About

When buying a product or service, we know exactly what it costs, and can often easily compare prices of competitive products and services with a few simple clicks.  And yet, when purchasing the services of a 401(k) provider, plan sponsors rarely have any idea of the actual hard dollar costs.  Some experience frustration at this reality, while others simply resign themselves to the idea that this is just how the industry works.  In each case, this severe information asymmetry puts plan sponsors at the mercy of the providers, which not surprisingly results in the most unnecessarily expensive asset-based providers with opaque fee structures having a disproportionately large share of the market.

Conflicts of Interest and Flawed Advisor Business Models

So why do financial advisors who plan sponsors often rely upon to recommend a competitive service provider in terms of price and quality so often recommend high-priced providers that aren’t necessarily higher quality?  One reason has to do with the fact that advisors affiliated with broker dealers often have restrictions on providers they can recommend due to contractual relationships that broker dealers have in place with large retirement plan service providers.  Another reason stems from advisors’ flawed compensation model that emphasizes the commoditized process of selecting and monitoring funds disguised as valuable and time consuming “management” services as well as vendor search and benchmarking services, all of which rarely require much time, especially in light of service providers like Fiduciary Benchmarks and InHub who help plan sponsors efficiently and effectively benchmark their plans and conduct and document provider searches.  Granted, an extensive vendor search for a large company with complex needs can take significant time, but that time highly depends on the number of vendors in the search.  The Department of Labor offers the following guidance and does not clearly specify the number of vendors required in a search:

“The duty to act prudently is one of a fiduciary’s central responsibilities under ERISA. It requires expertise in a variety of areas, such as investments. Lacking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions. Prudence focuses on the process for making fiduciary decisions. Therefore, it is wise to document decisions and the basis for those decisions. For instance, in hiring any plan service provider, a fiduciary may want to survey a number of potential providers, asking for the same information and providing the same requirements. By doing so, a fiduciary can document the process and make a meaningful comparison and selection.” 

An employer should establish and follow a formal review process at reasonable intervals to decide if it wants to continue using the current service providers or look for replacements. When monitoring service providers, actions to ensure they are performing the agreed-upon services include: 

  1.   Evaluating any notices received from the service provider about possible changes to their compensation and the other information they provided when hired (or when the contract or arrangement was renewed); 
  2.   Reviewing the service providers’ performance; 
  3.   Reading any reports they provide; 
  4.   Checking actual fees charged; 
  5.   Asking about policies and practices (such as trading, investment turnover, and proxy voting); and 
  6.   Following up on participant complaints.”

 

 

Consequently, if advisors have an organized and thorough process of compiling a list of due diligence questions which they can easy obtain from the checklists on this site, they can just periodically send these questions to the providers they work with and share the answers with plan sponsors.  And if plan sponsors use one of the suggested flat fee-based providers, then there will be no need for advisors to charge for negotiating or understanding the fees, which are so simple that they can’t possibly be misunderstood, and are low enough for many providers to write a check.  In fact, GuidelineEmployee Fiduciary, and Ubiquity even list their fees right on their websites.  Furthermore, the more time advisors spend with their clients, the more they should be able to understand their specific needs, and for that reason, construct a smaller, more targeted, and less time consuming vendor search, thereby making it impossible to justify charging significant fees for vendor search or benchmarking “services”.

In reality, the time spent with participants directly focused on helping them retire is the primary reason why plan sponsors should pay advisors, but doing so takes actual effort, and advisors know they can run more profitable practices by charging asset-based fees for activities that have no connection to the services they provide and require little if any time or delivery of evidence-based value.  And yet, sponsors have the opposite impression, as shown by these hundreds of examples.

 

 

To elaborate, because the accounts are participant directed in almost all cases, there is no actual management required, yet advisors continue to conflate managing an account with selecting and monitoring funds, while consistently recommending more funds than necessary and wrongly charging for this “management” of the account when research suggests that this process does not work as advertised.  Advisors also give the appearance of adding value by primarily focusing on actively managed funds when research also shows the extreme difficulty of consistently outperforming the market and that a simple line-up consisting solely of passively managed funds provides just as much diversification as a larger, more complicated fund line-up which gives the false impression of diversification because the funds typically have such high correlation.  In fact, not one ivy league endowment has consistently outperformed a simple 60/40 passively managed portfolio.  Asset-based providers of record keeping and administration services take part in this subterfuge by directly supporting this flawed financial advisor business model in multiple ways such as including advisors’ asset-based fees in their already opaque fee structures and through fund monitoring services which simply reinforces the misconception that continually reviewing a fund line-up requires any actual work or provides any actual value.

What Plan Sponsors Can Do

 

If plan sponsors would just decide to write a check to each service provider for advisory, record keeping, administration, and custodial services, then they would likely much more closely scrutinize these services in proportion to the fees – and this realization clearly explains why most service providers never make this suggestion.  And yet writing a check often serves both employers and employees best.  Alternatively, if plan sponsors prefer not to write a check, they could simply ask how much the total fees would be if they were to write a check.  This way, there would be no confusion.

Enabling Plan Sponsors and Participants

To address these issues and change the way the industry does business, I have focused my entire practice as an independent fiduciary and registered investment advisor on uncovering the excessive and unnecessary fees, lack of transparency, and conflicts of interest in the retirement plan industry since 2010.  I quickly became aware of these issues upon looking up the fees disclosed on plan sponsors’ 5500 forms and sharing this information with these same plan sponsors who consistently responded by saying they either did not know of any fees or knew there were fees, yet had no idea of the amount.  Consequently, I saw an opportunity to provide significant value to plan sponsors by simplifying the provider selection process and increasing transparency of fees and services, especially because of how destructive ongoing fees can be to retirement plan participants as the Department of Labor makes clear:

“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.” 
Given what I have learned about how the industry operates, I knew I had to find a way to shine light on it.  I hope this information will be helpful to people who want to secure their retirement savings.