A few months ago, my column, "The Truth," (see "The Truth," PLANSPONSOR, January 2008) pointed out that most employees did not know how much they should be deferring into their 401(k) plans to fund their retirement benefits adequately and, as a result, they were undercontributing.

This month's column addresses another largely untold truth: that employees are paying all or almost all of the costs of operating their plans.

In the typical 401(k) plan, the mutual funds (and their managers and affiliates—the “mutual fund family”) make payments, usually in the form of subtransfer agency fees and shareholder servicing fees, to the plan provider/recordkeeper to subsidize the cost of operating the plan. Stated simply, those are payments from the mutual funds to the plan provider for its services in allocating the shares of the mutual funds among the participants' accounts, distributing prospectuses, maintaining the Web site for plan transactions and information, and so on.

While the amounts of those payments vary, my experience is that they are most often in the range of 10 basis points to 25 basis points per year (that is, one-tenth of 1% of the assets invested in a mutual fund up to one-quarter of 1% of the assets invested in a mutual fund, paid each year), depending on the size of the plan. For small plans, the payments may be as high as 50 basis points, or one-half of 1%.

In addition, when the plan’s adviser is a broker (sometimes also called financial adviser, financial consultant, or registered representative), it frequently is compensated through 12b-1 fees paid by the mutual funds. Most often, the 12b-1 fee is 25 basis points per year.

Under the securities laws, those payments are for “distribution,” or sales, of the mutual fund shares, together with “incidental” services. Under ERISA, these payments are for the services the broker provides to the plan, including recommendations about the selection and monitoring of the plan’s mutual funds.

Thus, most or all of the plan costs are paid—either directly or indirectly—from the mutual funds. (I say “indirectly” because, in some cases, part of the money may come from the mutual fund’s investment adviser’s fee, as opposed to being a separate charge against the mutual fund’s assets.)

Since it is paid from the mutual funds, in one way or another, it reduces the value of the investments of the participating employees. However, this arrangement is almost never explained to the employees. Arguably, employees are left with the belief that the plan sponsor is paying for the plan—not because the sponsor says that, but because it seems to be a reasonable assumption.

In my opinion, unless employees are clearly told that they are bearing the cost of the plan, there is a continuing danger of litigation against plan sponsors and fiduciaries. To make matters worse, some plans make representations to employees that the plan sponsor is paying the costs.

For example, I recently saw a summary plan description (SPD) that said that the employer was paying all of the costs for the 401(k) plan, although most of the costs were being paid through revenue-sharing from the mutual funds. The statement in the SPD was meant to refer to any direct expenses after the revenue-sharing but it was, nonetheless, a misrepresentation to the employees.

Even if nothing is said, participants may be left with the impression that the plan sponsor is bearing the cost. The truth, of course, is that the silence doesn't mean that the plan sponsor is—or that it isn’t. However, that raises the question: Should the burden be on the plan sponsor and the fiduciaries to communicate the "truth" or should it be on the participants to investigate and learn the truth?

In most cases, and particularly in fiduciary relationships, the burden is usually on the more sophisticated and knowledgeable person—the fiduciary.

Forewarned is forearmed. Plan sponsors should embrace and encourage an environment of full and complete communication on important 401(k) issues. It is good policy, and it is good risk management.