The Differences Between 403(b) and 401(k) Pricing
While there are some exceptions, particularly among the very largest of retirement plans, the recordkeeping fees for 401(k) plans are generally less expensive than those for 403(b) plans of the same asset size.
Why is this you might ask? The answer is that 403(b) plans are fundamentally different than 401(k) plans. Many of these differences result in a greater amount of work required to administer 403(b) plans and more work equals more money.
Below are a few of the major 403(b) plan price drivers that do not exist in 401(k) plans:
- The lack of trusts in 403(b) plans — Since 403(b) plans evolved from contracts owned by employees, rather than by the employer, they are rarely funded by a group trust. Instead, the plans are funded by annuity contracts and custodial accounts. Accounting for these contracts is far more difficult and expensive than accounting for assets that reside in a single group trust. By contrast, group trusts are the dominant funding vehicle in 401(k) plans. Since group trusts involve much less work, this is a major pricing advantage for 401(k) plans.
- Legacy assets in 403(b) plans for which there is zero employer control — In a 401(k), the plan’s assets are generally all in one place; namely, the group trust. This makes the transition to a new recordkeeper and/or trustee a relatively straightforward process. 401(k) recordkeepers and trustees can easily price a transition, and thus, 401(k) plans (particularly large ones) enjoy the purchasing power of their all-in-one-place assets. In this respect, 403(b) plans are completely different. Assets in 403(b) plans typically reside in multiple contacts, and if a plan sponsor is lucky, some of these contracts may be group in nature with at least some employer control. But many will be individual in nature, where the plan sponsor will have little say. Thus, when a 403(b) plan changes recordkeepers, there is no trust; usually, there is just a hodgepodge of annuity contracts and custodial accounts. Those contracts could reside with a single vendor but are often with multiple providers. As you can imagine, pricing this mess can be nightmarish, as a 403(b) recordkeeper not only has to factor in the assets that will be in the control of the plan sponsor, but those that are not, since these assets affect the pricing of services such as compliance and participant communication.
- Most 403(b) plans offer annuity contracts as an investment option — This is due to the regulatory limitation of 403(b) plan investments to annuities and mutual funds (for many years, annuities were the ONLY allowable investment). While the percentage of 403(b) plan assets invested in annuities has declined, annuities remain a dominant investment type in 403(b) plans, offered as an option in 68% of 403(b) plans. 401(k) plans? Not so much (6%). Annuities are more difficult to recordkeep, particularly in the daily-valued environment that dominates retirement plans today, thus resulting in yet another expense driver for 403(b) plans relative to their 401(k) counterparts.
- Use of multiple recordkeepers in 403(b) plans — 401(k)s rarely utilize more than one recordkeeper, where it is not unusual for a 403(b) plan to have multiple recordkeepers. Multiple recordkeepers increases recordkeeping complexity, and thus cost.
The good news for 403(b) plan sponsors is that outside of the group trust issue, these pricing barriers are within the plan sponsor’s control. For example, an increasing number of plan sponsors are consolidating vendors and migrating to group contracts where the employer often has control over plan assets. If plan sponsors take appropriate action, they can obtain pricing with their 403(b) plans that is very close to, if not the same as, their 401(k) plan counterparts. And that’s a good thing, as many 403(b) plan sponsors are unable to move to a 401(k) plan due to the nondiscrimination testing requirements for salary deferrals.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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