How to Make Small Business 401(k)s Cheaper than Mega Plans

The conventional wisdom about 401(k) fees is that participants in small business plans pay higher account fees than participants in “mega” plans sponsored by large corporations. In truth, a small business can help their participants pay less by paying all 401(k) administration fees from a corporate account. Why would a small business owner incur this expense when they can pay the fees from plan assets - like most large corporations do - instead? To grow their personal 401(k) account faster while lowering their taxable income.

If you’re a small business owner, I strongly recommend you consider paying 100% of your 401(k) administration fees from a corporate account - not plan assets. The approach can be a win-win for you and your employees.

Here is what’s in it for you.

How 401(k) Administration Fees Are Allocated When Paid from Plan Assets

401(k) plans are never free. All 401(k) providers charge “direct” and/or “indirect” administration fees for delivering plan services such as asset custody, participant recordkeeping, Third-Party Administration (TPA), and investment advice. The major difference between direct and indirect administration fees is who pays them.

• Direct fees – These fees can be paid from either plan assets or a corporate bank account.
• Indirect fees – These fees are paid by investment fund companies – which increases the price of their funds.  The two most common forms of indirect fees are revenue sharing and annuity wraps.

In general, indirect and direct fees paid from plan assets allocated among plan participants pro rata based on their account balance. That means the plan participant with the largest account balance pays the highest amount – probably you in the case of your 401(k) plan.

Below are three fee allocations for a hypothetical $1 million, 10-participant 401(k) plan. As you can see, the business owner pays 60% of the total fee in all cases because their account balance represents 60% of plan assets.

Paying your 401(k) administration fees from a corporate account instead of plan assets can seem counterintuitive, but the approach can mean much greater savings for you in retirement and lower income taxes now.

Benefit #1 - More Savings in Retirement

When 401(k) administration fees are paid from plan assets, you won’t just miss out on your share in retirement – you’ll also miss out on the compound interest the payments would have earned had they remained invested instead. These losses can add up to hundreds of thousands depending upon the amount and the timing of the payments.

To demonstrate the problem, check out the example below. After 20 years, Owner 1’s account balance would be significantly reduced by the fees we assumed in our earlier example. Calculation assumptions - $20,000 in annual contributions with a 7% annual return.

After 25 years, Owner 1’s losses are even more dramatic.

Benefit #2 - Lower Income Taxes Now

401(k) administration fees paid from a corporate account are deductible as a business expense – which means they can help lower your taxable income. A portion may even qualify for the following small business tax credits:

• Qualified startup costs– The credit is 50% of your eligible startup costs, up to the greater of:
  • $500; or
  • The lesser of:
    • $250 multiplied by the number of Non-Highly Compensated Employees who are eligible to participate in the plan, or
    • $5,000.
  • This credit is available for up to three years.
• Automatic enrollment- you can earn an additional $500 tax credit by adding an automatic enrollment feature to a new or existing 401(k) plan.
  • The credit is available for each of the first three years the feature is effective.

How to Replace 401(k) Administration Fees Paid from Plan Assets

The simplicity by which you can replace 401(k) administration fees paid from plan assets will depend upon how your 401(k) provider is paid today.

If they are paid direct administration fees only, I have good news – you’ll probably just need to notify them that you’d like to pay their future invoices from a corporate account instead of plan assets.

If they are paid indirect administration fees, things get a lot more complicated. The reason? These fees are baked into the expenses of your current investments. That means you must:

• Switch the share class of your current funds to one that pays no indirect fees
• Replace your current funds with different ones that pay no indirect fees
• Replace your 401(k) provider if they won’t do either.

Make Retirement More Affordable for You and your Employees!

Approximately 80% of our small business clients pay 100% of our 401(k) administration fees from a corporate account instead of plan assets. This high rate is hardly surprising when you consider the approach’s benefits to business owners like yourself. You can deduct the fees as a business expense while keeping the portion that would have been paid from your personal account working for you until retirement.

The kicker – your employees will pay lower 401(k) fees too!