# Why isn’t your 401(k) doing better? The reason may surprise you

According to a just published paper, recordkeepers in defined contribution pension plans are often paid indirectly in the form of revenue sharing from third-party funds on the menu. 

And the researchers, Veronika Pool, professor at the Vanderbilt University, Clemens Sialm, a professor the University of Texas at Austin; and Irina Stefanescu, an economist at the Board of Governors of the Federal Reserve System, show that these arrangements affect the investment menu of 401(k) plans.

How so? According to the researchers, revenue-sharing funds are more likely to be added to the available investment options and are less likely to be removed. 

The 401(k) recordkeeper is essentially the 401(k) plan’s bookkeeper. The recordkeeper processes employee enrollment; tracks employee investments; logs the whether the contributions pre-tax, Roth, or employer pre-tax match, and the like; manages and records 401(k) loans and hardship withdrawals; and issues account statements to participants, according to David Ramirez’s blog.

The recordkeeper does not, however, give investment advice or provide employee education and onboarding, for instance, according to Ramirez.

Now there are many different types of recordkeepers. In some cases, the fund company that manages the 401(k) investments has a side recordkeeping business. Fidelity, Vanguard, TIAA, MassMutual, and Schwab are among those fund companies that also provide recordkeeping services. In other cases, payroll companies such as ADP, Paychex, and Gusto will do the recordkeeping. 

Or the recordkeeper might be an insurance company, such as Empower, Voya, John Hancock, and Prudential.

And then there are independent recordkeepers that don’t sell funds, don’t sell insurance products, and don’t have additional payroll products, according to Ramirez.

A primer on reviewing 401(k) fees

What do experts say about this research? First a bit of background.

All fees (direct and indirect) must be disclosed as required by ERISA Section 408(b)(2), the primary requirement of which is the upfront “fee notice” that service providers must deliver to plan clients. That fee notice spells out the various types of direct or indirect compensation payable to the provider.

Of course, no one ever reads those fee disclosures but here’s what you’d learn if you did:

Recordkeepers get paid in three ways, according to Bonnie Yam, a principal with Pension Maxima Investment Advisory.

1. Fees from investment companies for having their products listed on their platform;

2. Actual recordkeeping services; and

3. Investment fees from their own proprietary funds.

Recordkeepers also share some of these payouts by making rebates to third party administrators or TPAs, one time and on-going, according to Yam. Some of the TPAs use the revenue to offset their expense, some don’t. A TPA is used when a recordkeeper doesn’t perform any administrative work for your plan.

Now because there are so many ways these entities get compensated, it’s hard to unravel each level of revenue sharing. So, “the easier way is to look at total cost,” said Yam.

Though some of these costs can be paid directly by employers, participants bear all of these costs in the vast majority of plans.

And here are the components of total cost:

1. Recordkeeping fees (direct-billed fees, asset-based or headcount-based);

2. Additional TPA fees (direct-billed);

3. Adviser fees (direct fees); and

4. Fund expense (this is net of fund performance, so a higher fund expense will translate into a lower investment return).

Is the research current?

With that as a backdrop, Mike Webb, a senior financial adviser with CAPTRUST, said “the (researchers’) findings of the paper are generally consistent with the real-world experience; namely, the less revenue sharing that exists in a retirement plan, the better.”

This is true, he said, not only for the primary reasons cited in the paper, “but because it results in fee structures that are far less transparent to plan participants.”

Webb did, however, note that the researchers used old data and that their assertion that revenue sharing funds are less likely to be deleted from a menu may be a bit outdated.

“Employer backlash against revenue sharing in general, particularly among larger plan sponsors that were studied in the paper, has led to a movement to fund lineups that are zero-revenue share,” Webb said.

Still, the revenue sharing practice is still somewhat common among small- to mid-sized plans.

Joe DeBello, a plan consultant with OneDigital, said he’s still “amazed at how many plan sponsors we still encounter post-408(b)(2) that are still completely in the dark on what revenue sharing is and if it exists within their plan.”

One of the most common issues is that revenue sharing exists — usually in addition to a stated/direct recordkeeping fee — and the amounts being generated by the various funds is unlevel, according to DeBello. “This creates a scenario where, depending on fund selection — sometimes even by defaulting into the QDIA — one participant unbeknownst to them may be subsidizing the cost of administering and recordkeeping the plan for their peers,” he said.

What’s more, DeBello said many recordkeepers still force plan sponsors to select from a limited menu of funds with, of course, the prerequisite of being on that limited menu is the existence of a certain minimum threshold of revenue sharing within the fund. “This one step greatly limits the opportunity for sponsors to choose what’s in the best interest of their plan participants as opposed to what’s best for their recordkeeper,” he said. “Thankfully, we are seeing more and more ‘open architecture’ providers though there are still a lot of legacy problem plans out there.”

Given that the practice of revenue sharing still exists today, what should plan participants do about it? What can employees do to be smarter about their 401(k) fees?

Review fee disclosure documents

Yam said 401(k) plan participants should first review their 404(a)(5) fee disclosure document, which provides a breakdown of the fees on plan administrative side and on an individual basis (i.e., fees for distribution, loan administration etc.).

Look for any language describing revenue sharing and how it is utilized: offsetting other fees, rebated back to you, for example. “Revenue sharing isn’t always a problem, though how it’s treated is where the inequities can arise,” DeBello said. 

With respect to recordkeeping fees, Webb said it’s often expressed as an annual basis-point charge (e.g., 10 basis points = 0.10% = $10 per $10,000 of your account balance), but sometimes is the same regardless of account balance size (e.g., $50 per year per account regardless of size) particularly in larger plans.

“This fee is extremely important, as it often drives the total costs of plan investments as sponsors will often use revenue sharing to offset such fees rather than charging it directly to participants,” he said. 

Note: If you have a fee deducted from your account right now, do not assume that fee is the recordkeeping fee—account fee deductions may be made for a variety of purposes, said Webb.

Generally, plan participants are supposed to receive 404(a)(5) disclosure documents annually.

But if you don’t receive your disclosure, DeBello recommends asking the human resources department or your provider directly for those documents. 

Some, mostly large employers, have professionals on staff to explain the fee disclosure documents to you but often your employer may refer you to professionals employed by their recordkeeper, which is obligated to provide this information, said Fred Barstein, founder of The Retirement Advisor University.

Also of note: “If your employee benefits department cannot tell you the amount of the recordkeeping fee, you should view that as a red flag,” said CAPTRUST’s Webb.

Examine direct fees and fund expenses

Review too, your direct fees, which should appear on your account statement.” It should state how much expense is being deducted,” Yam said.

Finding out what your plan investments cost is easier than you might think, Webb said. Most participant websites have a page in their investments section that list all funds and their expenses. 

Expenses are often listed in basis points, or fraction of 1%. If you are in a large plan, expect that few, or zero, investments will exceed 100 basis points (or 1% or $100/per $10,000 invested in the fund per year), with most investments in the 30-80 ($30-$80 per $10,000) basis point range, Webb noted. 

Review Form 5500

Yam also recommends reviewing your company plan’s Form 5500 from the Labor Department’s website. The Form 5500 is an annual report, filed with the Labor Department, that contains information about a 401(k) plan’s financial conditions, investments, and operations. Among other things, you can examine your plan’s direct and indirect administrative fees in the Form 5500 report, said Yam.

Not all plans are required to provide such 5500 fee information—small plans with under 100 participants are exempt, and some plans don’t file a 5500 at all—but many plans are required to provide this disclosure, said Webb.

In Yam’s practice, they don’t worry about the indirect payouts because all indirect will be captured by the fund expense. And if the fund expense is too high, it will affect the performance.

In the somewhat-rare instances when an employer pays a plan expense directly, it will not appear on the 5500, said Webb.

Contact HR department

If the fee disclosure documents aren’t clear, DeBello recommends contacting your human resources department to determine whom within the organization is responsible for oversight of the plan and request regarding the presence of revenue share and specifically the plans policy for utilizing it.

“Who knows, you may be doing your plan sponsor a favor by drawing their attention to it,” said DeBello.

Webb is of the same opinion when it comes to fees. “If you don’t like your fees, let your employee benefits person know,” he said. “Most plans are subject to a federal law known as ERISA, which requires plan sponsors to act in the best interest of participants and beneficiaries. And even plans that are not subject to ERISA, such as governmental and most church plans, follow similar practices. That means that many individuals at your employer are what are called fiduciaries to the plan and must act in the best interest of you and other plan participants. Thus, if fees are high, they should at a minimum be able to explain why that is the case, and what they are doing to lower fees.

Nate Wenner, a principal at Wipfli Financial Advisors, shares this point of view.

“Participants should pay attention to their annual fee disclosure report from their employer plan,” he said. “Ask questions of the plan provider and their employer if the investment choices seem skewed toward expensive options.”

Employers, Wenner said, sometimes don’t realize the cost structure of the funds in their own plan. “But they generally want their employees participating and will likely respond accordingly if made aware of expensive choices that are making participants leery of participating in the plan,” he said.

Contact your plan’s fiduciary for help

Barstein also recommends asking the fiduciary retirement plan adviser or consultant employed by the 401(k) or 403(b) plan to get fee info and a better understanding of how fees are paid along with how you can best utilize the resources offered by the employer, recordkeeper and adviser/consultant to maximize results. “In all likelihood, the participant is paying the fees of that adviser/consultant through a percentage of the asset management fees of the plan’s investments. So act like they work for you — because they do,” he said.

Review target-date fund fees and performance

In plans where there is a zero-revenue share target-date fund (TDF), Webb recommends checking out the performance of that fund versus your self-selected investment portfolio net of investment fees for as long a time horizon as possible.

According to Webb, most online recordkeeper portals now allow participants to display the customized rate of return of their own portfolio for at least a year, making a direct comparison easy.

And, if the performance of the TDF is the same or better, switch to the target-date fund.

If, however, you don’t have a revenue-share-free TDF and wish to self-select investments, see if there are revenue share-free options in the asset classes in which you wish to invest, said Webb. “If so, compare the longest-term performance available net of fees of the revenue sharing and zero-revenue sharing option, and select the one with the better performance,” he said. “Of course, past performance is no guarantee of future performance, but cost actually is a decent future indicator, and often the fund with the better track record will be the lower cost fund at any rate.”

Then, observe your results over time and adjust accordingly, said Webb.

“If, on the other hand, your plan has zero revenue sharing options, or an insufficient amount to create a well-diversified portfolio, lobby your plan sponsor for zero-revenue share funds,” he said.

Look for low-cost investments and complain about poor-performing funds

You should also review your investment returns. “What we do is to try to find low-fee alternatives, i.e., funds that do equally well or better but with lower fees,” said Yam. “That will give you back the savings that you deserve.”

Look for low-cost index investments. Most large plans have them and their costs are generally 15 basis points ($15 per $10,000) or lower, Webb said. 

“Note that, unlike recordkeeping fees, there is not a flat dollar option here, which means the dollar fees grow as your investments grow,” he said. “If your investment costs are higher, particularly in a larger plan, it may be a sign that revenue-sharing is built into those investment fees, and is offsetting the recordkeeping costs of the plan.

This is not necessarily a bad thing, Webb said. “But the fee structure would be much clearer to you and other participants if the recordkeeping fee was simply deducted from your account rather than being ‘hidden’ in the costs of the investments,” he said.

Yam also recommends avoiding low-performing funds. And she recommends questioning your plan’s fiduciary poorly performing funds. “Plan fiduciaries are supposed to replace low performing funds and those who fail to do so are not really doing their fiduciary duty,” she said.

Take personal responsibility

Just as plan sponsors cannot delegate all fiduciary responsibility to third parties retaining the duty to hire qualified providers and ensure they are performing, individuals must take personal responsibility to understand how fees are paid and if the actual fees are reasonable given the types and quality of the service provided, said Barstein. 

“If not satisfactory, hire an independent adviser to roll assets out of the plan into an IRA (if such a rollover is permitted; most plans do not permit such rollovers while employed) but still contribute to get the match and higher contribution limits,” he said.