In general, most 401(k) plan participants should not bear a higher proportion of a qualified retirement plan’s administrative costs than other participants because of their investment choices. Yet that is the reality for many participants.
What is the Problem?
Many plans offset some of the administrative or recordkeeping costs through expense reimbursement from the plan’s investment options. These expense reimbursements are often referred to as “revenue sharing.”
Revenue sharing is built within a mutual fund’s expense ratio. Thus, depending on the chosen fund, participants may be selecting funds with more revenue sharing built into the fund’s cost than other available options. As a result, a significant portion of plan costs may be paid for by individuals who select high-cost funds because of the various payments charged including 12b-1 fees, shareholder servicing fees, sub-transfer agency fees and commissions.
This means that if two participants have the same account balances but are invested in different funds, one could be paying much more in plan administration fees. There is a good chance the participants are unaware of their 401(k) investment costs as well. In reality, figuring out how much a participant is paying in expenses requires more work than just looking at a recent investment statement.
Plan sponsors should examine whether this is occurring within their own plans. Allowing what is essentially a discriminatory practice to occur could be construed as a fiduciary breach. And it is unfair to those participants who are paying a disproportionate share of plan administrative expenses.
What to Do About It
What can you do to reasonably allocate fees? A “fee equalization” strategy can include the following steps:
Review how your plan distributes administrative fees among your participant population. If disparities exist, be sure you have a clear rationale to justify such distinctions.
Cover the Cost of Administrative Services
If possible, choose a set of funds for your plan that does not reimburse vendors for administrative services. Instead, have the plan itself cover administrative services and deduct them from participants’ accounts in a consistent fashion. Do not be afraid to ask for lower fees. The opportunity to renegotiate operating expenses may exist.
Choose Institutional Share Fund Classes
These fund classes generally reduce asset-based fees overall and provide for fee transparency. Most institutional funds have no revenue sharing and pay no 12b-1 fees.
If you still want to charge all participants the same administrative fee regardless of the level of assets in their accounts or the nature of the investments, use an investment lineup that applies a discrete fee to participant accounts on an ongoing basis, typically monthly or quarterly.
Do Not Wait to Act
401(k) plan fees and their connection to a plan sponsor’s fiduciary duties is one of the most litigated areas in retirement planning. To avoid problems, maintain internal processes to monitor whether your plan’s costs are reasonable for the offered services. An annual review of your plan’s allocation of administration fees should be standard.
For questions, contact Stephanie Zaleski at [email protected] or call her at 312.670.7444. Visit ORBA.com to learn more about our Employee Benefit Plan Services.