401k Hidden Fee Inequities

401k plans are coming under increasing scrutiny for a variety of reasons including shortcomings in providing retirement security and excessive administrative fees that take a large bite out of unwary participants’ nest eggs.

Another emerging area of concern is the 401k hidden fee inequity that is inherent in the design of 401k plan fee structures.

Most types of 401k plan fees are assessed to plan participants in the form of an “expense ratio”. Expense ratios typically are expressed as “basis points” or 1/100′s of a percent. A 125 basis point (bp) expense ratio equates to a flat tax of 1.25% on each participant’s 401k account balance. A 401k participant with a $100,000 balance pays ten times the fee that a participant with a $10,000 balance pays:

Annual Fee (Basis Points)	$100,000 Account	$10,000 Account
50 bp	$500	$50
100bp	$1,000	$100
125bp	$1,250	$125

But are 401k fees reflective of actual plan administration costs? In other words, are the costs of managing a $100,000 401k portfolio truly ten times the costs of managing a $10,000 plan?

A recent research brief from the Center for Retirement Research points out that constant expense ratio fees, while attractive from the standpoint of being easy to understand, are inherently inequitable:

(T)he familiar constant expense ratio also transfers retirement wealth from accounts with higher balances to those with lower balances. Other things equal, the fees collected from participants tend to be a constant proportion of the balances they hold in the plan. Yet, some of the costs covered by these fees – many administrative and sales costs – are relatively constant for all participants, regardless of the size of their balances. Moreover, participants with twice the balances of others are not likely to entail twice the management cost, although they pay twice the management fee. Thus, a constant expense ratio is a deceptively simple method of pricing, which, by decoupling fees from costs, reduces the return credited to higher balance accounts while boosting that on lower balance accounts. This transfer of wealth tends to be larger within plans with greater ranges of account balances and within plans that achieve greater economies of scale by controlling their costs more effectively.

401k fees and 401k fee inequities significantly impact plan participants’ retirement saving success. The author points out that over a 30-year career “paying an annual fee of 50 basis points can reduce the purchasing power of savings at the time of retirement by one-eighth.”