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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 for the costs of administrative expenses, such as those associated with trading and ongoing accounting of worker balances.
Retirement savers (like the wider investment world) may not be aware of the fees they are paying. Many financial companies inside and outside the 401(k) ecosystem often take annual fees directly from customers’ accounts instead of asking them to write a check.
Mutual funds in 401(k) plans are no different. And their overall expenses may include “revenue sharing” fees (also known as 12b-1 fees, distribution fees, or shareholder services fees, for example); the fund manager collects these fees and then pays the 401(k) plan administrator.
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This behind-the-scenes infrastructure represents the number of plans that pay for record keeping and other services from companies like Fidelity Investments, Empower Retirement and other 401(k) administrators.
Although declining, 16% of workplace retirement plans like 401(k) plans still use income splitting, according to a survey released Tuesday by consulting firm Callan. (The share was around 40% ten years ago.)
However, its prevalence may be more widespread than the Callan survey suggests; three-quarters of the 101 employers surveyed were among the largest in the country, each with more than $1 billion in assets.
Smaller 401(k) plans tend to use revenue splitting more easily. A separate survey by the Plan Sponsor Council of America, a trade group, of a broader range of plans indicates that 39% use this practice.
According to critics, revenue splitting masks the true cost of a plan and can lead to many unequal results for savers.
For example, not all investment funds charge these fees. Actively managed funds have revenue-sharing fees built in more often than index funds, for example. (Of course, there are exceptions.)
“There are many popular [401(k)] industry funds that use revenue sharing,” said Greg Ungerman, who leads a team at Callan working with workplace pension plans. “It’s all over the map.
The dynamic means that an investor invested only in index funds cannot pay revenue sharing fees for 401(k) plan expenses, while another worker in the same 401(k) plan invested only in actively managed funds may pay the fees.
Therefore, the latter subsidizes the costs of the former, even if they get the same services.
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Employers have begun to back away from the practice, amid a wave of lawsuits over excessive 401(k) fees and disclosure of federal fees rules to enhance transparency, which were adopted about ten years ago.
“[Investors] don’t see the money when it comes out; you don’t see a line item on your statement like you do on a credit card bill,” Ungerman said of revenue sharing. [used to be] an element of ignorance was happiness.
“But that’s just not appropriate these days.”
Employers may not really have a choice — they are somewhat at the mercy of investment firms.
Many companies have launched versions of their funds that do not include revenue sharing fees. However, some have not, and some employers may not be allowed access to those who do.
Given this dynamic, some recordkeeping firms have developed technology to capture fees and redirect that money to investors, eliminating any unfairness that may have existed.
“It gives the [employer] on behalf of plan participants a little more control,” Ungerman said. “But it’s not always used.
“Not all archivists can stand it.”