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401(k) Costs Coming Down, But Small Plans Still Twice as Expensive

Industry Trends and Research

Despite 401(k) plan investors paying less to invest than they ever have, even compared to just a year ago, the basis points saved are not shared equally by all defined contribution (DC) plan participants.

And while this isn’t a new concept, the cost participants pay to invest in their DC plans continues to depend significantly on the size of their employer, according to Morningstar’s 2023 Retirement Plan Landscape Report, which examines major trends in the U.S. defined contribution system.  

The firm examined the asset-weighted expenses associated with the plan, overall plan administration expenses and the total cost, which is the sum of both these numbers on a plan-by-plan basis. Not surprisingly, in both regards, scale is an enormous advantage. It found that individuals who work for smaller employers and participate in small plans pay around double the cost to invest as participants at larger plans—around 84 basis points in total compared with 40 basis points, respectively.

Small plans also feature a much wider range of fees among plans, with 35% of plans costing participants more than 100 basis points in total. Further, Morningstar reports that many plans are still outliers, with unusually high fees relative to their peers, particularly outside of the largest thousand or so plans in the U.S.

This leaves workers at smaller employers potentially having 9% less saved at retirement due simply to higher fees, the report emphasizes.  

“Fortunately, the majority of DC plan participants are in larger plans and benefit from the lower costs of these plans, with 80% of participants in plans charging less than 80 basis points, despite these plans only making up just 57% of the market,” writes Lia Mitchell, Senior Analyst at Morningstar and author of the report.

Still, while the median costs have dropped across all plan sizes, the median small plan moved the needle slightly faster, dropping 4 basis points in 2020 compared with 2019, while medium, large and mega plan total costs fell by 2, 3, and 1 basis points, respectively, the report notes.

That said, the report suggests that structural changes may be the only way to truly address this discrepancy in plan costs. One attempt at such a change was the creation of pooled employer plans, but because they were introduced in 2021, there is not yet a complete set of annual data that can be used to evaluate their effectiveness, Mitchell notes. Nevertheless, PEPs could help close this gap if there is sufficient and smart uptake, she adds.  

CIT Adoption

Another possibility that could aid in lowering costs is the broader adoption of Collective Investment Trusts, the report further suggests.   

Since 2012, CITs have grown from 13% of assets in DC plans, up to 28% of assets in 2021. Over that time, DC plan CIT assets more than quadrupled from $463 billion to $2.25 trillion, while DC plan mutual fund assets doubled from $1.52 trillion to $3.25 trillion.

During that period, the largest plans in the U.S. started moving away from mutual funds and today hold nearly 88% of all CIT assets. CITs have also doubled their share among the largest plans from 17% of assets in 2012 to 36% in 2021.

Yet, inroads to plans with less than $500 million in assets have been marginal, as these plans have only 12% of total CIT assets in the system, Morningstar notes. From 2019 to 2021, however, these smaller plans grew their CIT assets by over 10% each year, ending 2021 with CITs representing more than 11% of all their assets and significantly outpacing growth in mutual fund assets over the same period.

“Reaching a broader range of plans has been a struggle for CITs, but the most recent data shows the tide could be turning as CIT assets in smaller plans are growing not just in raw terms, which can always be partially attributed to market returns, but also in terms of percentage of total assets,” writes Mitchell.

Moreover, just over 50% of assets that plans with 100 or more participants hold in CITs are in TDFs, which should ensure they continue to grow as new plans and participants join the DC system, the report notes.

A System Under Stress?

In the meantime, while long-term consistent growth continues to make the U.S. retirement system look stable, the findings suggest that these numbers mask underlying turnover of thousands of plans and outflow of billions of dollars.

Here, the report explains that the U.S. DC system relies on new employers to create, on average, 44,000 plans a year to compensate for the more than 377,000 plans that closed from 2012 to 2021. Similarly, the system depends on new contributions and strong returns to obscure outflows of more than $400 billion a year since 2015, as reported by plans in their annual filings.

And while depending on a steady stream of new employers and contributions to balance closing plans and outflowing dollars in growing the overall size of the retirement system, the bulk of U.S. retirement security relies on a small group of employers.

To that end, mega plans with more than $500 million in assets have become increasingly important to the retirement system, the report notes. In 2011, these mega plans covered just 34% of participants, but by 2020 they had added more than 15.8 million more people and covered 45% of DC plan participants. Meanwhile, small and medium plans with $100 million or less in assets added fewer than 1.5 million participants in the same span, with their market share shrinking from 48% in 2011 to 38% by 2020.

More specifically, as of 2020, the U.S. retirement system relied on just 2,332 plans offered by 2,090 employers to cover half of all DC participants. These numbers have shrunk slightly from 2,451 plans and 2,122 employers in 2011, to the point that less than 0.4% of plans are covering 50% of participants. After these largest 2,332 plans, the next 16,412 largest cover half as many people, for a total of under 19,000 plans having 75% of participants but making up just 2.7% of DC plans.

Consequently, a series of poor returns would reduce many plans’ assets, which provides their market power, and thus may inhibit their capacity to offer institutionally priced investment options, the report further warns. What’s more, as the retirement system continues to only cover about two-thirds of workers, such headwinds could increase the number of workers falling behind in saving for a secure retirement.