by: Roxanne Fleszar
from:  401kWire
July, 26 1999

Nearly 80% of plan sponsors do not know how much their plan costs are, according to the Department of Labor's 1998 "Study of 401(k) Plan Fees and Expenses."  This ignorance is believed to be caused by the numerous methods vendors use to charge fees, leaving plan sponsors unsure of what questions to ask.

Recently I spoke with the trustee of a mid-sized plan, who believed he was not paying a fee to his insurance company provider because he never received an invoice.  Being unaware that his 401(k) plan provider deducts investment management fees directly from the investment accounts, he had fallen into the "free lunch" belief.  Unfortunately, provider representatives may choose not to voluntarily present fee information to plan sponsors who do not know the proper questions to ask.

In fact, this plan was paying a wrap fee.  A wrap fee allows insurance companies to charge an additional percentage over the fund's normal investment management fee to cover their own expenses.  Thus, for access to to name brand mutual funds through the insurance company, a plan may be paying up to 2% for a fund that normally carries an investment management fee of 1%.

An additional fee, imposed by some insurance contracts and mutual funds is the surrender fee.  This charge, which typically declines each year the assets are held, is applied if the plan withdraws all of its money from the account prior to a pre-specified date, often five years or more from the initial start date of the account.

The CFO of a growing start-up company was not aware that his plan, provided through a major mutual fund company, was purchasing B shares as opposed to A shares.  Mutual fund companies typically sell B shares to retirement plans, which incur no front-load, but carry an increased investment management fee.  For example, rather than paying a 5% upfront charge and 1% investment management fee on assets associated with A shares, the plan might pay 0% upfront with a 2% investment management fee.  This results in a significant growth in fees assets increase.  Should the plan sponsor not be satisfied with service, investment performance, or both, they are faced with an unanticipated expense or unhappy participants should they bear the cost.   Again, this information may never come to light if the plan sponsor does know to inquire.

Plan providers offering mutual funds may earn a 12b-1 fee to compensate for marketing expenses.  These fees can range from 0.15% to 0.75%, but plans may be able to recapture a portion of the expense through reduced administrative expenses.  Since many large providers are unwilling to handle the recordkeeping for small and mid-sized plans, they will negotiate with outside third party recordkeepers for the administration of these plans.  Often in such cases, the provider will rebate a portion of the 12b-1 fees to recordkeepers with whom they do a large volume of business, allowing them to lower their expenses to offer more competitive rates.  However, such agreements are rarely made known to the plan, and some recordkeepers are pocketing the rebates above and beyond base fees charged to the client.

To combat these secretive practices, plan sponsors must take the offensive when interviewing new service providers.  Your best weapon is a written request for full disclosure of expenses.  The following table provides a sample cost disclosure worksheet comparing two vendors, assuming 600 plan participants and $20 million in assets:

Charges                                                          Vendor A             Vendor B

Per Participant Charge                                               $0                      $25

Total Participant Charge                                             $0                $15,000

Other Administrative Expenses                           $14,700                  $2,500

Estimated Annual Administrative Expense           $14,700                 $17,500

Per Participant Annual Administrative Expense      $24.50                   $29.17

Estimated Basic Education Expense                    $5,800                  $10,500

Per Participant Annual Education Expense              $9.67                   $17.50

Per Participant Investment Mgmt Expense            $335.71                 $261.22

Total Per Participant Annual Expense ($)               $369.88                  $307.98

Total Per Participant Annual Expense (%)                1.15%                     0.95%

You may design your own cost disclosure worksheet, or hire a consultant to provide you a comparison of the prospective vendors.  A professional who specializes in retirement plans will not only know all the right questions to ask, but will also have the knowledge to initially choose and compare only those providers who are best able to meet your plan's goals and objectives.

Both of the sponsors mentioned are intelligent, well-educated gentlemen leading successful companies.  While knowledgeable in their own field, their mistake was not understanding the nuances of the retirement plan industry.