There has been a tremendous amount of focus on participant-assessed fees in 401(k) and 403(b) plans over the last couple of years. This has come about, in part, because of lawsuits and the Department of Labor (DOL) regulations that require greater fee disclosures to both plan administrators and participants. While it has been slow to develop, the focus on fees is a natural progression from traditional pension and profit sharing plans, where employers paid most of the expenses, to 401(k) plans as the primary source of retirement benefits where participant accounts and plan assets pay the lion’s share of administrative costs.
Plan administrative committees who ignore these issues could find themselves busy as defendants in excessive fee lawsuits. It’s far better to respond to the emphasis on fees in several ways that will reduce fiduciary risk. In 2012, the effective date arrived for service providers to deliver fee information to plan administrators. These “408(b)(2) fee disclosures” were part of the DOL regulations which established the proposition that if the fees charged against plan assets are not reasonable, the plan administrator has breached its fiduciary responsibilities and committed a prohibited transaction. Thus, plan administrators who have allowed more than reasonable expenses to be charged against participant accounts are not only accountable to the participants for the excess, but are also subject to sanctions by the DOL for a prohibited transaction.
Having received the 408(b)(2) fee disclosures, plan committees were urged to review them carefully. Is the disclosure complete? Are the fees reasonable? A conclusion that the disclosure met the regulatory requirement was only step 1. Deciding that the fees are reasonable is a bit more difficult. Often the service providers themselves had a description and comparison for their clients that accompanied the disclosures to show their fees, in comparison to industry averages or some other standard, were reasonable. One approach has been to add up all the fees and show the cost as an “all in” amount, expressed as a percentage of plan assets. Because many plans cover administrative and other costs largely out of asset-based fees, an expression of total costs as a percentage of assets (or as so many basis points) is consistent with much of the media coverage of 401(k) plan costs. For example, a recent Wall Street Journal article published median fee levels for 401(k) plans based on the size of plan assets and expressed them as a percentage of those assets.
The second part of the DOL regulations is the fee disclosure to participants. Having to make these more detailed disclosures to participants has increased the likelihood that participants will be asking questions and increases the risk of fiduciary exposure if participants are not pleased with the answers.
Paying plan administrative costs with asset-based fees presents issues of fairness and can be problematic if not followed carefully over time.
On timing, consider the 401(k) plan with 100 participants at the end of 2012 and total plan assets of $4 million. Assume the plan has about $300,000 in net contributions for 2013, with plan assets growing by 20% from investment performance, yielding plan assets at the end of 2013 of $5.1 million.
If this plan had a stable workforce and experienced no more than average plan activity (retirements, new hires, etc.), it might be concluded that administrative costs would remain fairly constant. The recent trend, in fact, has been to see administrative costs go down as the result of improved technology. If this plan paid administrative fees strictly on an asset-based model, however, its fees would go up by over 25% simply as a result of the growth in plan assets. What was reasonable for the 2012 fees may have become unreasonable in 2013.
This problem can be addressed with thoughtfulness and creativity in working with the service provider. Suggestions include capping asset-based fees at a dollar amount per participant, or agreeing on a flat administrative cost per year. Investment fund fees that may come to a service provider (sub-advisor, 12b-1, and other fees), can be reallocated to participants through an ERISA account in the plan. An “ERISA account” is a plan account that is not held in the name of an individual, but rather it is a temporary holding account for the asset-based fees paid from the plan’s investment funds. An ERISA account is generally reallocated in some manner on an annual basis.
A second issue of fairness among participants arises in many plans because the asset-based fees generated by plan investments are not spread equally over all investment funds. Employer stock funds, for example, typically generate no asset-based fees that can be used for administrative purposes. Among mutual fund choices, some funds may generate 40 basis points (0.40%) to a service provider while others generate nothing. It is not fair on an individual participant level if one participant’s investment choice provides 40 basis points toward the cost of administration, and another participant, due to different investment choices, “contributes” nothing toward overall plan costs.
Again, this potential disparity among participants, even if overall plan costs are reasonable, can be addressed through the plan’s service agreement and fee structure, as well as the use of an ERISA account.
The concept of “fairness,” however, can be elusive. While it might be argued that total plan costs can be accurately expressed as a flat dollar amount per participant, the truth is more complex. Different participants utilize plan resources, such as a website, daily trading, etc., at different rates. Even if resource utilization is relatively equal, it may not seem quite right to charge a newly hired participant, starting out with a zero account balance, the same administrative amount as a participant with a $500,000 account balance. Some blending of per capita flat fees and asset-fees, therefore, may be appropriate.
The principal point here is that individual account plan service agreements and fee structures should not be once-negotiated and left on auto-pilot. Fairness, as well as fiduciary responsibility, demand that these agreements be reviewed annually. In addition, an annual fee and service agreement review may be far more beneficial to participants than time spent going over a review of global markets, prognostications on interest rates, and projections of economic trends in the U.S., Japan, Europe, and China. Attention to plan fee structures and overall costs will minimize fiduciary risk and improve participant retirement prospects.