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There’s no such thing as a free 401(k) plan. Every 401(k) provider charges fees for their services, but how those fees are structured can make a big difference for both you and your employees. One common approach is revenue sharing, where administrative fees are tucked into the investment costs of mutual funds. While it might seem convenient, this method often leads to hidden costs, making it harder for you to meet your 401(k) fiduciary responsibilities and reducing your employees' retirement savings.
Here’s what you need to know about revenue sharing—and why switching to direct fees is the smarter choice for your business.
What is Revenue Sharing in a 401(k) Plan?
Revenue sharing is the practice of embedding 401(k) administration fees into a mutual fund’s operating expenses and then distributing those fees to service providers. Revenue sharing increases the cost of 401(k) investments, lowering their returns for plan participants. There are two general forms:
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- 12b-1 fees – these are paid to a broker for investment selection.
- Sub-Transfer Agency (sub-TA) fees – these are paid to a 401(k) provider for participant recordkeeping.
Funds that pay revenue sharing tend to be offered in multiple share classes, each with a different level of embedded fees.
Avoiding 401(k) revenue sharing is important for five reasons.
1. Totaling Fees Should Be Simple, But Revenue Sharing Complicates It
As a business owner, you have a fiduciary responsibility to ensure the fees paid from the assets of your 401(k) plan are “reasonable.” If fees are too high, they slow your employees' retirement savings unnecessarily and increase your liability. To keep 401(k) fees in check, you must be able to total their amount.
Direct fees are typically the easiest to total due to their transparency. Their dollar amount must be explicitly disclosed in 408b-2 and 404a-5 fee disclosures, plan financials, and participant statements.
Revenue sharing is a different story. It can be estimated in 408b-2 fee disclosures, buried in the fund expense ratios of 404a-5 fee disclosures, and not appear at all in plan financials or participant statements.
2. Revenue Sharing Can Lead to Overpaying for Services
Revenue sharing fees are typically based on the percentage of assets in the 401(k) plan. This can create a mismatch between the level of service you receive and the fees you pay. For example, services like participant recordkeeping and third-party administration (TPA) don’t scale with assets; they scale with the number of participants. However, with revenue sharing, the more assets your plan accumulates, the higher your fees—regardless of whether your service needs have changed.
Switching to direct fees can help ensure you’re paying for the services you actually receive, not overpaying simply because your plan’s assets have grown.
3. Revenue Sharing Can Limit Access to Prudent Investments
One of your most important fiduciary responsibilities is selecting prudent investments for your 401(k) plan. Prudent investments are those that meet their objectives with reasonable fees. Index funds and ETFs from leading providers, which offer market returns at low costs, are a safe choice generally. However, these investments usually don’t pay revenue sharing.
If you rely on revenue sharing to cover plan administration costs, you may find yourself limited to more expensive investment options. By choosing direct fees, you free yourself to select the best investment options for your employees without the restrictions imposed by revenue sharing.
4. Revenue Sharing Can Create Unfair Fee Distribution
Under ERISA , 401(k) fees must be allocated reasonably among plan participants. This can be done on a pro-rata basis (based on account size) or a per-capita basis (equal for all participants). But revenue sharing can create a hidden imbalance.
If not all plan investments pay the same rate of revenue sharing, participants who are invested in higher-revenue-sharing funds end up paying more in administrative fees than those in lower-revenue-sharing funds. This unfairly penalizes certain employees and can increase your fiduciary liability.
5. Revenue Sharing Limits Your Ability to Reduce Taxes
In a recent study, we found about 80% of our small business clients pay our 401(k) administration fees from a corporate bank account, not plan assets. This approach is popular because it’s often a win-win for business owners and their employees. Business owners can lower fiduciary liability, reduce corporate taxes, and increase personal savings, while helping employees grow their savings faster.
However, revenue sharing takes away this option. Because fees are baked into the operating expenses of mutual funds, you can’t pay them separately from your corporate account. By opting for direct fees, you gain control over how and where you pay your plan's costs.
Let’s Make Revenue Sharing Obsolete!
Revenue sharing creates more problems than it solves. It makes it harder to meet your fiduciary responsibilities, can lead to higher fees, limits your investment options, and creates an unfair cost burden for your employees. By switching to direct fees, you simplify your plan’s fee structure, increase transparency, and give your employees the best chance to grow their retirement savings as quickly as possible.
Now is the time to take action. Review your 401(k) plan today and consider shifting to a direct fee structure. By doing so, you’ll be taking an important step toward ensuring the long-term success of your retirement plan—for both your employees and your business.
