In England, many of the top pubs are owned by British breweries because watering holes are an effective means of beer distribution. If a business can control the method of distribution of their own products, they can expand the distribution while saving a couple of shekels by avoid having to pay a third party to distribute.
The 401(k) industry is dominated by mutual funds, so it should come as no shock that many mutual funds companies offer services as a third party administrator (TPA) because it’s an effective means of distributing their mutual funds. Mutual funds distribution is extremely important for mutual funds companies because their bread and butter are the funds’ asset management fees and more assets under management equal more revenue for the mutual fund company.
While many mutual funds companies only offer TPA services for larger plans, there are a few mutual funds companies that have been rather aggressive in offering TPA services to small and medium size plans. While mutual fund companies do offer an attractive alternative as part of a one stop shop, plan sponsors are under misimpression that the mutual fund companies’ TPA services are free or close to free.
As stated in a previous article about 401(k) administration, there is no such thing as a free lunch or free 401(k) administration. Mutual fund companies make their money as a TPA through those very same mutual fund management fees that I had discussed earlier. Many of the same companies that offer TPA services are the very same mutual funds companies that offer revenue sharing or sub TA fees to TPAs for plans that use their funds. So by keeping plans under their roof, these mutual funds companies can keep their revenue sharing/ sub-TA fees to themselves. These mutual fund companies also guarantee the fees they make, by requiring that a percentage of a plan’s assets (up to 100%) be invested into their own proprietary mutual funds. I recently came across a 401(k) plan with a mutual fund company as a TPA that offered 12 mutual funds to participants for directed investment and all 12 funds were the fund company’s proprietary funds.
For plan sponsors and trustees who serve as fiduciaries under ERISA, it is a question of the prudence rule and whether it is prudent to offer investments into a specific mutual fund company, only because that mutual fund company is the TPA. While some mutual fund companies have sterling reputations, there are a still a number of mutual fund companies who have been tainted by the late trading scandals of the last decade, as well as poor performance and high fees. All plan sponsors that utilize a mutual fund company as a TPA should understand that there is a cost involved with their plan’s administration (check those disclosure forms), as well as being advised as to the standing of the mutual fund company within the entire mutual fund industry to make sure it doesn’t become the next Steadman fund family.
Plan sponsors should consult with their 401(k) financial advisor to determine whether a mutual fund company as a TPA is the right fit for them. Mutual fund companies may be an attractive option for some, but plan that offer what is known as out of the box provisions may not be a good fit, as well as a plan sponsor that wants unbundled options in the selection of mutual funds.