The Hidden Cost of Revenue Sharing in 401(k) Plans

When a business owner asks their 401(k) provider how much the plan costs, they usually hear a number that sounds reasonable. But what they often don't hear about are the revenue sharing arrangements that can quietly add to the total cost and directly impact their employees' retirement savings.

What Is Revenue Sharing?

Revenue sharing is a practice where mutual fund companies pay a portion of their management fees back to the plan's recordkeeper or administrator. These payments come from the fund's expense ratio — the annual fee that every investor in the fund pays.

On the surface, this might seem harmless. The recordkeeper gets compensated, and the plan sponsor doesn't have to write a separate check for administrative services. But the reality is more complicated.

The Problem with Revenue Sharing

Revenue sharing creates a fundamental conflict of interest. When a recordkeeper's compensation depends on which funds are in the plan, there's an incentive to favor funds that pay higher revenue sharing — even if those funds aren't the best options for participants.

This means your plan might include funds with higher expense ratios than necessary. And because expense ratios are deducted directly from investment returns, your employees are paying for it through lower account balances over time.

The numbers are significant. Academic research has consistently shown that fees are one of the strongest predictors of long-term investment outcomes. A difference of even 0.25% in annual fees, compounded over a career, can reduce a participant's final retirement balance by tens of thousands of dollars or more.

How to Spot Revenue Sharing in Your Plan

Revenue sharing isn't always easy to identify. Here's what to look for:

• Compare expense ratios: If your plan uses share classes with higher expense ratios when lower-cost versions of the same fund exist, revenue sharing may be the reason.
• Ask about 12b-1 fees:These are distribution fees built into a fund's expense ratio that often flow back to the plan provider.
• Request a fee disclosure: Under ERISA 408(b)(2), your service providers are required to disclose all direct and indirect compensation. Review this document carefully.
• Look at the fund lineup:If your plan includes proprietary funds from the same company that administers the plan, that's a red flag worth investigating.

What You Can Do About It

As a plan sponsor, you have a fiduciary duty to ensure that plan fees are reasonable for the services provided. Here are concrete steps:

• Benchmark your fees:Compare your plan's total cost, including revenue sharing, against plans of similar size.
• Consider adding low-cost index funds:Index funds typically have lower expense ratios and don't involve revenue sharing arrangements.
• Explore flat-fee recordkeeping: Some recordkeepers charge a transparent flat fee instead of relying on revenue sharing. This eliminates the conflict of interest entirely.
• Engage an independent fiduciary:A fee-only 3(38) fiduciary has no incentive to select higher-cost funds because they don't benefit from revenue sharing.

The Bottom Line

Revenue sharing isn't inherently wrong, but it needs to be understood, disclosed, and evaluated. Too many plans carry unnecessary costs because no one has taken the time to look under the hood.

Your employees are counting on their 401(k) to fund their retirement. Every dollar lost to hidden fees is a dollar that isn't compounding in their favor. As a plan sponsor, ensuring fee transparency isn't just good practice, it's your fiduciary obligation.