The 401(k) market is largely dominated by players who are incentivized to offer certain mutual funds. For example, fund families providing 401(k) services and the distributors who sell the plans may have a conflict of interest. Often, one or more of these parties is compensated in some way by the mutual fund company(ies) that the sponsor selects (with the investment advisor’s help). Compensation often comes in the form of revenue-sharing arrangements, including:
- 12(b)-1 fees: annual distribution or marketing fee (i.e., the salesperson’s cut)
- Sub Transfer Agent (Sub-TA) fees: the fee for maintaining records of a mutual fund’s shareholders
- Soft dollar “excess commissions”: how mutual fund companies pay their service providers; “soft dollar” means they’re paying in the form of giving them business, rather than actual cash
These are all included in the fund’s expense ratio, which is the fee that all funds charge their participants. ETFs, on the other hand, cannot have the same revenue-sharing relationships that many mutual funds do. That means the 401(k) players who use ETFs aren’t being compensated behind closed doors, so they have to charge explicit fees for their services. This helps make it easier for plan sponsors to evaluate, compare, and understand true costs of administration. And it allows participants to see where their money is going.
This information has been provided by Betterment LLC, a registered investment advisor.