Duh Employees Pay IRA Admin Costs

December 31, 2003
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GRAND RAPIDS — A recent national news flash from a normally credible source reported discovering two supposed secrets regarding 401(k) plans.

First, in company-sponsored plans, employees pay the fees charged to manage their accounts, not employers. The story said workers and retirees were unaware of this and the fees they were paying were shrinking their accounts.

Second, older workers with larger account balances pay more than younger employees with smaller balances.

The story labeled this secret “revenue-sharing,” and explained that the higher fees paid by older workers were being used to subsidize the accounts of younger employees.

Secrets? Not to anyone who has been paying attention to their plan.

“The management fees for the fund are paid for by the individual — the investor,” said Eric Ericksen, a local investment counselor.

“It doesn’t matter whether it’s a big or small firm, the investor is going to pay the management fees of the mutual funds that they’re in,” he added.

The U.S. Securities and Exchange Commission reported that fund managers deduct an average of 1.4 percent from each investor’s account to administer a fund.

Sometimes a fund will have two charges that make up a fee. One is an internal fund fee charged by the fund manager, while a third-party administrator can attach a custodial charge.

But despite how the fees are arrived at, the employee is responsible for picking up the tab, not the employer — even if it’s a company-sponsored plan.

“My point is, the employer shouldn’t pay any of the 401(k) expense because there is no benefit to the employer to give someone a 401(k) plan,” Ericksen said.

He added that if an employer did pay the fees, employees might not have as many funds to choose from.

“There is an administrative cost to do all this paperwork and the employee pays it. It’s just a question of how. The smaller the company, the harder it would be to have a 401(k) plan because of those expenses. But there is no reason that a company should pay for someone’s personal retirement plan,” he said.

The revenue-sharing claim is also a bit misleading.

As long as management fees are based on a flat percentage, investors with more money in their 401(k) accounts will always pay a higher fee than those with smaller accounts regardless of age.

“If you have $100,000, you’re going to pay $1,400. If you have $10,000, you’re going to pay $140. So the dollar amount is bigger, but the percentage isn’t,” said Ericksen.

But a fee that employers and employees might want to take a closer look at is a custodial fee charged by a third-party administrator.

It could be argued that charge shouldn’t be based on a percentage of an account’s balance because it doesn’t cost any more to deposit $1,000 into a fund than it does to deposit $10,000. A percentage penalizes larger investments, and a fixed fee would be a fairer charge.

“Here we do have the case where bigger savers are subsidizing the smaller savers,” Ericksen said.

If an investor is concerned about the fees he or she is being charged, some shopping around might be in order.

Ericksen said there is at least one national broker that doesn’t charge investors a management fee. Instead, the firm gets paid by the fund managers to market their products, which allows the broker to drop the fee.

Still, he added, it’s pretty likely that an investor ends up supplying a fund manager with the money to pay the broker for marketing the fund.

But leaving an employer-sponsored plan to avoid paying a management fee will result in an employee losing the firm’s matching contribution to his or her account. So if a company contribution is higher than a fee, an investor should think twice before opting out of a firm’s plan.

Ericksen offered two realizations for every 401(k) investor, regardless of their age or the size of their investment. One is to pay attention — to the fund and to the market in general.

Two is to understand the fees that are charged.

“It certainly points out why — especially in a slower-growth economy — every investor in a 401(k) plan should be paying attention to what they’re being charged to own those funds,” Ericksen said.

“The cost to own those funds doesn’t matter; the amount that someone puts into it doesn’t affect the management fees that are deducted.”

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