Why you may subsidize an worker’s 401(ok) charges

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Employees who participate in a company’s 401(k) plan pay fees for a variety of related services. This includes the costs of administering the plan – for example, tracking daily fluctuations in account value, facilitating trading, and notifying investors regularly.

But depending on how your employer structures their retirement plan, you may unknowingly subsidize co-workers’ 401(k) fees.

The dynamic is a function of the investments you choose and how the 401(k) plan pays for administrative expenses.

Retirement savers (like gamblers in the broader investing world) may not be aware of the fees they have to pay. Many financial companies, both inside and outside the 401(k) ecosystem, often charge an annual fee directly from customer accounts rather than asking them to write a check.

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Mutual funds in 401(k) plans are no different.

The total cost of these funds may include a “share” fee (e.g. also known as a 12b-1 fee, distribution fee or unitholder service fee). The fund manager collects this fee and then forwards it to the 401(k) plan administrator.

This behind-the-scenes infrastructure is how many plans pay for record retention and other services provided by firms like Fidelity Investments, Empower Retirement, and TIAA-CREF, which are among the largest 401(k) administrators.

Small plans are more likely to use revenue sharing

According to a recent annual survey released by Callan, a consulting firm, only 8% of company pension plans like 401(k)s use revenue sharing to pay for plan administration. That’s down from 16% last year and about 40% a decade ago.

However, its prevalence may be more widespread than the Callan survey suggests. The majority of respondents have company pension plans with more than $1 billion in employee savings — among the largest in the country.

However, smaller 401(k) plans more commonly use revenue sharing to pay for services. A separate survey by the Plan Sponsor Council of America, an employer trade group, across a broader range of plan sizes shows that nearly 40% use revenue-sharing funds, and about three-fourths of these employers use the fees to pay plan costs.

“There may be some inequalities” for workers

This fee sharing is a somewhat opaque practice as it takes place behind the scenes. The practice also sometimes results in some employees paying more for 401(k) management than their colleagues — effectively subsidizing the service for colleagues.

That’s because not all mutual funds charge a revenue share. For example, actively managed funds are more likely to charge such a fee than index funds. (Of course there are exceptions.)

“There can be some inequalities in terms of who pays for what,” said Greg Ungerman, senior vice president at Callan, who leads a team looking at workplace retirement plans.

The dynamic means that a saver who invests exclusively in index funds may not pay revenue sharing fees on 401(k) plan expenses, while another worker in the same 401(k) plan who invests exclusively in actively managed funds does can pay fees.

There may be some inequalities in who pays for what.

Gregory Ungerman

Senior Vice President at Callan

The latter thus subsidize the costs of the former, although they receive the same benefits.

Employers have begun to move away from this practice amid a spate of lawsuits about excessive 401(k) fees and federal fee disclosure regulations passed about a decade ago to increase transparency.

Additionally, money managers have increasingly offered versions of their mutual funds that remove a revenue sharing fee. In this case, a 401(k) administrator would deduct a fee for its services separately from employees’ accounts, rather than being paid directly by the fund manager.

In fact, many employers have switched to such a fee model, Ungerman said. Often this takes the form of a flat dollar fee charged per plan participant.

Sometimes employers don’t have much of a choice – they’re at the mercy of the investment firms. For example, a particular mutual fund family may always include an income share.

But technology has advanced enough that many plan administrators are able to capture the revenue sharing fee and return the money to the investor who paid it — a workaround to make the 401(k) plan fairer. However, this feature is not always available and the employer must choose the option.

“It’s up to the plan sponsor to make that decision,” Ungerman said.

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