Up to this point, we’ve covered the basics of a 401(k) and the providers we should interview when setting up a new plan or evaluating an existing retirement benefit. Now, we get to have a little fun!
How a retirement plan is billed can be one of the most convoluted aspects of a 401(k). Not only are there several different ways to bill a plan, but each provider tends to charge for their services in a different manner. The first thing you should know is that there are generally three different ways a provider can bill for their services. I want to educate you on these differences so we can arm you with the knowledge necessary to flush out any hidden fees you may not be aware of when performing a plan evaluation.
The first method of billing a retirement plan is the most obvious. A plan provider can simply send the plan sponsor an invoice for the services rendered. These invoices are generally sent on a quarterly or annual basis. Since the employer is receiving a specific bill for a specific service, this method is the most transparent and the easiest to wrap our heads around. This method can also be known as billing the plan in "hard dollars".
The second billing method is a little less transparent because we are talking about billing the plan’s costs to the assets (also known as the plan’s total balance). In other words, the costs are billed to the participants by debiting their individual accounts in the form of an asset-based fee or an investment fee. If you've attended the last two classes, we covered how brokers are paid a commission from the investment fees charged by the mutual fund company. Likewise, the Third-Party Administrator, Recordkeeper, and Advisor can also charge their fees to the participants’ accounts. These asset-based fees are typically the most overlooked costs in the plan. I often ask plan sponsors how much they pay to sponsor the plan only to receive the answer, "We don't pay anything for our retirement plan.” This then becomes an unknown fee to both the plan sponsor and the participants. If the plan sponsor is unaware of these fees, it can become a fiduciary liability. This method can also be known as billing the plan in "soft dollars".
The third billing method is purely a combination of the previous two methods but it is also the most overlooked. By billing a plan in a combination of hard dollars and soft dollars, a plan sponsor can have a false sense of security in what they are paying to support the retirement benefit. Regardless of whether you are considering offering a retirement plan for the first time or you are evaluating an existing plan, you must look for fees billed both to the company as well as the assets of the plan. I can't tell you how many times I've worked with plan sponsors evaluating proposals and they tell me "I think we are going with Provider A because they seem to have the lowest cost." After reviewing the proposal with them, the first thing I ask is "What are they billing the plan in soft dollars?" Almost without exception, the lower proposed hard dollar fee is being made up in soft dollars and sometimes more. You should also know that some providers will charge a very low hard dollar fee but a rather high soft dollar fee. Now this may be attractive initially for a smaller or start-up plan, but your fees will become larger and larger as the plan grows. This is why this billing method can be so confusing.
We'll go deeper into these billing methods in future classes discussing topics like revenue-sharing but this should give you enough knowledge to begin your evaluation. Join us for next week’s class when we discuss what you should know regarding your investment options for the retirement plan…