August 14, 2022

Bucks: Getting Cheaper Vanguard Funds in Your 401(k)

In response to Ron Lieber’s column on why 401(k) plans should offer more low-cost index funds, a reader wrote asking why, as a 401(k) participant, he can’t buy a lower-expense class of Vanguard shares that are available to clients who have individual Vanguard brokerage or IRA accounts.

Libin Zhang, a lawyer in New York City whose employer has less than 50 workers, says that in his 401(k), he can buy “Investor” class shares of a REIT index fund (VGSIX) which has an expense ratio of 0.26%, for instance. But he can’t buy “Admiral” class shares of the fund (VGSLX), with an expense ratio of 0.13%.

Mr. Zhang says he has roughly $20,000 in VGSIX — more than the minimum $10,000 investment required for Admiral pricing in VGSLX for individuals — but he is stuck with the higher expense ratio because he is part of his employer’s group plan.

“If my account could have been eligible for Admiral class shares had I set it up as a brokerage account,” he wondered in an email, “why should I be penalized for using my employer’s retirement plan?”

Bucks asked Vanguard that question, and the answer has to do with both plan costs and regulatory requirements.

A Vanguard spokeswoman, Linda Wolohan, explained in a series of e-mails that details of access to various funds vary depending on whether a retirement plan is “recordkept” at Vanguard — meaning, whether Vanguard actually administers the plan for the employer. If that’s the case, and a plan qualifies for Admiral shares but doesn’t offer access to them, it’s probably because the plan, and perhaps its employee participants, would have to pay extra fees to cover administrative costs if it did offer them. To be certain, “it is best that the reader direct his question to his employer.”

But in general, Ms. Wolohan said, the criteria for access to Admiral shares is different in a retirement plan than in an individual account. A big reason for that has to do with the relative cost of administering such accounts: 401(k) plans are far more complex and expensive to administer than individual plans, what with accounting for payroll contributions, loans, participant education, regulatory filings and the like.

The revenue from lower-expense share classes “might not be enough” to compensate for all that extra busywork, which means employees might have to pay higher administrative fees in order to access those type of shares. In short, an employer “understandably might want to access a lower-expense option, but has to balance how to offer that and still compensate the recordkeeper” — Vanguard, or whatever firm is administering the plan– “for its costs.”

Regulation also plays a role. Internal Revenue Service rules, she said, prevent plans from allocating expenses in a way that favors “highly compensated” employees. Because the balance in an employee’s account “strongly” correlates with their pay, offering different share classes to participants within the same plan, based on their individual balances rather than on the overall plan balance, could violate those rules. (In other words, giving Mr. Zhang access to some lower-expense funds in his 401(k) plan because of his higher balance in the 401(k) plan or in individual brokerage accounts, but not giving that access to other plan participants, isn’t allowed.)

“Your reader should take heart,” she added, “in knowing that Vanguard funds are low cost no matter what share class he/she is in — the average expense ratio for Vanguard funds was 0.21% in 2010, versus the industry average expense ratio of 1.15.”

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