3 401(k) Problems That Can Shrink Your Returns
Your 401(k) may be your biggest retirement asset. When it comes to fees, contribution matches and eligibility, don't just trust: verify.
There are several common 401(k) administrative issues that can creep in unnoticed and chip away at your retirement savings. Losing a portion of your retirement savings is certainly scary, but often avoidable. Read on for three common issues, and tips to avoid each of them.
Although you may think you are only paying the underlying expenses of your mutual fund or ETF selections, that may not be the case. It is very common for plan sponsors to charge recordkeeping administration fees to the plan, which means you (the participant) are paying the fees with your 401(k), resulting in a lower investment return. In fact, some service providers charge an additional asset-based fee (or annuity fee) on top of the underlying mutual fund expense. In general, if your plan sponsor is charging fees to the plan (meaning you), the smaller the asset base in the plan, the more fees you are paying. So, if you work for a company where few employees are participating in the 401(k) plan, be especially watchful about fees.
If you are in a 401(k) where fees are charged to the plan, it’s important to keep an eye on how and when those fees are charged. Watching the consistency of the amount and the timing is important to ensure you are not paying a higher percentage of fees compared with the other plan participants. If your recordkeeping service provider or plan sponsor failed to charge fees to the plan or trust on a consistent basis, participants who cashed out of the plan during that time may not have paid their fair share of the fees.
For example, if your plan sponsor charges all fees to the plan on a quarterly basis, the fees should be taken out every quarter at the same time, such as the last day of each calendar quarter. If this does not happen in a timely manner, such as processing two to three quarters at the same time, any participant who received their full distribution in the first three quarters of the year did not pay any recordkeeping administration fees. This means the rest of the participants are paying more fees to make up for it.
If you think this happened to you, the plan sponsor or the recordkeeping service provider should determine the fees that the participants should have paid if processed on a timely basis (usually monthly or quarterly) and make sure your account is credited for those amounts.
Another area to review if your plan charges administrative fees is how the fees are charged to you. It can be by asset balance, a per-participant fee (where every participant pays the same fee each quarter) or a combination of both. If you have a large asset balance compared with most of the participants and the administrative fees are charged based on your asset balance, you will be paying higher fees than most of the plan participants. Plan participants do have some influence over the decision-makers in the plan, so if you see something that seems unfair, speak up.
We have heard stories about companies that are terminating their plans is a way such that the owner takes their money first and the outstanding fees are charged to the rest of the participants. At least in this case, if the plan is audited they will be caught—as they were not acting properly as a fiduciary.
It is important to note, some plan sponsors pay their administrative fees themselves out of pocket – meaning the company pays the fees, with the exception of the investment expenses from the investment menu.
All 401(k) plans must deliver an annual fee disclosure to participants, but the easiest way to review any fees charged to your account is by checking your quarterly participant statement, which is required to detail all fees charged to your account.
Moral of the Story: Check your participant statements quarterly and understand all fees charged to your account!
Missing out on Eligibility
Employees are usually provided information on their employer’s plan upon hiring (including instructions on enrollment and deferrals), and can often start deferring to the plan with their first check.
However, there are some plans that do not permit immediate eligibility. Sometimes eligibility and entry dates are based on quarterly, semi-annual or annual requirements, which can be based on elapsed time or hours worked in that period. Employees who met the criteria during the required period should be offered the plan in a reasonable time period before they can enroll.
If the participant figures out they are eligible for the plan after the fact (or a government auditor comes to the same conclusion), the plan sponsor must make a contribution from the plan sponsor/company’s own pockets on the participant’s behalf for the period they became eligible through the date they were offered the plan. The contribution amount is determined based on two variables:
- The first variable is how quickly the error was caught. The longer that time period, the higher the required contribution.
- The second variable is based on the type of plan and potentially the average deferral rate for all non-highly compensated employees.
If a newly eligible participant actually submitted an enrollment form with the deferral percentage and the company did not process it, the correction is similar. However, the contribution amount variable is based on the requested deferral percentage.
Moral of the Story: You may be eligible to defer to a 401(k) plan, and if you have never been offered the plan, you have recourse!
Unchecked 401(k) Company Match Calculations
If you are participating in a plan with a company match, make sure to check that your company deposited the match as required per the plan document. A classic example is a safe harbor company match or standard company match plan that matches 100% on the first 3% deferred and 50% on the next 2% deferred based on plan year compensation and deferrals. Many plan sponsors with a safe harbor match formula based on year-end compensation and deferrals will fund the safe harbor match during the plan year with each payroll.
In this scenario, if you increase your deferrals from 3% to 8% midway through the year you will receive a 4% match with each payroll during the latter half of the year, and the first half of the year you will receive a 3% match. However, if your company’s plan calculates your match based on plan year compensation and deferrals, your full-year match should be 4% and you are due a year-end true-up! That means your plan sponsor must make up the difference. In this same scenario, if the plan document indicated the match is determined by payroll compensation and deferrals, then the company match is correct as-is and no true-up is required (assuming every payroll calculation was accurate).
Approximately 80% of the plans with a company match for which we provide compliance services require a correction. Many plan sponsors and their service providers do not review your company’s safe harbor calculation—therefore it often goes unchecked, and if there’s a shortfall, you may never get these monies unless an IRS or DOL auditor catches the mistake in an audit!
Moral of the Story: If your plan has a company match feature, check your company match formulas from the summary plan description or plan document and make sure you are receiving your full company match.
About the Author
Managing Partner, DWC - The 401k Experts
Keith Clark is co-founder and managing partner of DWC - The 401k Experts, founded in 1999. He is the author of "The Defined Contribution Handbook" and was named one of the top five consultants in "Pension Management Magazine." Clark is also an adjunct professor at the University of Minnesota's Carlson School of Management.