Study Reveals Five Factors That Help Lower 401k Fees

Every 401k plan sponsor should want to step to lower fees (without cutting out anything important, of course). What if lowering 401k fees was as simple as counting off the fingers on one hand? In a study released over the summer, the Investment Company Institute analyzed the ins and outs of 401k plan fees and expenses (see “The Economics of Providing 401k Plans: Services, Fees and Expenses, 2010,” Investment Company Institute, June 2011). What the study reveals may be enough to have 401k plan sponsors smashing the palm of their hand against their forehead and yell “D’oh!”

Enough has been said about the negative long-term impact of higher fees on 401k investments. Clearly, if we can identify ways to lower costs and still insure reasonable service, 401k investors will benefit. As we enter into full per-participant fee disclosure beginning in 2012, 401k plan sponsors will find themselves under greater pressure to either reduce fees or justify higher expenses. The ICI identified five areas that help lower per-participant fees:

1. The competition among all investment products, including mutual funds, to offer 401k participants service and performance;
2. The decision my plan sponsors to pay for at least some portion of the costs of 401k plans, which allows them to select cheaper funds from unbundled platforms;
3. 401k plans have economies-of-scale advantages, permitting them to purchase lower cost share classes;
4. The proactive dedication of 401k plan sponsors to make cost-conscious and performance conscious decisions; and,
5. The fact 401k plans have greater allowance for a more limited role of professional investment advisers.

Now, there are several important caveats to these factors. The easiest way to lower expenses is to cut services and benefits. Take factor five, for example. Some studies suggest individual investment advice may help participants achieve superior investment performance. This advice doesn’t come for free.

As we’ve reviewed previously (“Great Info for Every 401k Plan Sponsor: Review of 401k Averages Book,” Fiduciary News, April 26, 2011), smaller plans will normally pay a greater percentage in fees than smaller plans for the same service. This represents the downside of the economies-of-scale rule. If you’re small, you’ll find fewer attractive fee options, so 401k plan sponsors must make sure they compare their plans to similarly sized plans, not the average 401k plan.

Finally, certain methods of achieving lower fees may not be in the best interests of 401k investors. In 2006, Congress passed the Pension Protection Act in part to dissuade 401k investors from placing too great a percentage of their assets in low return vehicles. Here’s the rub, low return vehicles tend to have lower fees. This means if 401k plan sponsors and participants focus too much on fees, they may select inappropriate investments.

And this ironically leads to the ultimate liability exposure for the 401k plan fiduciary. When it comes to fees, sometimes you get what you pay for. And that’s not necessarily a good thing.