401(k) Fee Equalization By: Gabriel PotterMBA, AIFA® 2014.03.26

We like to keep ahead of trends in the retirement industry.  Here’s an idea that is getting more popular and, we expect, will become a new standard in the near future: fee equalization.

Let’s back up for a second and think about how fees are paid for a defined contribution plan.  Imagine a company – John Doe Computers – has a 401(k) investment plan for their employees.  The management, custody, and administration of the 401(k) plan is the responsibility of XYZ investment bank.  John Doe computers has several mutual funds in their 401(k) investment lineup, but generally speaking, they fall into 2 categories:  first, the investment lineup is made of cheap mutual funds and second, there is a target date fund series available for participants. 

To the inexperienced eye, it looks like the administration and management of a complex 401(k) is free.  In reality, the administration of the plan is paid for with revenue sharing.  The mutual funds fees are SHARED between the mutual fund investment managers and XYZ investment bank.

Here’s the problem:  half of the employees invest their retirement assets only into cheap index funds and the other half of employees are using the target date fund series.  The cheap index funds have no revenue sharing agreement with XYZ investment bank, while the target date series shares a lot of revenue with the bank.   In other words, the employees who invested their money into the target date funds are paying the custody and administration fees for the entire pool of employees.

401(k) Fee Equalization plans attempt to take the average fees paid by the plan and split them equally, using rebates or additional fees, between all the plan participants proportionally.  The employees who use cheap index funds may get charged an additional hard-dollar fee from their account, but their combined costs will still be lower than the target date fund users.  The target date fund users may get a rebate to offset some of their costs.

Implementing this feature into a defined contribution plan is complex with high technology requirements, but many investment banks are working hard on this type of solution and we expect it to become standard in the marketplace within the decade.


Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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