Not All Pay Share of Revenue Sharing; Retirement-Plan Costs Fall Only on Some

By Ian Salisbury
Wall Street Journal

If the issue of revenue sharing by mutual funds in 401(k) plans hasn’t gotten your attention, consider this: It may mean you are paying far more to support your retirement plan’s back-office costs than the person sitting next to you.

“Revenue sharing,” a controversial aspect of many companies’ defined-contribution savings plans, involves using money some investors think goes toward managing mutual funds to cover the costs of services like calculating account balances and mailing out statements. Critics have long said these costs should be explicit, making it easier for employers and investors to assess each plans’ true merit.

But one problem with the current system has gotten little attention: Using investment fees to pay for other aspects of 401(k) expenses means investors in some high-cost funds, like actively managed funds, pay a much greater share of a retirement plan’s fixed costs than investors in more basic options like company stock or an index fund.

“The concern is it’s not equitable,” says Lori Lucas, leader of consulting firm Callan Associates Inc.’s defined-contribution practice. “Some people could pay almost all of the costs. Some could pay none of the costs. What funds you select can determine whether you pay or not.”

A recent Callan study found that only one in eight plans that used revenue sharing actually had their entire menu of funds contributing to the plan’s upkeep. In about a third of plans, half the funds or fewer contributed.

Mutual funds that employ complicated strategies, such as those that pay a portfolio manager and a large staff to research and pick stocks, charge investors higher fees and provide higher profit margins for fund companies. Therefore, these also can spare more money to defray back-office costs for retirement plans.

Low-cost “commoditized” offerings that include stable-value funds, index funds and company stock plans may contribute little or nothing toward common plan costs. For instance, nearly a third of plans studied by Callan applied no administrative fees to company stock holdings, giving investors a free ride on that part of their portfolios.

“Almost every single plan will have different funds that pay different amounts,” says Pamela Hess, director of retirement research at Hewitt Associates LLC, one of the largest providers of 401(k) plans. “It can be all over the map.”

While some investors pay nothing, Ms. Hess estimates that in a large plan the actively managed funds typically direct annual fees amounting to about 0.35% of holders’ assets toward plan costs. In small plans a typical figure may be more like 0.6%, although costs may be higher across the plan’s menu.

The issue has led larger plans to forgo mutual funds in favor of other investment vehicles like collective trusts or separately managed accounts that can eliminate revenue sharing, she says. Companies can then pay for record-keeping out of corporate coffers, let each employee pay a flat fee, or let each pay an agreed-on percentage.

Employees who themselves wonder which funds are paying what costs mightn’t have an easy time finding out. However, a rough indicator is so-called 12b-1 marketing fees, which often, but not always, correspond to these payments, says Mercer Consulting Partner Philip Suess. By avoiding funds with these marketing fees, “your contribution to administrative costs is likely to be substantially less.”