Are you spending too much on your 401k plan? With mutual fund and administration fees a hot current topic, a consultant suggests evaluating your plan--starting with a thorough review of the fees associated with the plan.

One of the big stories in 2004 is fees--mutual fund fees, asset-based fees, administrative fees and disclosed and undisclosed fees of 401(k) plans. Yet many CFOs who are responsible for these plans do not fully understand the fees they pay (or have participants pay), and don't always know the questions to ask a service provider.

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Some CFOs assume that because the hard-dollar fee they pay is low or even "zero" that they must be getting a good deal. The Employee Retirement and Income Security Act of 1974 (ERISA) requires that plan sponsors ensure that fees in retirement plans they sponsor are "reasonable." What follows can help you determine if, indeed, your plan is reasonable.

Warning Signs You May Be Paying Too Much:

* Low plan administration fee. Your plan administration fee is low or "zero." Nothing is free, and a zero hard-dollar fee means the plan is paying for administration based on plan assets (either through an asset-based charge or higher fund expense ratios that subsidize the record-keeper, or both). Fees that don't cover the cost of administration obscure the cost of the service and asset-based fees result in substantially higher fees as assets grow.

* Average participant balance over $25,000. Since 80 percent or more of vendor revenue is asset-based, high average balances result in very profitable business for the vendor. The economics of the industry make plans with average balances under $20,000 not very profitable for most vendors, while those over $25,000 become very attractive. If a plan has average balances over $50,000, it is a virtual certainty that you are overpaying the vendor and can negotiate a lower fee or additional services.

* Wrap or asset-based fee. Common in plans with low average balances and/or small total plan balances (roughly under $5 million), these fees result in over-payment by larger plans or plans with high average balances. Because they are asset-based, they result in ever-higher plan administration fees, while the plan services they pay for remain the same.

* Vendor compensation from funds is unknown. Many plan sponsors have never calculated how much the vendor earns in sub-transfer agent fees (sub-TA) or shareholder service fees. Most mutual funds pay compensation to record-keepers because they do accounting work the fund would otherwise have to do. These fees are asset-based and often amount to $175-250 or more on a $50,000 account balance.

* Heavy reliance on proprietary funds. A good rule of thumb is that service providers make 70 basis points (0.7 percent) or more on equity funds they manage. Requiring proprietary funds may be good for the vendor, but may not bfe prudent from either a fee or investment perspective for your plan.

* 12b-1 fees are kept by the vendor. 12b-1 fees pay financial advisors to service the plan. If you don't have an advisor, either the vendor or the fund manager is keeping those fees. Consider either getting an advisor to help with the plan or ask the vendor to offer lower expense ratio funds to the plan without this fee.

* Unknown stable value management fee. Stable value funds are a favorite place to bury additional fees. Insurance companies often minimize more visible fees by raising the management fee of the stable value product. The management fee for the same product can vary from as little as 30 basis points to over 125 basis points. Since assets in this type of fund are typically high, it can be very profitable for the service provider and practically invisible to plan sponsors and participants.

* You don't know your financial advisor's compensation. In the small to mid-sized market, broker compensation can have a major impact on what the plan pays the vendor. If the vendor has built in a high level of compensation for the advisor, it will be passed on to the plan in the form of higher fees in one or more of the forms discussed above.

What Vendor Services Cost

Just as you can negotiate a better price at a car dealer if you know the dealer's cost, you can ensure a reasonable fee from your retirement plan vendor if you understand what it costs to provide the services.

A good rule of thumb is that the ongoing cost (not including profit margin) for providing record-keeping, compliance, education, Internet access, call center and reporting to a standard 401(k) plan is between $60-85 per participant per year. Plans with fewer than 100 participants or complex plan design may cost more. Plan acquisition costs are extra and can vary widely.

All in, it is reasonable to assume that a vendor will want to get about $150 per participant per year or more for their services on a mid-sized plan. Vendors are understandably reluctant to provide details on their costs, but this is the key to understanding whether the fee your plan is paying is reasonable. (See the box with examples above.)

How Sales Compensation Affects Plan Fees

Large retirement plans often pay a separate fee for a consultant to help monitor investments and conduct vendor searches. For small to midsized plans, this fee is usually imbedded in the vendor's fees and not broken out separately.

Direct sales compensation: Direct sales models that pay a captive sales force to bring in business seek to recoup the cost of the sale over a three- to six-year period, depending on the type of vendor. But we don't know of any vendor that reduces a plan's fees once they have recouped their costs.

Financial advisor compensation: The first step in pricing a deal is determining financial advisor compensation. While some vendors have a set schedule, most let the advisor set both up front-end and ongoing compensation and pass it along to the client. None of this is typically disclosed. Some vendors actually mark up the advisor compensation so that for every basis point an advisor asks for, the vendor may charge the plan 1.25 basis points. An unreasonable plan fee may be the result of an advisor asking for unreasonable compensation. If so, reducing the advisor compensation to a reasonable level (or finding someone who charges a reasonable level) should result in corresponding reductions in the vendor fees.

Taking Action

If you suspect that your fees may be too high, here's what to do:

First, gather the facts. Ask your vendor to disclose all fees it receives from all sources, including the ones in the table above. Most vendors won't volunteer information, but if you ask most will provide information on revenue sharing they receive from mutual funds and the management fee they charge for the stable value fund. If you have an advisor, ask the advisor to disclose his or her compensation. Solicit bids from other vendors even if you aren't intending to change.

Next, determine what you want from the vendor. Do you want lower fees or funds with lower expense ratios? Do you want the vendor to pay for the annual plan audit, or do you want additional services, such as more education for employees?

Then, talk to your vendor. You may want to begin with your primary contact, but any decision will almost certainly involve a senior manager. Consider asking your day-to-day contact to set up a meeting or conference call to discuss your request. Demonstrate to the vendor that you understand the economics of the business and that you want them to make a profit--but a reasonable one.

Finally, ask for a plan services fee that is not asset-based. The cost of providing administration, testing and other services does not go up as assets go up--and neither should your fee. Ask your vendor to give you a price for services that is calculated per participant per year.

Fees are complex, and some of the information can be hard to get. But it can be worth the work in fees saved and in documenting that you have done your fiduciary duty. Most vendors will offer a fee concession if you present a clear case that demonstrates you understand how the business works. But they probably won't offer their best fee unless they believe you will leave if you don't get it. That is a decision you should make before talking with the vendor. Ultimately, this is a process of getting a reasonable fee--not necessarily the lowest fee.

Vendor Recurring Revenue Sources

Source               Type            Typical Range    Comment
                     (disclosed/non  Basis Points
                     -disclosed)     (bps)

Record Keeping       hard dollar     $0-125           Often based on
/Compliance          disclosed       per participant  assets resulting
                                                      in significantly
                                                      higher fees
Mutual funds         soft dollar     0-100 bps        If you have an
12(b)1               disclosed                        advisor, this will
                                                      pay them. If not,
                                                      the vendor
                                                      typically keeps
Sub transfer agent   soft dollar     0-50 bps         Part of expense
                     non-disclosed                    ratio
Shareholder service  soft dollar     0-100 bps        In lieu of 12(b)1
                     non-disclosed                    or sub-transfer
Pay to play          soft dollar     $0-millions      Ranges from
                     non-disclosed                    underwriting
                                                      training and
                                                      conferences to
                                                      major placement
                                                      fees in the form
                                                      of cash or
                                                      directed brokerage
                                                      to be in preferred
                                                      menu
Management fee       soft dollar     Bonds 25-60 bps  For proprietary
                     disclosed       Equities         funds. Typical
                                     40-150 bps       equity fee is
                                     Indexes 6-50     60-80 bps
                                     bps. Stable
                                     value 20-125
                                     bps
Sub-advised funds    soft dollar     30-70 bps        Vendors tout
Management fee to    non-disclosed                    independence
vendor                                                but receive higher
                                                      revenue share than
                                                      from mutual funds
Asset-based          soft dollar     0-200 bps        Typically found in
or wrap              disclosed                        annuity products,
                                                      but may be used
                                                      for company stock
                                                      or non-revenue
                                                      sharing mutual
                                                      funds

note: not all fees apply to any given situation or vendor. Ranges are
typical for nationally available vendors.

Two Typical Cases

Case 1 A $30 million 401(k) plan with 500 participants (average balance of $60,000), 12 funds, including 8 proprietary funds that have 70 percent of the assets. What might the revenue streams to the vendor look like?

Management fee = $21,000,000 (70% of $30,000,000) X .7%    = $147,000
(average management fee)
12b-1 and/or sub transfer agent fees from non-proprietary  = $24,500
funds = $7,000,000 X .35%
Total                                                       $171,500

In this example, before any hard-dollar fee or asset-based fee, the vendor is receiving $343 per participant. The vendor may add asset-based or hard-dollar fees without disclosing the revenue stream above, or may quote the plan a "zero" fee.

Case 2 A $10 million 401(k) plan with 300 participants (average balance of $33,333) with 12 funds, including 4 proprietary with 50 percent of the assets.

Management fee = $5,000,000 (50% of $10,000,000) X .7%     = $35,000
(average management fee)
12b-1 and/or sub transfer agent fees from non-proprietary  = $17,500
funds = $5,000,000 X .35%
Asset-based fee of .3%                                     = $30,000
Total                                                        $82,500

In this example, the vendor is receiving $275 per participant.

Donald Stone ([e-mail]) is a founder and principal with Chicago-based Plan Sponsor Advisors (PSA). PSA is an independent retirement consulting firm that provides small and mid-sized companies with fiduciary oversight, investment monitoring and vendor search for all types of retirement plans.