Are you paying hidden fees in your nonprofit 401k?
Morningstar.com, one of the older stock and mutual fund investment research firms, released a report last week about the landscape of 401ks (and close cousin 403bs.) Morningstar's biggest clients are firms in the investment industry, and they have some bias. However, as Wall Street research goes, they are very good for reporting on mutual funds and ETFs. (A reviled exception is their horrific 'star' rating system which is a shameless pander to Wall Street and a disservice to consumers everywhere.)
The Morningstar report highlighted a few things that surprised me. One is the continued importance of pensions ("Defined Benefit Plans") in the US. I wrote previously about the demise of the pension. Morningstar writes that employers are still moving away from pensions, but there are a lot of people that will be collecting for a long time. That’s less true for nonprofits. Of 618 nonprofits surveyed by the NonProfit Times, less than 2% offered pensions.
What caught my eye in the report was a large section showing that smaller 401k plans, which includes most nonprofit orgs, are paying double the 401k fees of larger plans. Smaller 401k plans are defined as $25M total plan assets or smaller and make up 27% of the nation's 401k assets.
Though fees have come down over time, small 401k plans have total expenses (.88%) that are more than double the national retail investor average (.41%) and larger 401k plans (also .41%). (Yes, that's 41 one-hundredths of a percent. If you want to seem smart at a financial planner convention, you say, "41 basis points." To sound really cool you say "41 bips.")
That difference, .47% (.88% minus .41%) doesn't sound like much but it is. Fractions of a percent in investment fees can make a huge difference over long timeframes. $20,000 invested at age 35 could easily be worth an additional $50,000 just by having a fee that’s .47% lower.
401ks have always been more expensive than retail consumer mutual fund fees, because they have administration and regulatory requirements. They charge those back to plan participants in various forms. Even the largest 401k plans, presumably with the size to negotiate good deals, don't get much cheaper than .41%, which is also the average mutual fund/ETF fee held outside 401k/403bs.
Small 401k plans, with no leverage in the marketplace, are paying .88%, 115% more than the big guys. And nonprofits in my experience do even worse.
How do you know if your plan is expensive? Unfortunately, it’s not easy to find out. More than half of the fees are ‘hidden,’ says the Morningstar research. By hidden we mean ‘really difficult to find and make sense of.’
Fees are all technically disclosed, but they are spread across several arcane forms including the 404(a)(5) participant fee disclosure, the plan sponsors 408(b)(2) disclosures (check out this sample), the fund prospectuses which you probably throw in the trash, the Summary Plan Description, and the Department of Labor form 5500. None tell the full story. Fees can be presented in aggregate, or per employee or per dollar invested in the 401k.
What do we do about this? It’s a broken system that needs policy change. The 401k was designed in 1978, there has been plenty of time for the marketplace to fix this. Wall Street and lawmakers have too many conflicts of interest. We are talking about moving trillions of dollars from Wall Street to the pockets of investors.
Some have suggested a group 401k plan or that the federal government Thrift Savings Plan be opened to smaller employers. I won’t hold my breath.
In the meantime, how do you find out if your plan is expensive? Here are two steps to estimate.
Look at the fees of the funds in your plan. You should have target date index funds that are listed as .35% or less. You probably won’t see cheaper than .20%. If it’s more, or you don’t have a target date index fund as an option, you are probably in an expensive plan.
Find your company’s 5500 here and look for the ‘Statements of Changes in Net Assets Available for Benefits.’ Look for the ‘Administrative expenses’ line, or there may be several lines under ‘Deductions’ that break out the administrative expenses. Divide that number into the ‘Net Assets available for Benefits’ to get the hidden admin fees expense ratio. (If admin fees are listed as 47,000 and ‘Net Assets available for benefits’ is 19,000,000, then the average hidden fee is .25% (40,000/19,000,000). If it’s much more than .30%, you are probably in an expensive plan.
If you or your HR want more help with this, gather the documents, and set up a complimentary meeting. I also do nonprofit consulting on 401k/403b plans.
