, received contributions of

$200 a month, and earned

               10 percent per year before expenses.

Value Of Account After 20 Years 30 Years 40 Years

Annual 1%              $133,577 $366,149 $936,264

1.5%                   $125,400 $330,141 $807,730

Difference              $ 8,177 $ 35,008 $128,534