The Shrinking 401(k) Margins

When I was 13, I bought my very first computer, an Apple IIe for $2,000, which would be about $4,067 in 2010 money. Last year, I bought my latest Dell laptop computer for about $600.

In 2008, I was reviewing the 401(k) plan of a soon to be defunct mattress retailer that was on an insurance platform that was on their side. A copy of the 1995 contract that actually expired in 2001, charged the plan sponsor 267 basis points in fees.  Obviously for a plan that had almost $4 million in assets, that was a lot of money. In 1995 when daily 401(k) plan were the exception and not the norm, 267 basis points was reasonable. In 2008, that was outright theft.

Since 1995, fees for daily recordkeeping plans and the margins in 401(k) administration have fallen in price as technology and economies of scale reduced costs. The advent of revenue sharing fees where mutual fund companies kick back fees to the third party administration (TPA) firm has helped as well. Since TPA firms had no requirement to breakout revenue sharing fees, the true costs of plan administration was actually masked to the plan sponsor and the plan participants.

With the advent of fee disclosure in July 2011 and participant fee disclosure in 2012, the mask of revenue sharing will be taken off and that revenue share subsidy will be exposed as another cost of plan administration that will act as sticker shock to plan sponsors. Hungry financial advisors and competing TPAs will use that opportunity to recruit new plan sponsor clients by promising lower fees with the use of lower fee mutual funds and/pr exchange traded funds (ETFs).  This will put the pressure on revenue sharing paying mutual funds, who may take that as an opportunity to lower the amount of revenue sharing payments they would promise to make to appear on the approved 401(k) fund menus of 401(k) platforms and TPAs. Of course, the cutting of the fees would save these mutual fund companies money, but would of course hamper their access to these approved fund lineups used by mutual funds platforms and TPAs.

The cutting of revenue sharing fees would hurt the margins of TPAs that tout these more expensive funds, but it is my belief that fee disclosure regulations would have already put pressure on these margins. If TPAs and 401(k) platforms ditch revenue sharing funds because they no longer pay sizeable revenue sharing/ sub ta fees, this would allow less expensive mutual funds and ETFs to pick up the slack which would save participants money and squeeze TPA firms to lower their fees.

Am I off the mark? Only time will tell.

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7 Responses to The Shrinking 401(k) Margins

  1. Nevin Adams says:

    Assuming someone actually looks at the expenses/expense ratios in the prospectus, then how does splitting out who gets what in any way change the cost – or even the perceived costs of the program? It’s the same expense, divided out among parties. People might have a beef with the apportionment, but overall they will be paying then what they are paying now.

    And, trust me, if people aren’t looking at the prospectus now, there is NOTHING about the proposed disclosures that will make that process any better. It’s a great theory – but unless the final version is better than the proposed, it’s going to kill a lot of trees and provide little in the way of true disclosure (IMO).

    That said, people will continue to write about the coming “sticker shock” – though I suspect that’s going to turn out to be overblown, as well.

    • admin says:

      I was asked by Chris Carosa at Fiduciary News about the proposed disclosures and my complaint was that I don’t think plan sponsors will read them, making them even more liable for costs since the costs will be disclosed.

      Sticker shock will come into play when an advisor prosecpting clients gets into a meeting with a prospect and is able to break out fees.

      With fee disclosure, your guess is as good as mine. Over the last 20 years, expenses on the funds and administration have been lowered. I think with disclosure, it will continue.

  2. Mike Finnegan says:

    Ari, I just saw a presentation on disclosure and it appeared that bundled progams like Fidelity’s would be getting more of a “free pass” on the detail level of revenue sharing.

    Any thoughts?

  3. Joe Gordon says:

    Margins are getting squeezed but I think it is more the brokers selling 401(k) plans than TPAs. We use a TPA that accepts no asset based fees or revenue sharing. We act as fiduciary with the plan sponsor. We account for all of the revenue sharing and offset our fees and other plan expenses. So we have zero incentive to allow funds only because they pay enormous revenue sharing.

  4. Craig Hawkins says:

    I believe brokers at wirehouses will have the worst time going forward. The RIA’s that specialize in 401k’s will be at an advantage with regard to pricing their services. I don’t see the brokers being able to meet their make a living offering insurance based platforms, even once fee disclosure becomes the norm. The TPA firms will have to find more RIA’s or become producing TPA’s to generate additional fees lost from their broker network.

  5. Timothy Yee says:

    Must say I am a fan of transparency. It is important to know your value and charge accordingly. It is also important for the plan sponsor to know what they want and are willing to pay for. Get a meeting of the minds before signing anything and that should result in less fireworks in the future.

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