- 12(b)-1 fees: annual distribution or marketing fee (i.e., the salesperson’s cut)
- Sub transfer agent (sub-TA) fees: the fee for maintaining records of a mutual fund’s shareholders
- Soft-dollar “excess commissions”: how mutual fund companies pay their service providers; “soft dollar” means they’re paying in the form of giving them business, rather than actual cash
These are all ultimately reflected in the mutual fund’s expense ratio, which is the fee that all funds charge their shareholders (in this case, 401(k) plan participants).
Trying To Follow The Money
However, the expense ratio often pays for these costs without making it easy to understand and track. Although the expense ratio is disclosed to the participant, the breakdown of who gets paid from it is buried in the prospectus or fee disclosures, which can be verbose and lengthy. In other words, participants don’t know where their money is going.
Fee disclosure rules have helped bring these hidden relationships to light in recent years, to some extent. However, it’s still confusing to participants when they don’t see the fees reported directly on their statements. Instead, they may only see earnings net of these costs.
This also makes it difficult for plan sponsors to compare the true cost structure of different providers, because it’s not always an apples-to-apples comparison. As fiduciaries, plan sponsors are required to evaluate the true costs of each plan and determine whether those costs are reasonable for the services rendered. But because of this lack of transparency, it’s hard for them to actually see what participants are getting for the cost.
ETFs, on the other hand, do not have the same revenue-sharing relationships that mutual funds have. That means the 401(k) players aren’t being compensated behind closed doors, so they have to charge explicit fees for their services, making it easier for plan sponsors to evaluate, compare, and understand true costs of administration. And it allows participants to see where their money is going.
Conflict Of Interest With Mutual Funds
The 401(k) market is largely dominated by players who are incentivized to offer certain funds: There are the service providers that are, at their core, mutual fund companies.
And there are the investment advisors, who sometimes get a cut of the sale, and are therefore incentivized to push certain funds.
That means that both fund families providing 401(k) services and the advisors who sell the plans may have a conflict of interest.
Dual Role Fuels Biased Advice
Mutual fund companies play a dual role in the world of 401(k)s: (1) They work with plan sponsors and their advisors to select a menu of investment options for their employees, and (2) they create and manage their own products that they want to sell.
As noted in this report by the Center for Retirement Research, 76% of plans had trustees affiliated with mutual fund management companies, which creates a conflict of interest. The report states:
