Is There Such a Thing as a Free 401(k) for a Small Business?

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A provider can set up a 401(k) for your business, run it for years, and never send you an invoice. That offer is real, and a lot of small plans work that way.

So who is paying the people doing the work?

Say you're Shawna. (Shawna's made up, though we take some version of this call a few times a year.) She's 41, owns a 16-person physical therapy practice in Pickerington, and set the plan up six years ago on an offer that cost the practice nothing to start and nothing to run. Thirteen of her people are in it and it holds about $1.3 million. Last month one of them brought her a statement with a charge on it she couldn't explain.

Where the money comes from

Nothing here is hidden and none of it breaks a rule. A provider is allowed to cover its costs out of the plan instead of billing the company, and the arrangement gets disclosed in writing. The Labor Department describes it in its own fee booklet: under a bundled program, "some or all of the plan service costs may not be separately charged to the plan or to your employer. For example, the asset-based fees charged on investments may subsidize these costs."

In Shawna's plan that happens in two places, both of them percentages, which is why nothing ever arrives as a bill. The first is a charge against account balances for recordkeeping and administration, taken quarterly and netted out before anybody sees a statement. The second sits inside the funds. Every fund on the menu charges an expense ratio, and part of that can be routed back to help pay for running the plan. Routing it that way is called revenue sharing, it is permitted, and it counts as indirect compensation under the Labor Department's service provider rule, which defines that as money "received from any source other than the covered plan, the plan sponsor, the covered service provider, or an affiliate."

Any provider expecting $1,000 or more from her plan has to put all of it in writing, which is what gives Shawna somewhere to start. What a 401(k) Really Costs a Small Business walks through the pieces of the bill and who normally carries each one.

What it costs her people

The recordkeeping charge on her plan runs 0.45% of assets and the funds on the menu average 0.52%, so the all-in cost is 0.97%. On $1.3 million that comes to $12,610 a year, or about $970 a head across her thirteen participants, and the practice pays none of it.

A percentage is a bill that grows on its own. The practice agreed to 0.45% when the plan held a few hundred thousand dollars. Nobody renegotiated anything, and the plan has grown every year since.

Whether 0.97% is too much depends on what the plan gets for it, which is the question How to Tell if Your 401(k) Fees Are Too High works through. There is no legal ceiling. The Labor Department is explicit that the law "requires the fees charged to a 401(k) plan be 'reasonable' rather than setting a specific level of fees that are permissible."

What a percentage does over a career

The Labor Department's own illustration is the clearest way to see it. Start with a $25,000 balance, leave it alone for 35 years, and assume a 7% average return with no further contributions. At 0.5% a year in fees and expenses, the account reaches about $227,000. At 1.5%, it reaches about $163,000, a difference of 28% at retirement.

Shawna's people are not going to see that number anywhere. It comes out of returns, one quarter at a time, and the statement still goes up.

Where a plan can come close to free for the business

Congress put tax credits in place for small employers starting a plan. An employer with 50 or fewer employees can claim a credit for 100% of eligible startup costs, up to $5,000 a year for three years, plus $500 a year for three years for adding an eligible automatic enrollment feature. A separate credit of up to $1,000 per employee covers employer contributions early on and phases down over five years.

Those credits offset what the business spends. They don't change what the plan spends, and the eligibility rules are worth walking through with your CPA. We'll cover them properly in a post of their own next week.

What Shawna does with it

She asks for her 408(b)(2) service provider disclosure, which is the document that lists what each provider is paid and where the money comes from. Any provider expecting $1,000 or more was required to furnish it, so it exists somewhere.

Then she asks for the all-in number, in dollars and as a percentage of plan assets, and for the list of services that number buys. Then she asks what the practice would pay to take the administration piece onto its own books, because that is a choice available to her and she has never priced it.

Nothing about that list commits her to changing providers. The Labor Department doesn't ask a plan sponsor to find the cheapest arrangement available. It asks for a process you can show later on, so a review that ends with "we looked, and we're priced fairly for what we get" counts.

Shawna hasn't decided anything. She has the disclosure on her desk and a meeting set for January, which is further than she was in September.

If you want a read on your own plan first, the ClearMind 401(k) Scorecard pulls your most recent Form 5500-SF and sends back an overall Plan Score in about a minute, free. Austin Wolfe and Joe Anderson run Workplace Retirement at ClearMind Capital here in Columbus, and you can book a call here if you'd rather start with a conversation.

Common questions

Is a free 401(k) plan really free?

For the employer, it can be. The services still get paid for, out of the plan, through a percentage charged against participant balances and through the expense ratios of the funds on the menu. The Labor Department's guidance on plan fees says to remember that all services have costs, and to compare all services received against the total cost.

Who pays for a 401(k) if the employer doesn't?

The participants do, through their account balances. ERISA lets a plan sponsor pay some plan expenses, all of them, or none, and the Labor Department has said that nothing in Title I limits a sponsor's ability to pay only certain expenses. Where the plan document leaves the method of allocating expenses open, choosing that method is a fiduciary decision and has to be made prudently and in the interest of participants.

Does a free 401(k) mean I'm not a fiduciary?

No. Hiring a service provider is itself a fiduciary act, whoever ends up paying for it. The employer still has to select providers prudently, monitor them at reasonable intervals, and keep a record of how those calls were made. Who writes the check has no bearing on it.

How do I find out what my plan is paying when I never get a bill?

Two documents carry the numbers. The 408(b)(2) service provider disclosure goes to whoever makes decisions for the plan and lists what each provider receives, including compensation paid by someone other than the plan. The 404a-5 participant disclosure goes to employees once a year and shows each investment's total annual operating expenses as a percentage and as dollars per $1,000 invested. Ask your provider if neither is in your files.

Can we move to paying the administration cost ourselves?

That's a conversation to have with your provider, and often the answer is yes. Taking the administration piece onto the company's books takes that charge off employee balances and makes it a deductible business expense. What it costs, and whether the plan's pricing changes, depends on the arrangement, so get the quote in writing before deciding anything.

Written byAustin Wolfe & Joe AndersonClearMind Capital | Workplace RetirementView bio →

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