“My 401(k) is Free isn’t it?” – Understanding 401(k) Fees and Your Responsibilities as an Employer

Do you offer an employer-sponsored 401(k) plan? Do your employees think the plan is free? Are you aware of your obligation for assessing and communicating information about fees to your employees?

It’s a valid question given that more than 75 percent of employees who sign up for 401(k) plans are unaware of the administration, investment and service fees associated with their plan.

The problem for you, as an employer, is that the law makes you responsible for acting on behalf of your employees when it comes to administering the 401(k) plan. This includes a specific obligation to consider the fees and expenses paid by your plan. And soon, new legislation will make it the employer’s responsibility to also make sure employees are fully aware of the cost of 401(k) fees and the impact on their retirement plan’s account balance.

Here’s what you need to know about your employer obligations when it comes to 401(k) fees and how to keep your employees informed of their true retirement plan costs.

Employer Obligations Relating to the 401(k) Fees

The nation’s major pension protection law, the Employee Retirement Income Security Act (ERISA) requires employers to follow certain rules managing 401(k) plans and these must be solely in the interest of the plan participants and their beneficiaries.  These obligations are:

• Establish a prudent process for selecting investment alternatives and service providers;
• Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of services provided;
• Select investment alternatives that are prudent and adequately diversified; and
• Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices.

Failure to comply with these obligations can be incredibly damaging to a small business and even result in investigation and employee lawsuits.

The Impact of 401(k) Fees on Employee Retirement Income

So what impact do these fees have on your employee’s retirement nest egg? Well, 401(k) retirement plans are not free. In fact, the fees and expenses paid by a plan can substantially reduce the growth of an employee’s account and reduce the amount of retirement income paid. This example from the Department of Labor (DOL), explicitly demonstrates how detrimental the cumulative effect of fees can be to an employee’s 401(k) balance:

“Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.”

Are your employees fully aware of the role fees play in their potential retirement income?

New Law Requires Employers to Provide Employees with Greater Transparency on 401(k) Fees

To help employees gain a better understanding of the fees and expenses associated with their plans, the Department of Labor has introduced a new fee-disclosure rule that requires employers to disclose information about plan and investment costs to workers who direct their own investments in ERISA-covered 401(k) and other individual account retirement plans.

The rule requires that employers provide initial disclosures no later than 60 days after the first day of the first plan year beginning on or after November 1, 2011, or 60 days after the effective date of the related fiduciary-level fee disclosure rule, which is April 1, 2012, whichever date is later.

The good news for employers is that the rules also require that a detailed fee disclosure be made available from service providers to plan sponsors, making it easier for employers to determine if fees are “reasonable” and competitive. 

Failure to Comply can Be Costly

Mismanagement of an employer-sponsored 401(k) can have far-reaching consequences for a small business:

• Failure to operate a plan prudently and for the exclusive benefit of participants (and this includes negotiating reasonable fees) can result in an investigation by the Employee Benefits Security Administration (EBSA). While EBSA’s policy is to promote voluntary and proper corrective action by the plan’s sponsor if this is not achieved, EBSA may refer a case to Labor Department attorneys for litigation. Read more about ERISA enforcement.
• For an employer, the risks of inadequately communicating or disclosing the fees to employees can result in lawsuits, disgruntled employees, and a breakdown in trust between employer and employees.

How to Communicate these New Fee Disclosures to Your Employees

If your employees are already aware of the fees they pay then this new rule will come as no surprise. However, data from AARP* shows that only 17 percent of employees are aware that they are paying 401(k) fees. In the light of the new disclosure requirements this fact represents a potential problem for employers.

So what’s the best way to comply with the new rule and let your employees know about the fees they are paying.

• Decide how to communicate the new fee disclosure. This is really up to you – email, flyer, memo, etc. But be prepared for follow-up.
• Expect tough questions from your employees such as, “why didn’t you tell us about this before?” and “how come I’m learning about these fees now?” If you have communicated these fees before in a plan highlights document, make a point of reiterating this fact, “As we have communicated for several years, the associated fees…”
• Consult HR and your benefits/investments representative to brainstorm the expected backlash of questions you may get and document the answers in an FAQ cheat sheet.
• Stress the positives – Such as the benefits of employer-matching and administration of the plan.

This resource from the DOL – A Look at 401(k) Plan Fees – is designed for employees, but it also provides useful information for employers on the dynamics of these fees and the type of questions employees may have about them.

Useful Resources for Employers Operating 401(k) Plans

The following resources from the Department of Labor can help employers better understand and comply with the requirements of the Employee Retirement Income Security Act (ERISA) as it applies to employee retirement plans.

• 401(k) Plan Fees Disclosure Tool – A form that provides employers with a handy way to make cost-effective decisions and compare the investment fees and administrative costs of competing providers of plan services.
• Understanding Retirement Plan Fees And Expenses – This booklet will help retirement plan sponsors better understand and evaluate their plan's fees and expenses. 
• Reporting and Disclosure Guide for Employee Benefit Plans – A quick reference tool for certain basic reporting and disclosure requirements under ERISA.
• 401(k) Plans For Small Businesses – This booklet highlights some of a 401(k) plan's advantages, some of the options and responsibilities of an employer operating a 401(k), and the differences among the types of 401(k) plans.
• Meeting Your Fiduciary Responsibilities – This publication provides an overview of the basic fiduciary responsibilities applicable to retirement plans under the law.

For more information visit the Department of Labor’s ERISA Compliance Assistance website.

Related Articles

• 4 Tips for Giving Your Business Retirement Plan a Check-Up; Before the IRS Does!
• Human Resources 101: A Quick Guide for Employers
• Finding and Managing the Right Retirement Plan for Your Small Business

*Note: Hyperlink directs reader to non-government website.

About the Author

Caron Beesley is a small business owner, a writer, and marketing communications consultant. Caron works with the SBA.gov team to promote essential government resources that help entrepreneurs and small business owners start-up, grow and succeed.