Thanks to new federal rules that went into effect July 1, employers must provide their employees with fee information on every investment choice they offer in their 401(k) plan by Aug. 30.
Fees that must be disclosed include the charge for record keeping, investment management, consulting and administration. Until the new rule, investment companies were not required to disclose fee information unless requested by the employer.
Once the fees are disclosed to employers, they are required to determine if the fees are reasonable and, if so, provide a breakdown of the fees to all employees. Employees won't be able to see the actual fees until the third quarter statements arrive.
In most 401(k) plans, investment management fees accounts for the majority of the plan's cost, and are often misunderstood by plan sponsors.
According to an April 2012 study published by the Government Accountability Office, about half of the employers they surveyed wrongly believed the investment management fees in their 401(k) were waived or didn't know if they were paid by the employer or the employee.
Many 401(k) plans can have multiple fees. For example, investment management fees are paid out of plan assets to the investment adviser for portfolio management.
Marketing and distribution fees, also known as 12b-1 fees, often are used to pay commissions to brokers and to various service providers in a 401(k) with a bundled service arrangement. Sub-transfer (Sub-TA) fees typically are used to compensate a third party administrator for participant accounting.
Trading costs are fees associated with an investment manager's buying and selling of securities. Wrap fees are usually associated with insurance products such as variable annuities, and can encompass myriad fees such as investment management, mortality risk, administrative, surrender and transfer charges.
The GAO report noted that studies focusing on pension fees have found that plans pay a range based on the size of the plan.
For example, BrightScope recently estimated that the average fees paid by plans with less than $10 million in assets for all recordkeeping, advice and investment management services was 1.9 percent and 1.08 percent for plans with over $100 million in assets.
However, BrightScope's estimates do not include plans with fewer than 100 participants, which account for about 88 percent of all 401(k) plans.
Another study conducted in 2011, which included plans of all sizes, estimated that the average total amount paid in defined contribution plans for recordkeeping, administrative and investment fees was about 1.3 percent.
While these figures may seem small and inconsequential to some, studies have shown that fees can have a big impact on retirement savings over the long term.
According to ABC News, a report published by a nonpartisan public policy research group, Demos, found that a household with two people earning the median U.S. income of their age group from 25 to 65 will pay an average of $154,794 in 401(k) fees and lost returns.
Participants in 401(k) plans should be on the lookout for the fee disclosures by the end of the month from their employers. This may present a good opportunity for participants to ask questions about their company's 401(k) structure and get a better understanding of the costs involved.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Travis Flenniken is a certified financial analyst with Campbell Asset Management LLC. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Time Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at dflessner@timesfree press.com.