Are your employee benefit plan’s fees reasonable?
Posted On: 2-3-2016 | Posted By: Jon Class, CPA, and Kristen Brown
The Department of Labor’s 408(b)(2) fee disclosure regulations require service providers to disclose how much employee benefit plan sponsors are paying in fees.
As a result, plan sponsors now have more information at their fingertips than ever before about the fees being charged to administer their plans. However, sponsors may find the amount of fee disclosure information overwhelming and may also be uncertain how to use this information to fulfill their fiduciary requirements.
While it is important for plan sponsors to compare and evaluate the costs for plan services, it is just as important to consider the quality of the services being provided and how those services benefit the plan participants. Therefore, it is essential for a plan sponsor to have a process in place to evaluate the fee structure of its plan. This process should include the following steps.
IDENTIFY all parties receiving compensation from your plan.
Before you can begin assessing the fees paid by your plan, you’ll need to identify each of the service providers receiving compensation from your plan. Typical service providers include recordkeepers, investment advisors, brokers, and plan consultants.
Providers receiving direct compensation may be easier to identify, but you also need to consider those providers receiving indirect compensation. Indirect compensation is compensation received by service providers from a source outside the plan, which can include finder’s fees, brokerage commission, or other transaction-based charges resulting from plan transactions. The 408(b)(2) disclosures should provide a good starting point for identifying each of the compensated service providers.
Evaluate each provider’s qualifications, the scope and quality of the services, and the fees charged for each of these services. Not all providers are created equal, so just because one provider’s fees are lower doesn’t necessarily mean they are the best option for your plan.
Conversely, the provider who charges the highest fees may not necessarily provide the best services or the services that match your needs. To fulfill your fiduciary responsibility, you should gain an understanding of what each service provider does for your plan and monitor their performance to ensure you are receiving the services you were promised.
UNDERSTAND the fee arrangements
Identifying the current fees associated with your plan will provide a good starting point to determine if they are reasonable. Knowing how the fees are calculated is an important step in allowing you to compare your existing provider with other providers. Fee arrangements can be structured in a variety of ways, including per-participant fees, per-plan fees, and a percentage of total plan assets.
There are generally three types of fees: administrative fees, individual fees and asset-based fees.
Administrative fees cover such items as recordkeeping, accounting, legal and trustee services. Administrative fees often include a base fee, plus a per-participant fee.
Individual fees are charged based on transactions initiated by participants. Common individual fees include distribution fees and loan fees.
Asset-based fees cover expenses associated with the investment of plan assets and can vary greatly depending on the type of investments offered by your plan. Asset-based fees are less apparent as they are paid through a reduction of the plan’s investment return, so most participants never notice them.
Some service provider fee arrangements contain a revenue sharing component, which can offset expenses charged directly to the plan and its participants. In a revenue sharing arrangement, the investment fund manager rebates a portion of its investment fee to the service provider. As a result, the service provider charges less to the plan because it receives additional income from the revenue sharing agreement to offset it administration costs. However, the amount of revenue sharing can vary significantly by individual investment, so one participant could see a greater reduction in fees than another participant invested in a different fund. Read the agreements with your service providers carefully to determine if your plan is subject to a revenue sharing arrangement.
The fairness of participant fees is also an important, but complex, issue for plan sponsors to understand. Whether the participant fees are a fixed amount, a percentage of the total investment, or have a cap, they can affect participants differently based on their account balances.
For example, if a plan’s administrative fee is $100 per participant, a participant with a small account balance pays a higher percentage in fees relative to a participant with a large account balance. On the other hand, if a plan’s administrative fee is based on a percentage of total assets, a participant with a large account balance pays a larger fee than a participant with a smaller account balance, which can also be viewed as unfair. Your service providers and plan advisors can help you evaluate the most appropriate participant fee structure for your plan.
COMPARE your fees to the industry
As a result of the recent attempts to make plan fees more transparent, additional benchmarking data is available to compare your plan expenses to plans of similar size. Benchmarking your fees against industry data can give you a better idea of the reasonableness of your plan’s fees.
A 2014 study conducted by Deloitte found that plan size is a significant determining factor for plan fees. As total plan assets and participants increase, fees as a percentage of total plan assets tend to decrease. However, be cautious when benchmarking your plan’s expenses to industry data as it may not give you a complete picture of the type and quality of the services provided by various vendors. It is also important to consider the correlation between the services provided and fees, which can be a crucial factor in preparing your plan’s participants for retirement.
CONSIDER the value of the services for the fees being paid
It is important to determine if the fees being paid are reasonable in comparison to the value of the service you are receiving. You want to ensure the services are benefiting you as the plan sponsor, as well as the plan participants. Develop a list of the services that are currently covered by your plan fees and what additional services you would like to have included. These services may include management services, plan reporting, access to online participant accounts, compliance monitoring, and consulting. Then, prioritize these services according to what provides the most benefit to you and the plan.
Don’t lose sight of the fact the primary goal of offering a retirement plan is to help the plan participants build a retirement account that will allow them to have adequate income upon retirement. Therefore, you should measure the value delivered by your service providers not only in terms of the quality of service they provide and their ability to minimize your fiduciary risk, but also how they generate positive outcomes for the plan and its participants.
Ensuring your plan pays only reasonable expenses is one of the key responsibilities of a plan fiduciary, so it’s extremely important you have a process in place to do so on a regular basis. Evaluating fees can be a difficult and confusing endeavor, so you might consider hiring a consultant to assist with the comparison of a plan’s expenses against peer plans, or request a proposal from other potential service providers. However you perform this review, it is critical to establish a process through which the information is evaluated and decisions are documented. In the event of any future challenges, you’ll be glad you did.