“The fund companies pay all of the fees for our 401(k)…” If you’re a fiduciary and have ever uttered any variation of that phrase, you might want to ask your plan’s adviser about your situation and the risks you are taking.
While the practice of mutual funds paying back revenue sharing in the form of 12b-1 and Sub-TA fees is common in the 401(k) industry, a prudent plan sponsor should not consider this a “wash” against the fees they owe to plan service providers.
Fee disclosure is coming, and while the final implementation date may or may not be pushed again, we will eventually get there. When we do, the industry is preparing for a potential backlash from the rank and file employees that have been paying fees for their company’s retirement plan all along without realizing it.
Recently I had lunch with a friend, Ron Sanders of Sanders Booze Capital Advisers, where the conversation moved to fee disclosure (don’t judge us, it was a good conversation). As we discussed the obvious issues, he pointed out a concern that plan sponsors may face - HCEs overpaying for certain services.
Let’s walk through this example.
A plan fiduciary, doing his best to fulfill his fiduciary responsibilities does a fee benchmarking study to find out how their fees compare to similar companies. And let’s say for the sake of argument that recordkeeping services come out to be $100 / participant, which given the company demographics and size seem reasonable. Following fiduciary best practices, the study and results are documented.
Let’s also assume that this plan has entered into an arrangement with their plan administrator to offset the administrator’s fees with the Sub-TA fees from the plan’s investment options, instead of billing directly for their services.
For the sake of simplicity, let’s say there are 100 participants in the plan with total assets of $5 million. If you work through the math, the $100/ per participant fee works out to be $10,000 or 20 basis points.
Now the basic functions of recordkeeping are the same whether a participant has a $2,000 account or $200,000 account – account maintenance / transactions, call center, website, statements, etc. So when fee disclosure does finally happen, which poses the bigger risk: the participant with a $2,000 account who has paid $4/ year for recordkeeping services or the participant with $200,000 who has paid $400/year? Remember, the plan’s fiduciary fee benchmarking study shows $100 is a reasonable expense. So the $400 amount is four times the reasonable amount.
How does a plan fiduciary respond to participants who question the fees; particularly if it is a long-term employee that has likely taken a beating on returns over the past couple of years? Now they find out later that they are paying four times the amount that the plan deems reasonable for the services being provided. It could get ugly.
I encourage all plan fiduciaries to look closely not only at the fees being paid on an aggregate level, but also at a participant level to determine appropriateness. There are some fees that do make sense when charged as basis points such as investment or account management. But some services make more sense from a practical matter to be charged on a per participant basis. Evaluate carefully, and as with any fiduciary decision, document your process and decision.
Scott Swezy
VP Smart401k