[Part 1: Selecting a provider, Part 2: Selecting the investment options]
I was recently involved in helping to setup a 401(k) plan for a startup company. I thought I’d share the results of my research and my thoughts on this subject. I gathered my information from a variety of sources, including past coworkers, the Bogleheads forum and other online resources.
I was given the following criteria to work with:
- The Plan should offer a choice of low cost mutual funds that cover diversified asset classes, and
- The Plan is not overly expensive for the company to sponsor.
I obtained proposals from three different providers — ADP, Employee Fiduciary (EF) and Vanguard. The quotes are current as of Nov 2016, and for an initial 5 participants.
- Setup cost = $0 (normally $1500, but waived)
- Monthly base fee = $340 (yearly = $4080)
- Per participant fee (per month) = $11.90
- Asset-based fee = none
- Note: ADP provided two options. IPS Zero and IPS Direct. IPS Zero offers low cost funds while IPS Direct offers more expensive funds and “kicks back” part of the fee to the sponsor by reducing the monthly and per participant fees. IPS Direct is not considered in this post.
- Setup cost = $500
- Yearly base fee = $1500 (up to 30 participants; additional $30 per participant)
- Asset-based fee = 0.02% / quarter
- Setup cost = $1000
- Yearly base fee = $3475 (up to 15 participants; additional $75 per participant up to 50 participants)
- Asset-based fee = none
- Note: Vanguard offers a “recordkeeping” credit if investor shares are used instead of admiral or institutional shares. For comparison in this post, we only consider admiral or institutional shares for all three providers, so we will not apply this credit.
The following table shows the yearly base fee and the asset-based fee for the three providers:
The cost of ADP is higher than Vanguard at every scenario, even accounting for the fee waiver when setting up the plan. So ADP can be dropped and we are left with comparing Employee Fiduciary with Vanguard.
Employee Fiduciary has a quarterly asset-based fee of 0.02% (or 0.08% per year). So the cost to use EF increases when the asset under management (AUM) increases. Vanguard does not impose a fee based on AUM.
Some sample AUM values are listed in the table above. Why these numbers are chosen is explained below:
- $270k : this is 15 x $18,000, i.e. 15 participants with maximum contributions in a year (not adjusted for growth).
- $540k : this is 2 x 15 x $18,000, i.e. 15 participants with maximum contributions for two years (not adjusted for growth).
- $2.47m : this is the break-even point at which EF and Vanguard have the same fee for 5 to 15 participants.
- $3.41m : this is the break-even point at which EF and Vanguard have the same fee for 25 participants.
When the asset in the plan is small, the lowest cost provider is EF. This “lower-cost” advantage will persist until the asset level reaches around $3m. Beyond $3m, the Vanguard plan becomes more cost effective than EF.
Between EF and Vanguard, Vanguard has more brand name and is very well-known and established. EF is a smaller company founded in 2004. While it has very positive reviews on the web and was very prompt and polite in response to my inquiries, we cannot deny that it is a less known entity when compared to Vanguard.
If both EF and Vanguard offer the product at the same price point, Vanguard would be my preferred choice. However, if the AUM is expected to remain small for more than a few years, using EF is probably better since this will save the sponsoring company some money.