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Plan size is clearly an important dimension in the amount of fees and expenses a plan will absorb. This is largely a result of the fact that there are certain fixed costs of providing services to a plan that are not highly sensitive to the number of plan participants, and the fewer the participants, the higher the per-capita expenses. More and more vendors, especially mutual funds, focus only on the larger plans, those with 200 or more lives (Richardson, July 1997).
Another consideration related to plan size is that many small plans are new accounts with few assets. Access Research is reported to be encouraging technology companies to set up automated service bureaus that would handle administration for multiple 401(k) service providers as a cost savings for small plans (Richardson, July 1997).
Some sponsors may remain too small to easily afford a 401(k) plan. For firms with substantially less than 100 employees, the SIMPLE IRA plan or a profit-sharing arrangement may be a more affordable solution. Also, those small firms with higher than average income workers may prefer the higher maximum contribution limits in 401(k) plans over the SIMPLE IRA.
401k Tips and Facts:
According to Southern California-based (401k) Enginuity
(www.401kenginuity.com), twenty-year veteran in developing and running 401(k) administration and 401(k) software and recordkeeping systems, the Internet will be the primary delivery system for 401(k)s by 2007. Many web-based 401(k) plans will run on administration and recordkeeping platforms that plan providers will outsource to 401k specialists and 401k Application Service Providers (ASP).
The advantages of web-based online 401(k) plans are obvious to today's workers, and include use conveniences, real-time monitoring and reporting, and instant re-allocation of their retirement assets. The internet has also dramatically reduce the cost of 401(k) plan administration, saving plan sponsor 50% or more in ongoing fees and costs when compared to the older traditional labor-intensive plans. Outsourcing of 401(k) functions by plan providers will extend the trend towards lower cost, high-quality 401(k) products.
401(k) plan providers of all types, financial institutions including banks, insurance companies, brokerages, mutual fund companies, credit unions, and third-party administrators, are now actively outsourcing 401(k) administration and recordkeeping tasks to 401(k) ASPs --- vendors such as 401k Enginuity, whose sole function is to maintain, updated and supervise software-based 401(k) administration and recordkeeping systems on behalf of plan providers. 401(k) ASP vendors are responsible for all routine day-to-day 401(k) recordkeeping and administration functions, thus allowing the plan providers to reduce internal staff, eliminate the expense and complications of licensing, housing and running hardware and 401(k) administration software in-house. Plan providers can refocus and concentrate their efforts on to the needs of their plan sponsors and plan participants, and rely upon the outsourced ASP 401(k) vendor for the recordkeeping and technical "backbone" supporting providers' Internet-based plans. It is inevitable that some of this 401(k) outsourcing to ASPs will include secondary outsourcing of certain non-critical low-level routine day-to-day tasks to non-US locations, where labor costs are less yet the expertise is abundant.
SELECTION OF PLAN FEATURES AND INVESTMENT OPTIONS
Decisions by the plan sponsor have a considerable influence on the magnitude of fees and expenses that will be charged. These decisions involve the specification of services that will be provided to the plan as well as the selection of investment options that will be offered to the participants. An extensive set of services is available to 401(k) plans, and many of them are more elaborate than the minimum requirement mandated by law and regulation. When the plan sponsor chooses to include more elaborate services than the minimum requirement, albeit in response to employee demand, the administrative costs are increased. For example, the sponsor might specify that the plan allow employees to change their investments daily, and the service provider would quote an incremental price for this additional service (Quinn, January 1998). Increasing the frequency of compliance testing is an example of another service for which most providers would charge an additional fee (HR Investment Consultants, 401(k) Provider Directory).
Another significant influence of plan sponsors' decisions on plan fees and expenses is in the selection of the suite of investment options that will be offered to participants. The plan that offers a wide spectrum of investment choices is likely to include investment options that have a higher than average expense ratio. For some investment options, for example employer stock and instruments purchased from institutions other than the full service provider, the provider will charge an additional itemized or census-based fee (HR Investment Consultants, 401(k) Provider Directory). Finally, including investment instruments that impose sales commissions on their purchases will increase the expenses being charged to participants who select these options.
Plan sponsors influence the magnitude of fees and expenses when they select a service provider that only offers investments loaded with sales charges or that packages investment options in a group annuity. An example might be the typical major insurance provider that offers a set of investment options that feature choices among mutual funds. These funds are included in a group annuity wrapper and an asset-based wrap fee is imposed (except for the larger plans) (HR Investment Consultants, 401(k) Provider Directory). A similar set of investment options could be provided by a non-insurance provider, absent the group annuity. This does not suggest that the group annuity does not have value, only that it comes with an additional cost. Similarly, the plan sponsor that selects a full service mutual fund provider that offers only loaded retail funds, could find another provider that offers a set of no-load funds with similar risk-return characteristics.
Participant behavior directly affects transaction costs. The typical plan provider charges additional fees for transactions such as withdrawals and loans. In the case of loans, there are charges for both loan origination and monthly maintenance (HR Investment Consultants, 401(k) Provider Directory).
Participant behavior selection of the investment instruments also drives the level of fees and expenses. To the extent that participants understand the investment management fees imposed on alternative investment choices (mutual fund expense ratios, for example) they have the opportunity to influence the amount of expenses that will be charged to their accounts. This does not suggest that the rational choice is always the lowest cost fund.
The participant's selection of actively managed versus passive investments will have an effect on investment management fees. The average expense ratios for particular fund categories encompass wide ranges from low to high expense ratios across individual funds (Fortune, December 23, 1996).
One key factor in this wide range of expense ratios is the notable difference in expense ratios generally observed between indexed (or passive) funds and actively managed funds. In an indexed fund, the investment manager seeks to maintain a portfolio closely tracking an appropriate market performance indicator. For example, a U.S. large company stock fund might be benchmarked to the Standard & Poor's 500; a small company stock fund to the Russell 5000; an international stock fund to the Morgan Stanley EAFE (Europe, Australia, Far East) Index. Other fund categories have similar benchmarks meant to capture the overall performance of particular segments of stock and bond markets. In actively managed funds, the investment manager expends more costs on research, investment selection, and buying and selling.
Similarly, the choice of equity versus fixed income investments affects expenses. Inspection of mutual fund expense ratios reveals that bond fund expenses are significantly lower than are those for equities (Sheets).
Generally speaking, there are two types of pension plans: defined benefit plans and defined contribution plans. A defined benefit plan promises you a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service -- for example, 1 percent of your average salary for the last 5 years of employment for every year of service with your employer.
A defined contribution plan, on the other hand, does not promise you a specific amount of benefits at retirement. In these plans, you or your employer (or both) contribute to your individual account under the plan, sometimes at a set rate, such as 5 percent of your earnings annually. These contributions generally are invested on your behalf. You will ultimately receive the balance in your account, which is based on contributions plus or minus investment gains or losses. The value of your account will fluctuate due to the changes in the value of your investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. The general rules of ERISA apply to each of these types of plans, bust some special rules also apply. To determine what type of plan your employer provides, check with your plan administrator or reach your summary plan description (see p.13).
A money purchase pension plan is a plan that requires fixed annual contributions from your employer to your individual account. Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.
Your employer may establish a defined contribution plan that is a cash or deferred arrangement, usually called a 401(k) plan. You can elect to defer receiving a portion of your salary which is instead contributed on your behalf, before taxes, to the 401(k) plan. Sometimes the employer may match your contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount you may elect to defer each year. The dollar limit on the amount you elect to defer each year. The dollar limit in 1995 is $9,240. The amount may be adjusted annually by the Treasury Department to reflect changes in the cost of living. Other limits may apply to the amount that may be contributed on your behalf. For example, if you are highly compensated, you may be limited depending on the extent to which rank and file employees participate in the plan. Your employer must advise you of any limits that may apply to you.
Although a 401(k) plan is a retirement plan, you may be permitted access to funds in the plan before retirement. For example, if you are an active employee, your plan may allow you to borrow from the plan. Also, your plan may permit you to make a withdrawal on account of hardship, generally from your funds you contributed. The sponsor may want to encourage participation in the plan, but it cannot make your elective deferrals a condition for the receipt of other benefits, except for matching contributions.
The adoption of 401(k) plans by a state or local government or a tax-exempt organization is limited by law.
The Department of Labor enforces Title I of ERISA, which, in part, establishes participants rights and fiduciaries' duties. However, certain plans are not covered by the protections of Title I. They are:
The Labor Department's Pension and Welfare Benefits Administration is the agency charged with enforcing the rules governing the conduct of plan managers, investment of plan money, reporting and disclosure of plan information, enforcement of the fiduciary provisions of the law, and workers benefit rights. But other agencies also are involved in pension law monitoring and enforcement. Additional non-profit websites that include relevant unbiased information about 401k plans include: www.asap-401k.com
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