Small biz 401(k) plans: No need to pay high fees

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(MoneyWatch) High fees in your 401(k) plan can seriously slow the growth of your retirement nest egg. Fortunately, new federal 401(k) fee disclosure regulations can help you determine whether the fees charged in your 401(k) plan are competitive.

The new disclosure requirements can be a non-event for large employers, which generally do a good job of negotiating reasonable fees on behalf of their employees. But the landscape is different when you work for a smaller company. One phenomenon that's emerged from the 401(k) disclosures is the high level of fees at companies with 50 employees or less. (I recently wrote about the poor disclosure statement received by a relative who worked for one such small employer.)

Here's what happens all too often with small employers. The owner has a "guy" who takes care of all the company's insurance and investment needs. Typically the guy is a broker who's paid on commission. The guy is often the owner's friend -- he takes the boss out to lunch or golf -- and tells the owner he's doing his best to take care of him.

This broker will place the 401(k) investments in funds that pay the broker a "revenue-sharing" fee. That is basically a way for the investment institution that's sponsoring the funds to pay the broker for his services, including plan administration and consulting on investments. Plan participants pay for this revenue sharing through the expense ratios that are assessed against the investment funds in the 401(k) plan.

Until the recent 401(k) fee disclosure requirements, plan participants -- and plan sponsors -- often didn't know how much money their funds were being assessed in fees or whether they were paying for revenue sharing. As a result of these new requirements, we're seeing annual expense ratios well north of one percent (100 basis points, to use investment lingo). Fees this high will inhibit the growth of the retirement savings for everybody in the plan, ranging from rank-and-file employees right up to the boss. Those lunches and golf outings can cost the boss thousands of dollars!

It doesn't have to be this way.

A better approach, says John Sciarra, president of National Retirement Services, is to unbundle the plan administration and consulting from the revenue sharing. In other words, the owner or the plan can pay for these services directly, and then seek investment funds with the lowest possible expense ratios and best possible investment performance. Sciarra's firm handles 401(k) plans this way for hundreds of small businesses.

"Most likely, this will significantly reduce the fees paid by plan participants, giving a big boost to their retirement savings," he says.

Ted Madden, senior vice president for Workplace Investing at Fidelity Investments, agrees. "We work with 10,000 small businesses, as well as thousands of financial advisors advising many of those businesses, and most of these plans offer investments with annual expense ratios ranging from 0.60 percent to 1 percent," he says.

If you're a small business owner, it's pretty straightforward to determine if this approach might work for your business. First, estimate how much you and your participants are paying each year through the expense ratios in the existing investment funds. For example, suppose your fee disclosure statement shows that the average annual expense ratio in your plan is 1.5 percent and that the plan has a total of $1 million in assets for all participants in the plan. This means that all the plan participants are paying collectively $15,000 per year for investment management expenses, plan administration, and consulting services.

Next, estimate how much you might pay for investment management, administration and consulting services under the approach recommended by Sciarra. It's possible to find index funds with expense ratios ranging from just 0.1 percent to 0.5 percent, but they won't have any revenue sharing, and the fees paid from plan assets will be devoted just to covering investment management expenses.

In this example, if the plan used funds with a 0.5 percent expense ratio, plan participants would together be paying $5,000 per year -- $10,000 less than with the higher expense ratio. If the plan can find a firm that charges much less than $10,000 for plan administration and consulting, then there's a lot of money that can be saved. And the potential savings is higher still if you can find funds with expense ratios that are less than 0.5 percent, which is entirely possible.

There are many 401(k) administration and investment firms that could conceivably charge much less than $10,000 for these services. To determine if this approach would work for you, all you need to do is put your plan out for bid.

By the way, there are many qualified investment consultants or financial advisors who can help plan sponsors make informed decisions and who charge a reasonable fee for their service.

This will involve a bit of work on your end, but the upside is the potential for you and your participants to transfer thousands of dollars from the "guy" who oversees your plan to your 401(k) account. Your retirement savings -- and your retirement years -- will be that much better because of it.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.

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