NAFCU Services Blog

Aug 30, 2011

Is The Fox Guarding the Henhouse Cheating Your Employees With Hidden and High 401(k) Fees?

I know that employee benefits can be complex and hard to understand, but I wanted to flag an issue that may be needlessly costing your employees as much as 50 basis points on transfer and between 20 and 25 basis points a year on their 401(k) investments.

It is not uncommon for credit unions without the requisite in-house expertise to hire a consultant to look at outside options for their employer-sponsored 401(k) plans. Usually the process involves an RFP, an evaluation of the responses, and presentations to the credit union leadership by the finalists.  Credit union managers think they have gone through an impartial and unbiased assessment of what is best for the credit union.

But appearances can be deceiving.  Often the consultant that the credit union turns to will receive hefty initial and ongoing fees directly from the 401(k) provider.  These fees can be substantial – for a credit union with $20 million in its employer-sponsored 401(k), first year fees to consultants can run $125,000 or more, and ongoing fees can run $25,000 or more, depending on who the business is placed with.

These payments are called ‘Rule 12b-1 fees’, after a section of the ERISA code, and can be next to impossible to discover – but your employees’ 401(k)s can be losing between 20 and 25 basis points each year to the consultant. The only service the consultant performs to earn such extraordinarily high fees is running the ‘unbiased’ evaluation of plan providers.

With many typical providers, there are several steps in the value chain involving different service providers, from the broker to plan administration and investment management.  But others (like multiple employer plans) have a single provider that offer all these services as part of a bundled package with a far more favorable fee structure. These bundled packages do not offer an opportunity for consultants to be paid for their ongoing involvement with the credit union program, since there is no need for their services going forward.

But you have the fox guarding the henhouse -- any alternative that does not offer the consultant an opportunity for compensation either does not make the finals or gets extremely low marks. What makes it worse is the appearance of impartiality, and the fact that these consultants are also often being paid by the credit union for doing the evaluation – which is a clear conflict-of-interest.

It can be difficult to find out whether your consultant is receiving compensation.  If you ask them what seems to be a direct question (“Have you asked any vendors to pay you compensation?”) you’ll probably hear ‘NO’ for an answer.  But the better question to ask is “Will you eventually be compensated for placing the business with a particular vendor that our committee chooses?”  Don’t be surprised to find that the finalists selected sell through a third party distribution channel and have fees embedded in their operation expense (through the funds offered by the vendor) to pay out the broker for directing the business to them.

The challenge of ferreting out the fees will become easier on April 1, 2012, when new regulatory requirements from the US Department of Labor take effect.  Quarterly 401(k) statements will be required to list all fees charged to the account on the front page, including a statement, if applicable, that some of the plan’s administrative expenses for the preceding quarter were paid from the annual operating expenses of one or more of the plan’s investment options through revenue sharing arrangements, Rule 12b-1 fees or other such fees and arrangements.

Further, and with respect to the conflict of interest issue outlined above, investment firms handling company 401(k) accounts also will be expected to operate under the higher "fiduciary" standard of conduct, rather than the lower "suitability" standard that has been used for years. While firms will not be required to adopt the fiduciary standard, they will be required to disclose whether or not they are operating as a fiduciary.

You may not know the difference between a suitability standard and a fiduciary standard – but you should.  Under a fiduciary standard, advisers are legally bound to do what is best for a client and treat the client's money as its own.  Most firms, however, currently provide retirement services to employer retirement plans under the suitability standard, which allows brokers to legally put clients into products that charge higher commissions when a similar product would reduce the client's costs, which in turn enables such an overt conflict of interest.

(Full Disclosure – our Preferred Partner in this area (Pentegra Retirement Services) has a multiple employer plan, with a low fee structure, significant savings on annual audits, recordkeeping and reporting, and which assumes fiduciary responsibility instead of whomever currently signs on the dotted line for your credit union.  But it doesn’t pay fees to consultants.)

Post written by Dave Frankil, President, NAFCU Services Corp.

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