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In a small business 401(k) fee study, we found that 8 of the top 10 most expensive 401(k) providers were insurance companies. I can’t say I was too surprised by this finding due to the complex web of 401(k) fees charged by these companies – which can include hidden 401(k) fees that other 401(k) providers can’t charge and additional fees for unrelated service partners.
So how do insurance companies with high 401(k) fees get away with it?
Likely their lack of 401(k) fee transparency. Insurance companies typically don’t report their 401(k) fees in 408b-2 fee disclosures as a simple dollar amount – instead, they estimate them as a percentage of assets. Or worse, bury them in dense annuity contracts.
If you’re a 401(k) plan sponsor, you should understand the complex web of 401(k) fees possible with an insurance company. Generally, these fees will make it harder for you to meet your fiduciary responsibility to pay only reasonable fees from 401(k) plan assets.
What are “reasonable” 401(k) fees?
Employers have a fiduciary responsibility to pay only reasonable plan fees from 401(k) plan assets. To determine whether your 401(k) provider’s fees are reasonable, you must benchmark them. This process involves two steps:
- Calculate the “all-in” fee (service provider fees + investment expenses) for your plan
- Compare this fee to the all-in fee of 3 or more competing 401(k) providers
Your 401(k) provider’s fees don’t have to be the lowest to be reasonable, but you must be able to justify paying higher fees. To make meeting this fiduciary responsibility as simple as possible, I recommend you only consider 401(k) providers with fees that are easy to total.
Hidden 401(k) fees charged by insurance companies
401(k) providers can be paid by three sources today – the plan sponsor, participant accounts or plan investments. 401(k) fees paid by the plan sponsor or participant account deduction are considered “direct compensation,” while fees paid by plan investments are considered “indirect compensation.”
Direct compensation is the most transparent type of 401(k) fees. It must be explicitly reported in 401(k) provider invoices, 408b-2 and 404a-5 fee disclosures, and plan statements. Indirect compensation is a different story. It can be estimated in 408b-2 disclosures, buried in the investment expense ratios of 404a-5 disclosures, and not appear in plan statements. For this reason, indirect compensation is often called “hidden” 401(k) fees.
Insurance companies can receive up to two types of indirect compensation – variable annuity “wrap fees” and revenue sharing. While any 401(k) provider can receive revenue sharing, wrap fees are unique to insurance companies. Most wrap fees are disclosed as a percentage of assets in the provider’s 408b-2 disclosure, but others may be disclosed in the group annuity contract between the employer and insurance company – which are often dense.
Fees paid to 401(k) service partners by insurance companies
Insurance companies – particularly in the small business market – almost always partner with an independent third-party-administrator (TPA) to deliver the three administration services that every 401(k) plan requires - asset custody, participant recordkeeping, and ERISA compliance (plan document maintenance, nondiscrimination testing, Form 5500 reporting, participant notices). They may also partner with a broker for plan fund selection.
While a broker is usually paid from the revenue sharing or wrap fees collected by the insurance company, it’s not uncommon for the TPA to be paid additional direct compensation – either by the plan sponsor or participant account deduction.
Don’t be surprised by insurance company 401(k) fees!
About 2 years ago, comedian John Oliver railed against the high fees charged by his company’s insurance company 401(k) provider, John Hancock, on his show Last Week Tonight. If you haven’t seen this show segment, you should check it out now - it was educational as well as hilarious.
At the time, I wrote John Oliver was right – his John Hancock fees were too high. Unfortunately, high 401(k) fees are par for the course with insurance company 401(k) providers. When we compare 401(k) provider fees as part of our no-cost 401(k) fee comparison service, we routinely find insurance company 401(k) providers to be expensive.
Unfortunately, these 401(k) providers also tend to charge the most hidden fees. The combination of high 401(k) fees that are hard to find make insurance company 401(k) providers a risky bet for employers with a fiduciary responsibility to pay only reasonable 401(k) fees from plan assets.
