What happens behind the scenes in a 401k plan?

Question

I work for a medium sized technology company in Silicon Valley. I have been participating in the company 401k plan for 5 years. Every once in a while the 401k funds available to us change completely. Even the funds that are doing spectacularly well. I can never get a straight answer from our 401k plan administrator or the company that provides us with the plan, as to why funds are added and dropped at will. Apparently there is a board of trustees that manages the company 401k and decides which funds to make available.

Being a salesperson myself, I am guessing that this Board of Trustees has other incentives to choose one company's 401k mutual fund over another. How does this work exactly? Are these board members given kickbacks and free lunches when approached by new fund administrators?

Answer 1

Most likely it's because of service. That's the typical reason that a firm your size would switch administrators. However, if they aren't witching the company that provides the plan but only the funds then they hopefully are doing their due diligence and making choices based on appropriate information. Why would they switch a fund? Perhaps the fund moved out of the appropriate investement category...ex: a large cap starts buying small cap funds to prop up it's returns or a value fund starts buying up growth stocks. Or it could be as simple as the fund has a lot of turnover in it's management. Perhaps the fund was targeted by Eliot Spitzer for fee issues....could be a myriad of reasons.

For smaller firms the mutual funds sold to them typically pay for the fees out of 12b-1 fees which are hidden in the expense ratios. The higher that fee the more that is being paid to the administrator and or investment firm. That means less out of pocket expenses by the company....essentially a "free" product...but it's not free it's being paid for by the participants.

Check your funds expense ratios...see if there 12b-1's being paid by the fund...check to see if they are higher than before. If not the reasons are probably reasonable. Mutual Fund companies are not supposed to pay bribes or kickbacks...delisting would be the end result if caught.

btw...if the fee were the same...would you rather know you were paying it via a fee column or would you rather it be hidden as part of the funds expense ratios? I think the former...but the mutual fund companies say the latter.

Answer 2

Mutual funds are tricky.
They can be closed to new investors. Mutual funds can become too large. BRKA has $40 billion in cash that they have no idea what to do with. Other mutual funds can run into the same "problem" so they close them. This has happened in my 401K.

Mutual funds can merge. A poor fund can be merged into a fund that does well. The poor record is erased and the broker temporarly looks better than he or she is. The 401K trustees might not like this and dump the fund. The fund you have might get a name change instead. You might see they are dropping one fund and getting another, but it could be just a name change. This has happened in my 401K.

The brokers of the mutual funds might change, charge extra fees, be corrupt or get arrested etc. Trustees and brokers can fight over this and so the mutual fund gets dropped. I've heard of this happening.

Answer 3

A 401k has basically two parts to it. A plan administrator (processes the loans and prepares the tax reporting) and the investments. Sometimes they are sold together (bundled) and sometimes they are sold separately (unbundled). The primary reason employers change is service related, but sometimes it also has to do with cost. As your 401k plan grows it attracts the larger fund companies who will charge your company less for the plan administration and less for the investments. This usually results in more funds for you to choose from at a lower cost.

Answer 4

Oh! There may be a " free lunch" here and there but probably it just has more to do with "normal business" procedures...What would these guys do if they didn't make some changes now and again? ...get paid for " just watching"? Why do you think yahoo changes mail, message boards, this and that....because it's someone's job....why are we paying them if they aren't doing anything?...It's rampant in the business world almost as much as in Politics. There are very few " lean, mean" businessmachines...everyone takes care of a " political" crony here and there!
Do you really think a jet fighter should cost 380 Million dollars?
Do you really think a 3 day stay in a hospital( observation) should cost 75 Thousand ?
...and WE aren't half-bad ...can you imagine the " business" dealings in China? Russia? Latin America? Kurdistan?.....and our economy somewhat depends on them.... gives ya the "willies"!!!

Answer 5

Gretchen Morgenson of the New York Times has written a number of really good articles about 401ks & conflicts of interest. I suggest you check them out (go to nytimes.com & search for "401k" and "morgenson").

The incentives are not straightforward brines or kickbacks but often more subtle and difficult-to-trace. I can't do her journalism justice, but I suggest you check it out. Similar conflicts of interest go on wuth consulting firms that set executive compensation policies.