Publications

March 1998

Rising Plan Fees Force Companies to Reconsider But firms find it hard to compare costs of services from providers

By H. Lee Murphy

When many employers launched 401(k) retirement plans less than a decade ago, workers were hungry for account service. First, they wanted quarterly account statements; then they wanted toll-free phone numbers to check their balances. Rollover and loan privileges were also viewed as a necessity.

But few thought to ask how much all this service was costing.

Now, however, 401(k) balances have risen, and investment fees - often charged as a percentage of a total portfolio - have become substantial, if not onerous. Spurred by a U.S. Department of Labor investigation launched last November, many companies have been prompted to scrutinize fees for the first time.

Disparity identified

What the government has found is a wide disparity in fees. These differences were confirmed in a recent study by HR Investment Consultants in Towson, Md. It shows that for a company with 300 workers, annual fees ranged from $158 to $767 for an employee with a medium sized account. At big companies such as E~xon Corp., some 401(k) savers pay as little as a nickel for each $100 invested, but at other companies, the fees run $2 and more per $100.

With the stock market soaring, it's been easy for many investors to overlook their fees. But when stocks cool, fees' effect will become more obvious. By one calculation, a two percentage-point difference in fees can reduce returns on a 401(k) held for 30 years by nearly $250,000, or close to 25% of the balance.

It's not just individual investors who have ignored this issue. Benefit administrators have a difficult time sorting through the maze of fees their 401(k) plans are assessed to calculate total costs. Some plan administrators charge for everything from legal work to auditing and employee communication services. There are separate fees for wire transfers, loan originations and loan servicing.

Even prospectuses don't spell out the whole story. Comparison shopping is nearly impossible in many cases.

Ronald Boorstein, owner of Acorn Self Storage in Chicago and Mundelein, Ill., is seeking a 401(k) plan for his 20 employees and has encountered nothing but frustration.

"It's very hard to compare proposals," says Mr. Boorstein, a lawyer. "Fees are obfuscated and buried. Some providers want to charge you for every single employee communication, others want to charge you every time you add or drop an employee in the plan. They have invented all kinds of separate charges. I had to go to my accountant to dig out all the numbers in the end."

On average, about 75% of a typical 401(k) plan's fees goes for investment services and 25% for trustee and administrative services. Corporations once routinely financed the latter, in many cases doing the administrative work in-house. But increasingly, plan maintenance is farmed out to independent specialists, and more companies ask their employees to pay the fees.

A survey by Hewitt Associates, the Lincolnshire, Ill.-based human resource consulting firm, found that companies, and not employees, paid record-keeping fees for only 65% of 401(k) plans last year, down from 78% in 1991.

According to HR Investment Consultants, the average plan participant last year paid $37.16 in record-keeping fees and 1.11% of portfolio assets in investment fees. But comparing fees paid is tricky: Big companies usually are able to negotiate more favorable fees, but a company with employees in 15 different locations likely will be hit with much higher record-keeping fees than the company with a single location and thus just one set of payroll records to send to its 401(k) administrator.

New services affect fees

Joseph Valletta, a principal with HR Investment, says fees are difficult to compare, in part, because new services are being introduced all the time.

"It used to be that participants were happy with their 800 numbers to call," Mr. Valletta says. "Now they want access to their account information via the Internet and they want to be able to do transactions over the Internet.... The old baseline for service is no longer enough for many companies."

The fee maze has been further complicated by the rise of bundled providers - big insurance companies and brokerages that provide both administrative and investment services. Some muddy comparisons by charging unrealistically low administrative fees and recouping the difference on investment commissions.

"If you're not paying for administration, then you're almost certainly paying for high-cost funds," says Tim Murphy, a consultant in Hewitt's benefits delivery group. He advises clients to focus less on individual fees and more on overall costs in comparing plans.

Most 401(k) participants invest in big-name mutual funds and, by law, must pay retail load expenses. Some corporations have introduced their own generic wholesale funds to give their employees a lowercost option.

But the appeal of such funds is often limited.

"Investors can't follow an in-house proprietary fund in the newspaper each day," says C. William Burke, a partner in human resource counseling at Ernst & Young in Chicago. "Many investors are reassured by the fact they're using a retail investment vehicle rather than some generic equity fund, even if the retail fund carries higher fees."

Joel Solomon, a vice president at Rothschild Investment Corp. in Chicago, an investment management and advisory firm, says corporate clients are asking more questions about their 401(k) fees. But, he notes, most have other priorities.

"Service is the most problematic issue for most companies," Mr. Solomon says. "If statements aren't timely, if (toll-free) phone lines go unanswered those are the reasons that a 401(k) plan is likely to be discontinued. When we focus on a client, we stress service and performance, not fees."