Personal finance

You might be subsidizing a colleague’s 401(k) fees

Kemal Yildirim | E+ | Getty Images

You may unknowingly be subsidizing your colleagues’ 401(k) fees.

The dynamic is a function of your 401(k) investments and how the retirement plan pays costs for administrative expenses, like those associated with trading and ongoing accounting of workers’ balances.

Retirement savers (like the broader investment world) may be unaware of the fees they pay. Many financial firms inside and outside the 401(k) ecosystem often levy an annual fee directly from client accounts instead of asking them to write a check.

Mutual funds in 401(k) plans are no different. And their overall expense may include a “revenue sharing” fee (also known as a 12b-1 fee, a distribution fee or shareholder services fee, for example); the fund manager collects this fee and then pays the 401(k) plan’s administrator.

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This behind-the-scenes infrastructure is how many plans pay for record-keeping and other services from firms like Fidelity Investments, Empower Retirement and other 401(k) administrators.

While on the decline, 16% of workplace retirement plans like 401(k) plans still use revenue sharing, according to a survey published Tuesday by Callan, a consulting firm. (The share was about 40% a decade ago.)

However, its prevalence may be more widespread than the Callan survey suggests; three-quarters of the 101 employers polled were among the country’s largest, each with more than $1 billion in assets.

Small 401(k) plans tend to use revenue sharing more readily. A separate poll by the Plan Sponsor Council of America, a trade group, across a broader swath of plan sizes indicates 39% use the practice.

Revenue sharing obscures a plan’s true cost and can lead to many unequal outcomes for retirement savers, according to critics.

For example, not all investment funds levy that fee. Actively managed funds have a revenue-sharing fee built in more often than index funds, for example. (Of course, there are exceptions.)

“There are a lot of popular [401(k)] industry funds that use revenue sharing,” said Greg Ungerman, who leads a team at Callan working with workplace retirement plans. “It’s all over the map.”

The dynamic means a saver invested solely in index funds may not pay any revenue-sharing fees for 401(k) plan expenses, whereas another worker in the same 401(k) plan invested solely in actively managed funds may pay the fees.

Hence, the latter subsidizes costs for the former, even though they get the same services.

Firms abandoning fees

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Employers have begun moving away from the practice, amid a flurry of lawsuits around excessive 401(k) fees and federal fee-disclosure rules to boost transparency, which were adopted about a decade ago.

“[Investors] don’t see the money when it comes out; you don’t see a line item on your statement like you do a credit card bill,” Ungerman said of revenue sharing. “There [used to be] an element of ignorance was bliss.

“But that’s just not appropriate in these days.”

Employers may not have much of a choice — they are somewhat at the mercy of the investment firms.

Many firms have debuted versions of their funds that don’t include a revenue-sharing fee. However, some haven’t, and some employers may not be allowed access to the ones that do.

Given these dynamics, some record-keeping firms have built technology to capture the fees and funnel that money back to investors, eliminating any unfairness that may have existed.

“It gives the [employer] on behalf of the plan participants a bit more control,” Ungerman said. “But that’s not always utilized.

“Not all record keepers can support it.”

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