Is your retirement plan shark bait?
How much do you know about your company’s 401k plan? I’m not talking about the kinds of investments your plan offers or the kind of company match it provides. I’m talking about the nitty-gritty details of your plan, like how much you pay in fees for investment management and plan administration.
It used to be that nobody paid much attention to what happened in 401k plans. That has changed in recent years and the number of lawsuits against 401k plans has increased dramatically. For example, according to Bloomberg Law, only two class action lawsuits were filed against 401k plans in 2013. By 2016, the number of lawsuits grew to 56 and, in the first eight months of 2020, 65 lawsuits were filed.
These lawsuits have generated some attractive settlements. In 2019, health insurer Anthem paid $24 million to settle a complaint filed by its employees, while Franklin Templeton settled a case against it for $14 million and Brown University settled for $3.5 million. These settlements are like chumming the water for sharks and more plaintiff attorneys are beginning to notice.
The situation begs several questions, are your fees appropriate or is your plan getting a raw deal? If you’re a plan sponsor, are you carefully benchmarking your fees and documenting your due diligence? If not, your retirement plan might be shark bait.
Since 2012, the U.S. Department of Labor has required 401k plans to disclose plan expenses to participants every year. I encourage you to read your disclosure while paying close attention to administration expenses and investment management fees.
Plan administration includes necessary activities such as record keeping, tax filing, participant communications, etc. Most plan sponsors allocate administration costs among the plan participants. If yours does, a simple calculation will help you estimate your share of the burden.
Ask your employer for a copy of your plan’s summary annual report. The report includes a table of financial data including fees. If you divide the fees by the plan’s ending balance, you will get fees expressed as a percentage of total assets. Multiply that number by your 401k balance to get an estimate of the dollar amount of administration costs you pay each year as a plan participant. The actual expenses you pay may be higher if you receive individual services like loans from your 401k account, but this estimate should be reasonably close.
The amount you pay for investment management depends on the specific funds you use. You can calculate your investment fees by multiplying the expense ratio for each fund by the amount of money you have invested in that fund. Expense ratios are part of the annual disclosure, but you can also look them up on websites like FINRA’s fund analyzer (https://tools.finra.org/fund_analyzer/).
For example, if you had $25,000 invested in the Dodge & Cox stock fund, you would multiply $25,000 by 0.52% to get $130—the amount it cost you to own Dodge & Cox stock fund in your 401k for a year. Repeat this process for all your funds to calculate your total direct annual investment cost. In today’s world, your total direct investment costs should be well below 1 percent of your invested balance.
As you read your fee disclosure, pay attention for something called revenue sharing. Under revenue sharing, the plan sponsor receives a portion of the investment management fees charged to the plan participants. These fees are often used to defray expenses that would otherwise be charged directly to plan participants or for plan-related services the sponsor would pay for separately. Usually, if there is revenue sharing, the expense ratios for the funds in the plan will be higher than without revenue sharing. For example, an index fund expense ratio should normally run between 0.10% and 0.20%. However, with revenue sharing the expense ratio for the same index fund could be as high as 0.50%.
Higher fees don’t necessarily mean your 401k plan is ripping you off. Some plans provide additional services like participant education and financial planning. These services usually entail additional costs, but they can make the plan much more effective for the participants. However, if your plan expenses are high, but the plan delivers bare-bones service, you may want to have a conversation with your plan’s trustees.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.