Considerations when evaluating 401(k) net investment fees as an ERISA fiduciary
As a 401(k) plan sponsor, you have many fiduciary duties under ERISA. Among them is to make sure that your plan’s investment fund fees are reasonable. While this doesn’t mean that you have to offer the cheapest possible funds, it does mean you have to ensure that your participants don’t overpay.
Investment fees compensate fund managers for their services, which include security selection—such as stocks or bonds—and day-to-day fund management operations. Because different investments have various styles, objectives, and relative complexity, fees can vary. The average stock fund expense ratio is 0.52% and the average bond fund expense ratio is 0.48%, but the median stock fund costs 1.15% and the median bond fund costs 0.80%, so fees vary widely.¹
Fees and ERISA
As a plan fiduciary, you have an obligation under ERISA to prudently select and monitor plan investments, which includes monitoring investment fund fees to determine whether they’re reasonable. Although ERISA doesn’t say what’s reasonable, one widely accepted way to test reasonableness is to compare the fees of like investment funds. Sometimes, however, making sure you’re not overpaying for a fund provider’s services requires that you go deeper than making simple comparisons.
Understanding 401(k) investments’ revenue sharing
The same 401(k) investment can come in different packages, known as share classes. Different share classes have different fees, which are included in the expense ratios. Why? Some classes share revenue with the plan sponsor, a practice known as revenue sharing. A plan sponsor can use revenue sharing to pay for plan services, such as recordkeeping or investment advice. Funds that share revenue have higher expense ratios than those that don’t.
Example 1: Same fund, different share classes (%)
Fund share |
Expense ratio |
Revenue sharing |
Net fee |
Class R |
1.00 |
0.50 |
0.50 |
Class Z |
0.50 |
NA |
0.50 |
This is a hypothetical illustration only and is not indicative of any particular investment.
For example, two different share class (and expense ratio) versions of the same fund are available for the plan sponsor to choose: Class R shares and Class Z shares. Both have the same net fee, which goes to the investment manager. But Class R has the higher gross fee because it shares revenue. Which fund plan sponsors choose depends on how they want to pay for plan expenses.
Some 401(k) funds are cheaper after refunds
Even if you don’t use revenue sharing to pay for plan expenses, you may want to consider funds that share revenue, because, unlike in our simple example, net fees aren’t always equal. This creates an opportunity for plan sponsors to cut the net fees participants pay by refunding unused revenue sharing to them.
To see how this can work, let’s change the example so that Class R has a lower net fee than Class Z.
Example 2: Same fund, different share classes, and different net fees (%)
Fund share |
Expense ratio |
Revenue sharing |
Net fee |
Class R |
1.00 |
0.55 |
0.45 |
Class Z |
0.50 |
NA |
0.50 |
This is a hypothetical illustration only and is not indicative of any particular investment.
Class R is now 0.05% cheaper on a net-of-fee basis. Plan sponsors can lower participant investment costs by selecting Class R and asking their recordkeeper to refund revenue sharing to participants. In this case, the savings to participants from refunded revenue sharing is 0.05%, or the difference in net cost between Class R and Class Z. This example deals with investment expenses only—there are other costs potentially borne by participants, such as plan expenses, for you to consider as well.
Even if you don’t rely on your 401(k)’s investment managers for revenue sharing, you may want to consider asking your recordkeeper or financial professional to provide information on revenue sharing funds, which could have lower net expenses. The fund with the lowest gross expense isn’t necessarily the least expensive for participants.
Make it your policy
Most plan sponsors draft an investment policy statement (IPS) to establish guidelines and benchmarks for the selection and monitoring of plan investments. The IPS can be useful to help plan fiduciaries demonstrate that a prudent process has been followed when selecting and monitoring plan investments. It can also help demonstrate that participants aren’t paying more than necessary for their plan investments by incorporating share class restrictions or expense ratio considerations.
Watching 401(k) investment net fees helps you and your participants
ERISA frowns on overpaying for services, including plan investments. If you don’t ask your recordkeeper or financial professional to investigate lowest net cost fund options, you may not be living up to your ERISA responsibilities. Make sure your regular fund reviews include exploring alternative share classes. Even if you don’t require revenue sharing, you may be able to lower participant investment fees by using revenue sharing funds and refunding unused revenue sharing to participants.
Formalizing this process using your IPS is also a wise move. As an ERISA fiduciary, this may help you ensure that your participants aren’t paying too much for their retirement investments.
1 Investment Company Fact Book, Investment Company Institute, 2019.
Important disclosures
For complete information about a particular investment option, please read the fund prospectus. You should carefully consider the objectives, risks, charges, and expenses before investing. The prospectus contains this and other important information about the investment option and investment company. Please read the prospectus carefully before you invest or send money. Prospectus may only be available in English.
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made herein.
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