Understanding Retirement Plan Expenses and Fees

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Retirement plan sponsors are becoming more aware of retirement plan expenses and how these expenses affect a participant’s ability to be ready to retire. Understanding and assessing plan expenses are also an important ERISA fiduciary duty.

While there is no ERISA statute that assists plan fiduciaries in determining how to assess plan expenses, the Department of Labor (DOL) Field Assistance Bulletin 2003-03 states that “ … a plan sponsor … has considerable discretion in determining the method of expense allocation.” The Bulletin also states that “A fiduciary must be prudent in the selection of the method of allocation.”

Your decision-making will require you to understand costs that are involved.

You may be thinking…

What should fiduciaries be doing with respect to plan expenses?

It is important for plan fiduciaries to determine the value of plan services received in relation to the expenses being charged to the plan, as well as understanding how these expenses are being paid.

To do this, the best method is to conduct and document a prudent process of determining the appropriateness of all plan expenses and determining the best way to pay plan expenses.

Benchmark Plan Expenses

All retirement plans incur plan expenses. With the advent of the 408(b)(2) disclosure requirement, all vendors receiving compensation from a retirement plan must disclose the amount received from the plan.

Plan fiduciaries are responsible for making sure they have disclosures from every vendor receiving compensation from a plan. Fiduciaries also have the responsibility to determine the reasonableness of this compensation. An effective way to assess the reasonableness is to conduct a benchmarking study. This can be accomplished by completing a Request for Information (RFI) or Request for Proposal (RFP) process. An RFI or RFP is the best way to benchmark plan expenses using the actual plan demographics, plan services provided and design of the plan.

The DOL does not require a plan to utilize the services of the lowest cost provider(s). Plan fiduciaries are required to assess that plan expenses are reasonable, given the level, quality and value of the services received.

Plan Expenses and Revenue Sharing

If plan expenses are paid by the plan, revenue sharing has been a traditional method used to pay plan expenses. Revenue sharing is a method by which investment fund companies build plan service expenses into the overall expense ratio of a fund.

Investment fund companies retain a portion of the expense ratio related to investment management, compliance and other administrative services associated with the management of the fund, and remit a portion of the expense ratio (revenue sharing) to service providers to cover plan administrative expenses, such as maintaining participant account records, preparing statements, staffing call centers, maintaining web sites and providing participant education.

Prior to the 408(b)(2) disclosures, revenue sharing was not readily visible to most plan sponsors. Today, revenue sharing is still invisible to plan participants, since revenue sharing does not need to be explicitly disclosed to them. This is often cited as to why many plan participants view plan services as free because the revenue is not being explicitly deducted from their plan accounts. These reductions are instead reflected in the investment returns of the plan funds.

Fee Leveling and Impact on Revenue Sharing

Plan fiduciaries are becoming more aware that traditional revenue sharing methods often create imbalances among plan participants.

For example, the table below outlines the impact of revenue sharing for three different participants based upon the selected investment fund. Investment Option A has 25 basis points in revenue sharing. Investment Option B has 10 basis points in revenue sharing and Investment Option C has no revenue sharing. In this example, each participant invests in only one investment option and plan administrative expenses total 15 basis points.

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In this example, the three participants pay different levels of plan administrative expenses. These real differences and the perceived inequity of paying administrative fees through revenue sharing are a primary reason plan fiduciaries are beginning to explore alternative ways to allocate plan expenses to participants.

Fee Leveling Alternatives

Plan sponsors have several alternatives to consider should they decide to level the amount of expenses paid by participants. Some of these options require the ability of the plan’s service provider to properly allocate fee credits and charges to individual participants.

Fee leveling options include:

  • Eliminate revenue sharing paid by the investment options in the plan and charge administrative fees to participants, either on a pro rata or per capita basis
  • If the plan sponsor elects to continue offering investment options with revenue sharing, the decision can be to adjust revenue sharing for all of the investment options so that all investment options are sharing the same amount of revenue to the plan. Some participants may receive a credit for excess revenue collected, while others are charged for the revenue shortfall to allow for the level payment of plan expenses.
  • If the plan sponsor elects to continue offering investment options with revenue sharing, the decision can be to credit all revenue sharing back to participants. Then the plan charges plan expenses to participants on either a pro rata or per capita basis.

Fee Application – Pro Rata, Per Capita or Combination

Once plan expenses have been determined to be at an appropriate amount, the decision needs to be made as to the most appropriate way to charge plan expenses to plan participants. Plan expenses can be paid by the organization sponsoring the plan and are often tax deductible.

Otherwise, the decision can be made to charge plan expenses against the plan forfeiture balance, if available, or be charged to the plan and its participants.

Plan expenses can be charged to participants on a pro rata, per capita or combination basis:

  • Pro Rata – Expenses to be paid on a pro-rata basis are charged to participants on a percentage of their plan account balance. In the pro-rata scenario, participants are charged the same percentage charge relative to their asset balance. Therefore, participants with higher account balances pay a higher level of expense than those with a lower account balance.
  • Per Capita – Expenses to be paid on a per capital basis are charged with each participant receiving the same charge. The same amount is charged to each participant without regard to the participant account balance. While the per-head charge is the same for all participants, the percentage amount paid by each participant may vary widely, and the amount charged to smaller account balances may be relatively significant.
  • Combination – Expenses may be charged to participants in a combination of pro rata and per capita basis. This combination approach is a possible compromise to mitigate the higher per head charge to lower balance participants and the higher nominal charges to participants with higher asset balances. For example, each participant is charged $5 per quarter, plus a 10 basis point charge on the assets in each participant’s account.

Conclusion

Plan fiduciaries have a responsibility to confirm that plan expenses are appropriate and reasonable for the services, quality and value provided to the plan. Fee transparency provided to plan sponsors from plan fee disclosures and with the assistance of a qualified plan fiduciary consultant can help plan sponsors determine the reasonableness of plan expenses. Another important step is to prudently select a method to allocate plan expenses to participants.

As experienced consultants serving ERISA fiduciaries, Highland assists clients with this important process. Our firm also has successful experiences assisting clients with an RFI and/or RFP process to determine, compare and negotiate plan fees. We also work with clients to determine the most appropriate process to attribute plan expenses to participants to meet fiduciary responsibilities.

photo credit: Understanding By Blue Diamond Gallery

Kelly O'Hara

Kelly has more than 35 years of relevant consulting, finance and investment experience. She has extensive experience in establishing client objectives, policies, procedures, plan design and investment monitoring. She has assisted clients with all aspects of their plans including manager selection, ongoing analysis and monitoring of investment results and employee education. Kelly is also a member of Highland’s research team and has substantial experience with financial, credit and cash flow analysis. Kelly has a B.S. degree from West Virginia University, graduating magna cum laude. She earned an MBA degree in finance from The University of Akron. Kelly holds the Retirement Plan Analyst designation, the Certified Employee Benefits Specialist designation, and is an ISCEBS fellow.

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