Counting the Cost of 401(k) Plans

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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At a time when many corporations are cutting benefits, beefing up your employee benefits can differentiate your small business as a desirable employer. Though 401(k) plans have been under scrutiny for excessive fees, retirement plans are still attractive to prospective employees and long-time employees alike. Sorting through the costs of 401(k) plans can be time consuming, but counting the expenses step by step can be helpful in deciding what type of plan — if any — to offer employees.

Figuring out-of-pocket expenses is simple but dissecting and segmenting all of the costs involved is messy. In fact, a 2009 survey Trends and Experience in 401(k) Plans by Hewitt Associates indicated that "complexity" is "the number-one reason why employers have not calculated total plan cost." Over half of those companies surveyed have 10,000 or more employees, so these businesses certainly have the resources to evaluate plan fees.

As a small business owner with a 401(k) plan, you'll incur expenses, directly and indirectly, not only as the sponsor but also as a participant. Sponsor fees might be reasonably straightforward, simply equaling the charges that are invoiced by service providers plus company contributions. But expenses for some services are embedded in management fees and deductions from investment returns, and allocated among all participants, including you.

Start by considering the services delivered by providers such as plan administrators and investment professionals. Then, track down the expenses.

Plan Setup, Administrative, and Trustee Services

Setup services (or conversion services if your company is changing providers and converting employees to a new plan) involve preparing plan documents, including the summary plan description (SPD) and starting up systems for plan administration.

Basic, ongoing administrative activities include:

• Recordkeeping of participants' enrollment, investment selections, and contributions;
   
• Trustee services to hold plan assets on behalf of participants;
   
• Nondiscrimination testing and preparation of Form 5500 for compliance purposes;
   
• Preparation of account statements and summary reports;
   
• Distribution of funds to beneficiaries.

Additional services might include:

• Communications with employees to discuss the 401(k) plan and its features, and encouraging participation to help satisfy ERISA requirements;
   
• Education on investment risk, options, and methods of diversification;
   
• Loan processing and administration;
   
• Online access to plan information and account balances.

One-time setup or conversion fees may run $500 to $3,000 and administrative fees can cost a few thousand dollars each year. There is often a base price plus per-participant charge. Your business might work with an independent retirement plans provider or online 401(k) provider, such as ING Sharebuilder or Fidelity. Note that some providers may charge less for setup and annual administration, and recoup costs from asset management and investment management fees.

Employer Contributions

Employer contributions are optional and vary as a percentage (typically 1 to 3 percent) of annual payroll, depending on plan design and IRS guidelines. Employers can match employee contributions, fund each employee's account regardless of employee contributions (non-elective contribution), contribute in both ways, or contribute nothing at all.

Investment Management

Investment management and related fees (such as sales charges) and wrap fees may comprise 50 to 80 percent of total plan cost. Costs are associated with selecting and providing investment options (e.g., mutual funds, annuities), and are generally deducted from investment returns. In practice, then, these expenses are passed along to participants; but as a small business owner you will have dual accountability for controlling these costs as the plan's sponsor as well as paying your portion of these expenses as a participant. These fees can account for 1 to 2 percent of assets for smaller plans (with fewer assets), paid each year.

Strategies for Cost Containment

To contain costs, get a breakdown of expenses from providers to determine the total plan cost (TPC). Out-of-pocket costs invoiced by providers (such as annual administrative fees) are the most visible and simplest to measure and contain. Other fees may be assessed as a percentage of assets or deducted from investment returns. Ask providers for a schedule and explanation of these charges.

To save money, limit plan features that may be costly to administer, such as allowing frequent changes in investment selection. Work with your financial adviser to build investment offerings with lower-cost options, such as passively managed investments (e.g., index funds) rather than actively managed investments.

More Retirement Plans

There are a multitude of options for retirement plans besides the 401(k). The SEP (Simplified Employee Pension), SIMPLE IRA, and Profit Sharing Plans, for example, may have lower administrative and management expenses than traditional 401(k)s but require employer contributions.

A Payroll Deduction IRA is an even less complicated approach, simply involving employee payroll deduction and deposit into an IRA. Investments are owned and controlled by employees, and employers do not make contributions. Though employees could easily take these steps, they may value the ease and convenience of contributing to a retirement fund.