News & Resources


Retirement Plan Fee Equality

By Anthony Agbay

 

The Employee Benefit Security Administration (EBSA) agency’s investigators recovered $599.7 million in direct reimbursements for employee benefit plans and participants during 2014.  The total came from 3,928 civil investigations closed by EBSA in 2014, with 2,541 of those cases (64.7%) resulting in monetary compensation for plans or other corrective action. 

 

In an increasingly transparent and a heightened regulatory environment, there is still a need to go above and beyond the minimum standards of retirement plan compliance. Think about it, the minimum standards are actually the least amount of activities, protocols and procedures necessary to comply with regulations.  Doing the minimum is not enough and plan sponsors should lead their regulatory efforts in a commonsense fashion by exceeding the least amount of oversight required.

 

Obviously the Department of Labor (DOL) is looking for low hanging fruit in its regulatory enforcement efforts.  While fee equality does not currently “hang on the tree” as a hot button, pundits believe it soon will.  It is imperative consultants and plans sponsors, whenever possible, anticipate the next wave of regulatory scrutiny.  It will not be surprising for the DOL to soon be asking what efforts plan sponsors have established to make sure fees are equitable (this is a completely different conversation than “reasonable”) and to ensure there are no disproportionate amount of fees paid by some while others do not pay their fair share.

 

The current fee structure in 401(k) and 403(b) plans often has some participants paying a larger cost of plan expenses while others pay less, or sometimes, even nothing. This form of fee subsidization is anything but fair.  Participants in a company sponsored retirement plan typically have identical features: the same investment options, the same access to the plan investment consultant, etc.  If that is the case they should also pay identical fees (as a percentage or per participant charge) pertaining to the cost of plan-related expenses.

 

Of course different mutual funds have different investment expenses. Those are certainly going to vary depending on which funds the participants choose. However, there are often fees built into those funds [12b-1 and sub transfer agency (Sub TA fees)] that go toward covering the cost of plan administration and consultant fees. Those fees could range significantly from fund to fund.

 

Case Study

Let’s look at a hypothetical $50 million 401(k) that requires .20% in revenue ($100,000) to run the plan by the plan administrator.  Assume the following:

 

1.   One mutual fund in the plan pays 0% in revenue sharing while the others pay .40%

2.   Half of the plan assets and participants are divided evenly between those two funds as indicated in the chart below

 

 

Number of participants

Assets per investment

Revenue sharing per investment

Amount paid per investment

Investment A

250

$25 million

0%

$0

Investment B

250

$25 million

.40%

$100,000

 

 

In this case, 250 employees in Investment A paid nothing to cover the cost of administering their retirement plan.  Their fair share should have been $50,000 but they paid $0.  The other 250 participants in Investment B paid a total of $100,000 - the entire amount required to run the plan. They overpaid by $50,000 to subsidize the $50,000 shortfall from participants in Investment A.

 

Therefore, half of the plan participants are paying nothing to administer the plan while the other half are paying for all the participants. This is an obvious subsidy and unfair overpayment by 50% of the participants.  A fiduciary breech occurs when a participant pays for something and does not receive a service in return for the payment.  In this case there is a service received but there is also an excess charge/overpayment by half the participants – they are paying twice the cost they should.  If the payment is not adjusted, this could be considered an excessive payment by the plan participant.  Unless each fund in a plan's investment menu pays the identical revenue share, the plan is a participant subsidized plan with overpayment of expenses for some and unfair benefactors for others. This situation occurs in many 401(k) and 403(b) plans.

 

Solutions

 

The obvious solution would be to have an investment menu that pays identical revenue for each choice - this is not a practical solution unless using a single family investment menu (this too, is not ideal). 

 

A second option is to use funds with no revenue (zero revenue option) and tack on the same cost for every participant creating identical plan level expenses (again the specific mutual fund costs will vary). This option seems logical and quite reasonable. Only fee-based consultants (and not commission-based brokers) can offer this solution so you may receive some pushback that this solution is not an option.

 

A third option is to have an investment menu that pays varying fees – but with a fee equalization twist. The twist is to reimburse those that overpaid and to debit those participants that were the benefactors of underpayment. In the example stated above, those investors that paid .40% when the required revenue was only .20% should be rebated the difference of what they overpaid (.20%). Conversely those investors that paid nothing should be required to pay their fair share and be charged .20%. In this example, although the funds charge varying plan level expenses, the participants are debited or credited to create a leveled cost structure.  This is a fair approach, which does not disenfranchise any participants and levels the costs for administering the plan evenly across the participant base.

 

From a fiduciary standpoint, these leveled solutions are an excellent way to avoid any real or perceived conflicts of interests.  For example, conflicts could occur when a consultant recommends investing in higher revenue generating funds and avoids those that pay less revenue.

 

Eventually I believe the DOL will soon place fee equality in its crosshairs as a regulatory enforcement issue.  Proactive compliance efforts and substantiating the process is one of the best approaches to insulate fiduciaries from breaches in their legal duties. 

 

Anthony Agbay is a Certified Financial Planner, Accredited Investment Fiduciary and an independent retirement plan consultant.  He was included in the Financial Times 2015 Top 401 Retirement Plan Advisors nationwide.  For questions about this topic, Anthony Agbay can be reached at aagbay@agbaygroup.com or www.agbaygroup.com.

 

 

 

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