Have you ever wondered why your 401(k) plan's investment options include low-performing or pricey mutual funds?
No need to wonder anymore.
Revenue-sharing has been determined to be the culprit, according to researchers.
A recently published paper states that defined contribution pension plans’ recordkeepers are frequently compensated indirectly through revenue-sharing from third-party money on the investment menu.
The researchers, Veronika Pool of Vanderbilt University, Clemens Sialm of the University of Texas at Austin, and Irina Stefanescu of the Federal Reserve Board of Governors, demonstrate that these arrangements have an impact on the 401(k) investment menu.
What does that mean? Researchers claim that revenue-sharing funds have a greater chance of being added to the available investment choices rather than removed.
Basically, the recordkeeper for the 401(k) is the bookkeeper of the plan. As per David Ramirez’s blog, the recordkeeper handles employee enrollment, maintains employee investments, monitors if the contributions are pre-tax, Roth, or employer pre-tax match, and so on, administers and records 401(k) loans and hardship withdrawals, and delivers account statements to participants.
Although, Ramirez says that the recordkeeper does not, for example, advise on investments and doesn’t educate or integrate employees.
Today there are various recordkeepers’ types. Sometimes, the fund corporation that oversees the 401(k) investments may have a side recordkeeping business. Among the fund providers that offer recordkeeping services are MassMutual, Vanguard, Schwab, Fidelity, and TIAA. In other circumstances, recordkeeping will be handled by payroll firms such as Gusto, Paychex, and ADP.
An insurance firm (like Boya, Empower, John Hancock, and Prudential) could be the recordkeeper.
Finally, as stated by Ramirez, there are independent recordkeepers. They don't sell funds or insurance products and don't offer extra payroll products.
Reviewing 401(k) fees: a primer
What are the opinions of professionals on this study? First, some background information.
All fees (direct and indirect) have to be reported per ERISA Section 408(b)(2). The most important cost is the upfront "fee notice." The service providers have to submit this fee to plan participants. The many sorts of direct or indirect compensation owed to the provider are spelled out in that fee notice.
If someone would actually read those fee disclosures, they’d find out the following:
Bonnie Yam, a principal with Pension Maxima Investment Advisory, says recordkeepers are compensated in three ways.
1. Fees charged by investment firms for listing their items on their platform;
2. Services for actual recordkeeping; and
3. Their proprietary funds’ investment fees.
According to Yam, recordkeepers also split some of these payouts by providing one-time and ongoing refunds to third-party administrators or TPAs. Some TPAs neutralize their costs with the revenue, while others do not. When a recordkeeper does not undertake administrative work for your plan, a TPA is employed.
It's hard to decipher each level of revenue-sharing because there are so many ways of compensation. According to Yam, “The easiest way is to check out the total cost.”
Some of these costs may be covered by employers. Still, in most of the plans, participants are responsible for all of them.
The elements of the total cost are as follows:
1. Fees for recordkeeping (asset-based, headcount-based, or direct billing);
2. Extra TPA fees (direct-billing);
3. Fees for advisors (direct fees);
4. Fund cost (since this is a net of fund performance, a higher fund cost will mean a lower investment return).
Is the paper still valid?
In light of this, Mike Webb, a senior financial adviser at CAPTRUST, stated that the paper’s findings are usually congruent with the real-world experience; essentially, the less revenue-sharing there is in a retirement plan, the better.
That is true, he added, for the reasons outlined in the research and because it leads to fee structures that are significantly less transparent to plan participants.
Webb pointed out that the researchers used old data and that their claim that revenue-sharing funds have less chance of being removed from a menu is a little out of date.
In general, employer resentment of revenue-sharing has sparked a drive to fund zero-revenue-share lineups, especially among the bigger plan sponsors covered in the research, according to Webb.
However, revenue-sharing is still quite frequent among small and mid-sized plans.
OneDigital plan consultant Joe DeBello stated he's still stunned at the number of plan sponsors post-408(b)(2) who still have no idea what revenue-sharing is and whether it is in their plan.
According to DeBello, one of the most typical difficulties is that revenue-sharing is in place – usually on top of a stated/direct fee for recordkeeping – and the amounts generated by the numerous funds are uneven. He added that this develops a scenario in which, based on fund selection – at times simply by defaulting into the QDIA – one participant may be subsidizing the expense of running and recordkeeping the plan for their mates without them realizing it.
Furthermore, according to DeBello, many recordkeepers still oblige plan sponsors to choose from a restricted funds menu. And the requirement of being on that restricted menu is the existence of a specific minimum revenue-sharing threshold inside the fund. “This one step severely limits sponsors' ability to choose what is best for their plan members rather than what is best for their recordkeeper,” he said. Although many legacy problem plans still exist, the number of 'open architecture' providers is increasing.
What should plan participants do regarding revenue-sharing, considering that it still exists today? What are employees’ options to save money on their 401(k) fees?
Check fee disclosure forms.
Participants in 401(k) plans should first check their 404(a)(5) fee disclosure form, which breaks down the fees on an administrative plan level as well as on an individual basis (i.e., fees for loan administration, distribution, etc.), according to Yam.
DeBello advises looking for any wording that describes revenue-sharing and how it is used, such as offsetting other fees or being rebated to you. “Revenue-sharing isn't always an issue; it's how it's handled that causes inequities,” he said.
Webb explained that recordkeeping fees are usually expressed as an annual basis-point charge (e.g., 20 basis points = 0.20% = $20 per $10,000 of your account balance). However, they can also be the same irrespective of account balance size (e.g., $60 per year per account, no matter the size), especially in larger plans.
He said that this fee is critical since it often raises the total costs of plan investments because sponsors often utilize revenue-sharing to offset such fees instead of directly charging participants with it.
Note that, according to Webb, if your account has a fee deducted right now, don't assume it's the recordkeeping fee – account fee deductions can happen due to several reasons.
In most cases, plan participants should receive 404(a)(5) disclosure paperwork once a year.
If you haven't received your documents, DeBello suggests contacting your HR department, or your provider, to ask for them.
Some employers, mainly major ones, have professionals in their organization who can explain the fee disclosure. However, usually, your employer might redirect you to professionals who work at their recordkeeper’s organization. They are required to provide the info on this, according to The Retirement Advisor University’s founder, Fred Barstein.
According to CAPTRUST's Webb, it's worth mentioning that it should be considered a red flag when your staff benefits department can't state the recordkeeping fee.
Review direct fees and costs of funds
You should check your direct fees on your account statement too. Yam says that it should be specified how much is being deducted.
“Figuring how much the plan investments cost is more straightforward than you would expect,” according to Webb. In the investment segment of most participant websites, there is a page that lists all funds and their costs.
Expenses are frequently expressed in basis points, which is a fraction of a percent. If you're in a big plan, anticipate few, if any, investments to surpass 100 basis points (or 1% or $100 every $10,000 invested in the fund every year), with the majority of investments falling between 30-80 basis points ($30-$80 every $10,000), according to Webb.
Examine Form 5500
Yam also suggests looking at your company's Form 5500 on the Labor Department's website. The Form 5500 is a yearly report submitted with the Labor Department that details the financial state, investments, and activities of a 401(k) plan. In addition to other information, in the Form 5500 report, you may look into your plan's direct and indirect administrative fees, according to Yam.
Not all plans have to give information about the 5500 fee. For instance, small plans with fewer than 100 participants are excluded, and other plans do not submit a 5500 at all. However, many are still required to provide information about this fee, according to Webb.
In Yam's experience, indirect payouts are not a concern because the fund expenditure entirely covers them. And if the fund expenditure is too high, the performance would suffer.
According to Webb, when an employer pays a plan's expenditure directly in rare cases, the expenditure will not show up on the 5500.
Contact the Human Resources department.
If the fee disclosure paperwork isn’t clear, DeBello suggests contacting your HR department to learn who is in charge of the plan's supervision. Also, inquire about the presence of revenue share and the plan's policy for using it.
“Who knows, you could be helping your plan sponsor by bringing it up,” added DeBello.
On the subject of fees, Webb has the same viewpoint. He said to tell your employee benefits representative if you don’t like your fees. Most plans are governed by the Employee Retirement Income Security Operate of 1974 (ERISA), which obliges plan sponsors to conduct plan business in a way that’s of best interest to the plan members and beneficiaries. Even non-ERISA plans, like governmental and most church-sponsored plans, follow identical procedures. That implies that many people at your workplace are fiduciaries for the plan and must behave in your and other plan members' best interests. As a result, if fees are expensive, they must, at least, be able to explain why and what they are doing to reduce them.
That is a viewpoint shared by Wipfli Financial Advisors’s principal, Nate Wenner.
Wenner said that participants must be attentive to their employer plan's annual fee report. In addition, you should ask the plan provider and their employer inquiries if the investing alternatives appear to be biased towards pricey solutions.
According to him, employers are sometimes unaware of the expense structure of the funds in their plan. However, they typically want their workers to participate. So, if it’s brought to their attention that costly options are making participants hesitant to participate in the plan, they will likely act accordingly, he added.
Ask your plan’s fiduciary for assistance.
Barstein also advises contacting the 401(k) or 403(b) plan's fiduciary retirement plan adviser or consultant for fee information and a better insight into how fees are paid, as well as how to best use the resources provided by the employer, recordkeeper, and adviser for best results. In all probability, the member is paying that adviser (or consultant) through a portion of the plan's investment asset management fees. “Behave as though they're working for you because they are,” he explained.
Examine the costs and performance of target-date funds
Webb suggests, for a target-date fund (TDF), comparing the performance of a zero-revenue share TDF to your self-selected investment portfolio net of investment costs for the longest possible time horizon.
He says that most online recordkeeper websites now let users see their own portfolio's specific rate of return for at least a year, allowing for a direct comparison.
Also, if the target-date fund’s performance is the same or better, switch to it.
“If you don't have a revenue-share-free target-date fund and want to self-select assets, Webb recommends looking into revenue-share-free possibilities in the asset classes you want to invest in. If that's the case, compare the revenue-sharing and zero-revenue-sharing options' longest-term performance available net of fees. Then, go for the superior performance one,” said Webb. Of course, previous success is no guarantee of future results. Still, the cost is a good indication of future performance, and the fund with the superior past performance is frequently the lower-cost fund at any rate.
“Then,” said Webb, “keep track of your outcomes over time and make adjustments as needed.” He also said that if your plan has no revenue-sharing alternatives or inadequate amounts to form a well-diversified portfolio, press your plan sponsor for zero-revenue share funds.
Seek low-cost investments and complain about funds that don't perform well
It's also a good idea to go over your investment results. Yam explained that we attempt to locate low-fee options, which are funds that perform similarly or better but have lower fees. As a result, you'll get your well-deserved savings back.
Look for index investments with low fees. According to Webb, they are available in most major plans, and their cost typically is 15 basis points ($15 per $10,000) or less.
He explained that in contrast to recordkeeping fees, there is not a flat dollar option here, so your dollar fees will rise in lockstep with your investments. Suppose your investment costs are higher (especially if you have a larger plan). In that case, it might be a clue that revenue-sharing is integrated into those investment fees and covers the plan's recordkeeping expenses.
According to Webb, that doesn’t have to be a bad thing. However, if the recordkeeping charge were deducted from your account rather than being "buried" in the investments’ costs, the fee structure would be considerably more transparent to you and other participants.
Yum also says you should avoid low-performing funds. She also advises you to examine your plan's fiduciary low-performing funds. “Plan fiduciaries are required to replace underperforming funds, and those who don’t do that are not fulfilling their fiduciary responsibilities,” she added.
Accept personal accountability
Plan sponsors cannot pass on all fiduciary duty to third parties but have an obligation to employ qualified providers and make sure they are performing well. “So, participants also have to take personal responsibility to understand better how fees are paid and if they're reasonable considering the provided service's type and quality,” said Barstein.
If the plan is not adequate, engage an independent consultant to roll assets out of the plan into an IRA (if such a rollover is allowed; most plans do not allow such rollovers while still employed). “But, continue to contribute to earning the match and higher contribution limits,” added Barstein.