A new study offers an interesting spin on 401(k) fees.
By Scott Parker
Defined contribution plans represent more than one-quarter of the entire U.S. retirement market, with more than $4 trillion in assets. They have become an important component of Americans’ retirement security. These plans involve a number of design considerations by the plan sponsor, and savings and investment decisions by participants. Fees and expenses are an important aspect and are often difficult to understand. Fee structures vary, built around who pays them and how they are paid.
As assets in defined contribution plans have grown, so too has the scrutiny around these plans, especially in light of the turbulent investment markets experienced in recent years. The fees charged for these plans have come under particular focus as the Department of Labor (DOL) aims to create greater transparency through regulatory disclosure requirements under Sections 408(b)(2) and 404(a) of the Employee Retirement Income Security Act (ERISA).
To gain a better understanding of the mechanics of 401(k) plan fees and the factors that impact them, Deloitte Consulting LLP conducted a survey of plan sponsors on behalf of the Investment Company Institute. The study, Inside the Structure of Defined Contribution/401(k) Plan Fees, which updates and expands a 2009 survey, looks at total fees charged across a broad sample of 525 defined contribution plans, with a range of plan sizes, service levels, investment offerings, retirement service providers, and fee structures.
What appears to drive fees in 401(k) and other defined contribution retirement plans are closely related to a number of factors including:
• Size of the plan (number of participants and average participant account balance);
• Allocation of plan assets to equities;
• Number of investment options;
• Participant contribution rates; and
• Use of automatic enrollment.
More than 250 data points on average were gathered from each of the 525 plans studied. For each plan, Deloitte researchers calculated an “all-in” fee—a broad measure of administrative, recordkeeping and investment-related fees, whether paid by the plan sponsor, the participant, or the plan—as a percentage of plan assets.
A particular finding of the study shows that for the companies surveyed, the number of participants and the average participant account balance in the plan are primary drivers of a plan’s all-in fee. Specifically, plans with more participants and higher average account balances typically had lower all-in fees, benefitting from economies of scale by spreading fixed administrative costs over more assets and participants.
The allocation of plan assets to equity investment options is also cited as a primary driver of plan fees in the analysis. Plans with higher allocations to equity investment options tended to have higher all-in fees as a percentage of plan assets, consistent with the fact that equity investment options generally have higher expenses than other types of investments.
Three other factors also were found to be significant in explaining variation in defined contribution plan all-in fees. Plans with more investment options tended to have higher all-in fees than plans with fewer. On the other hand, plans with higher participant contribution rates or automatic enrollment tended to have lower all-in fees.
“This study serves a valuable purpose by separating the factors that drive fees from a number of other plan features that do not appear to have a significant impact on fees for the companies studied,” explains Daniel Rosshirt, a principal with Deloitte Consulting LLP, who led the research effort. “It’s notable that a number of factors that might be associated with complexity in servicing plans did not appear to have a significant effect on fees.”
These variables include the number of payrolls and number of business locations that a plan sponsor has. The study also found little fee impact resulting from the type of service provider (whether a mutual fund sponsor, life insurance company, bank, or third party administrator) or variables relating to the plan’s relationship with the service provider (such as tenure with the service provider, years since the last competitive review, or the percentage of assets invested in proprietary investments of the service provider).
“Defined contribution plans, including 401(k)s, represent about one-quarter of Americans’ retirement assets and play an important role in Americans’ saving for retirement,” says ICI President and CEO Paul Schott Stevens. “As regulatory changes and increased scrutiny on fees affect these plans, this study provides both a framework for analysis as well as an understanding of the factors driving fees for a cross section of plans.”
While any individual participant’s experience depends on the defined contribution plan offered by his or her employer, the median defined contribution plan participant is in a plan with an all-in fee of 0.78 percent of assets, based on plans included in the study. Across all participants, the all-in fee ranged from 0.28 percent of assets (the 10th percentile participant) to 1.38 percent of assets (the 90th percentile participant). Larger plans tended to have lower all-in fees.
“Commitment by employees and employers to saving for retirement appears to help drive fees lower,” says Sarah Holden, ICI’s senior director of retirement and investor research. “The study found that the plans tend to have lower all-in fees when the participants’ contribution rates are higher or the plan has automatic enrollment, which increases participation and also may increase participants’ contributions over time.”
While the survey was not intended to provide a statistical representation of the defined contribution plan market, the survey respondents represent a wide cross section of plans. The plans surveyed from January through August 2011 ranged from less than $1 million in assets (56 percent of plans in the sample) to more than $1 billion in assets (7 percent of plans in the sample).
The development of the all-in fee provides a more direct comparison of these fees and the drivers of fees. The variation in the all-in fee is significantly impacted by three independent variables: the number of participants, the average account balance, and the percentage of total plan assets in equity investment options. In addition, differences in fees of similar-sized plans can be attributed to a number of secondary drivers such as higher participant contribution rates, the number of investment options, and automatic enrollment. And finally, commonly perceived influencers of fees—number of payrolls and use of proprietary investments—were identified to be insignificant in this study.
Scott Parker is a senior manager in Deloitte Consulting’s financial services practice focusing on retirement services.