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I have a TransAmerica 401K through my employer. Every fund choice is a fund of a fund, increasing fees. Typical?

For example, TransAmerica creates a fund for the 401K by investing in nothing but the Vanguard Total Stock Market Index fund, and then calls their account "Vanguard Total Stock Market Index Retirement Account." And of course the expense ratio is much higher than if you just invested directly in the Vanguard account. Am I getting anything by these higher fees besides the value of being in a tax-deferred account?

Oct 28, 2014 by Keith from Washington, DC in  |  Flag
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Keith,

Good detective work noticing the difference in the expense ratio of the fund your plan fiduciaries (those responsible for your plan) have placed in your 401(k) and the lower cost fund they could have put in your plan. If all employees paid attention to their plan I’m certain that plan fees would drop.

Having said this it could well be that your plan fiduciaries are doing their job and the plan fees are reasonable. To operate a 401k plan you need various services providers, all of whom prefer to be paid. You need a recordkeeper, third party administrator, custodian and, of course, the fund companies (like Vanguard). There can be other vendors like a financial advisor, directed trustee and auditor.

It’s very common in the 401(k) world for service providers to get paid by what is called “revenue sharing”. The cost of the mutual fund is increased and then the fund distributes the increase to the platform (in this case Transamerica) who in turn pays all of the service providers.

I’m not a fan of this arrangement because the fees are basically hidden from view. In fact most plan participants don’t even notice them because the effect of the additional fund expenses is a reduced investment return. Say the investments inside the mutual fund made 8.0% but the fund company reports a 6.5% return to the fund shareholders. The 1.5% difference is used to pay everyone involved.

Those in charge of your plan have a fiduciary responsibility to you to ensure the plan fees are “reasonable”. This is a requirement under the Employee Retirement Income Security Act (ERISA). You can ask to see their documentation that they have reviewed the fees, know who is being paid what, and that each service provider is receiving a reasonable fee in exchange for their service.

Again, good job noticing the potential fees in the plan.

2 Comments   |  Flag   |  Oct 28, 2014 from Woodbridge, VA
Keith

Thanks John. Very helpful. I've been frustrated that, after pushing for some index funds to be included in our 401K fund lineup, that those funds have, for example, a 0.97 expense ratio (that's the Vanguard Total Stock Market Index). That is made up of 0.80 for "Administrative/ Management Fee/ Expense Ratio" [of the underlying fund] plus 0.17 for "Contract Asset Charge." Since the point of an index fund is to trade active management for ultra-low expense ratios, it is annoying to pay this much just for TA to set up and "manage" a fund that actually has no active management. Is there a way to get these fees lowered without switching providers and without significantly increasing the number of people in the plan/assets under management that you can think of? Appreciate your insight.

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Flag |  Oct 28, 2014 near Washington, DC
John A. Frisch CPA/PFS, CFP®, AIF®, PPC

Keith, like most seller / buyer relationships the more clout the buyer has the better the price they can negotiate with the seller. Clout in the 401k space is mostly defined as the amount of assets in the plan because the fees are based on the plan size. As the plan grows the fiduciaries have a responsibility to their participants to attempt to negotiate better fees (as a %). And they really should consider other providers as well to keep the negotiations fair. I'm a not a fan of active fund management either since it does require higher fees to pay for the effort to manage the fund. If the average active stock fund is 1.20% and the average passive fund is 0.30% that's a large fee gap to overcome via active management out performance. On July 1, 2012 rule 408(b)(2) went into effect which required service providers to provide fee, and other, information to your plan sponsor. The sponsor then was supposed to do a fee reasonableness analysis. It could be that you are actually getting a good deal. You have to speak to your employer. I will say that "generally" Transamerica is one of the higher cost providers. Also you must have an annuity contract if you have a contract fee and it could be that switching out of the annuity will reduce cost.

Flag |  Oct 28, 2014 near Woodbridge, VA

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John is correct in noting that you need to expect to pay some fees somewhere somehow in the plan. It is unreasonable to expect to pay the same fee as if you bought the fund direct from Vanguard due to all the costs involved in 401k recordkeeping, reporting, and management. He is also correct that if more people took notice, fees could be lower. Can your employer find a plan with lower fees if they shop around? Probably. Will they? Well, that depends in part on how many employees speak up and complain. Small employers may also have fewer in house resources to devote to 401k plan management, and may rely on more expensive providers to take over some of the burden. So speak up, ask your employer to do a little research. Let them know you care!

3 Comments   |  Flag   |  Oct 28, 2014 from Bridgewater, NJ
Keith

James: thanks for answering. It is good to know that some of these costs are to be expected. Is there a way to get these fees lowered without switching providers? Does my employer have any leverage in trying to negotiate lower fees with the current provider?

Flag |  Oct 28, 2014 near Washington, DC
Jeremy M. Shafer, CFP®

Keith, your employer can always negotiate fees. They probably cannot get the fee for "TransAmerica/Vanguard Total Stock Market Index" lowered, but they may have a comparable index fund available at a lower cost. Either your employer or TransAmerica has a fiduciary duty to select investments with an eye on what's best for you, the employee. As for leverage, that depends on the total plan assets; more dollars = more bargaining power. You're on the right track. Keep after this as tactfully as possible. All the best!

Flag |  Oct 28, 2014 near Midland, MI
Keith

Jeremy: thanks for the info and encouragement!

Flag |  Oct 28, 2014 near Washington, DC

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Keith,

It is unlikely that your employer can negotiate their own fee schedule unless the company plan is huge. If you are uncomfortable with the range of choices you have, you would probably get further lobbying for them to change providers.

There are a number of companies that provide "open architecture" programs with access to literally hundreds of funds, including ETF and some alternatives as well.

However in defense of your plan's selections, under some pressure from regulators, many plan providers have moved to fund of fund or target date funds as a way to simplify the selection process and thereby get participants "off the sidelines" and actually move them to make a choice. Unfortunately most participants are not as actively involved in managing their allocations as you apparently are...much more common is people either not signing up or if they do participate, leaving their money in money market or the default choice.

One other perhaps "heretical" observation. Fees are certainly important but they play a much smaller role in determining the ultimate performance than does the allocation decision. I would recommend that you spend most of your time on making the best performance picks you can make given your risk tolerance and objectives.

1 Comment   |  Flag   |  Oct 28, 2014 from Fort Washington, PA
Keith

Thanks John!

Flag |  Oct 28, 2014 near Washington, DC

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Tunc Tanin Level 10

I would add few points here why you should never expect to find the same expense ratio in a 401k as compared to individual account at Vanguard. The individual account at Vanguard has a minimum account balance of 3000 and subsequent contributions have to be at least 50. If your account balance is less than 10000 and you dont receive electronic statements you have to pay additional statement. The 401k on the other hand, could have someone invest 10 in their first paycheck and stop contributions, you really cant add annual fees to that and until they leave the company so this will increase overall cost for everyone in the 401k plan. You can also add 2 a month to your 401k and Vanguard has to process that. For practical reasons you cant make everyone first contribution 3000 either, they may not make that much to begin with. So you have higher fees in 401k due to lower opening account balances, many small accounts and contributions, you really cant change the dynamics here. They have not mentioned this, but there is also the cost of loans. It costs money to issue 401k loans and collect them from the paychecks. You pay for the cost of issuing loans through the expense ratio. You don't have these costs with individual accounts at Vanguard.

1 Comment   |  Flag   |  Oct 28, 2014 from Somerville, MA
Keith

Good points! Thanks for the insight.

Flag |  Oct 28, 2014 near Washington, DC

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Another aspect here is the assumption that the benefits of tax-deferral. There are many scenarios where individuals do not benefit as much as they believe from deferring taxes. One downside of deferring are the conversion of capital gains into ordinary income, where your stock gains which would have been taxed at a lower rate (and for those in the 15% bracket at 0%) into taxable ordinary income. Another is that social security tax and the loss of deductions may lead to a higher tax in retirement.

I typically counsel individuals to consider all of their savings options. Generally, it makes sense to receive the maximum match, but here too it will depend on the level of fees, the ability to diversify, and the amount of the match. There are situations even the match is not all it seems to be due to cost.

That said, deferring is often the best route, but your question brings up the importance of understanding all of your options as well as having a current and future tax strategy.

Comment   |  Flag   |  Nov 08, 2014

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