A True Open Architecture 401(k) Platform

By Burke Johnson1

The term “open architecture 401(k)” has become altogether common in today’s retirement plan marketplace. In fact, almost all recordkeepers are offering some kind of an investment menu that is comprised of mutual funds from numerous fund families. In the current retirement plan landscape, it’s becoming increasingly less likely for any 401(k) plan to only include investments from a single fund family anymore.

While many 401(k) recordkeepers claim to have an open architecture platform, are they truly indifferent to the funds selected by the plan? Probably not. In practice, many 401(k) recordkeepers vary their fees based on revenue sharing received by the recordkeeper from mutual fund companies or the number of proprietary funds offered by the recordkeeper that are selected by a plan. Revenue sharing can be defined as fees paid by the mutual fund companies to service providers for performing recordkeeping services and/or sub-transfer agency services to retirement plans.

Examples of what a 401(k) recordkeeper might claim to be an open architecture platform include:

1) Offering 500 mutual funds from 50 fund families, all of which pay some sort of revenue sharing to the recordkeeper.

2) Offering 1000 mutual funds from 100 fund families, some of which pay revenue sharing to the recordkeeper. The fees charged by the recordkeeper for a plan will vary based on how many funds selected by the plan pay revenue sharing to the recordkeeper.

3) Offering 1000-plus mutual funds from 100-plus fund families, and charging an additional asset-based fee for all balances in funds that are not deemed “proprietary funds” by the recordkeeper.

In all of these scenarios, the plan is free to select non-proprietary mutual funds. At the same time, however, either the revenue to the recordkeeper or the explicit fees paid by the plan (or both) will fluctuate depending on the funds selected by the plan.
In the first illustration, the plan must choose funds that charge an additional expense in the form of, for example, service, shareholder servicing or sub-transfer agency fees. If these fees are not passed back to the plan to offset the plan’s costs, the “all in fee” paid by the participants would be higher than a lineup of mutual funds that didn’t include revenue sharing. In the second example, the recordkeeper would not be able to provide an accurate fee quote to the plan until it knows what funds the plan intends to utilize. The recordkeeper here has the discretion to retain the revenue sharing payments as partial compensation and then charge lower explicit fees based on how many funds the plan selects that engage in revenue sharing. In the third example, any participants invested in funds not offered by the recordkeeper in the form of “proprietary funds” will simply have an additional asset-based fee deducted from their accounts.

A true open architecture 401(k), on the other hand, allows plans to select investments from hundreds of mutual fund families and exchange traded funds (ETFs) without impacting the record keeper’s fees to the plan. In other words, the recordkeeper’s fee schedule will clearly disclose the specific fees the plan will be charged. These fees should not be impacted by a plan’s investment lineup.

For recordkeepers that choose to use all or a portion of revenue sharing payments to offset plan expenses, the actual dollar amount paid by the plan may vary based on the proportion of participants invested in funds that offer revenue sharing payments. This type of arrangement, however, still provides a plan with unlimited flexibility to select an investment lineup that it considers truly “best of breed” without regard to the potential implications the fund selections will have on the plan’s recordkeeping fees. This design allows plan sponsors and plan-designated investment advisors to fully customize their fund lineups based on the needs of their participants.

So, when hearing a recordkeeper stake their claim to offering an open architecture 401(k) platform, be sure to ask the following questions:
1) How many mutual funds are available for inclusion in the plan’s lineup?
2) How many mutual fund families are on the platform?
3) Are institutional share classes available?
4) How many ETFs are available on the platform?
5) Am I required to utilize a certain number of proprietary funds?
6) Will my fees vary based on the funds I select?

The answers to these questions will tell you very clearly if the firm offers an open architecture platform.

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