As a retirement plan fiduciary, you have an obligation to consider the fees incurred by the plan. Do you know the true cost of your retirement plan? And do you know if those costs are reasonable?
Higher plan fees can make a significant impact on the growth of retirement accounts. Consider this example cited by the Department of Labor: If an employee with 35 years until retirement has a current investment of $25,000 and expenses on the investments of 0.5 percent, the account balance would grow to $227,000 at retirement, even if no additional contributions were made. If the same employee incurred 1.5 percent on the account in fees and expenses, the same account balance would grow to only $163,000 by retirement. The one percent difference in expenses could reduce the balance at retirement by 28 percent.
ERISA requires plan sponsors to exhibit a high standard of care and due diligence to ensure that fees and expenses paid on the plan are reasonable for the level and quality of services provided by the service providers. And unfortunately, fees can be structured in different ways, making it more difficult to conduct a true comparison.
Bundled vs. Unbundled
It can be confusing to compare fees between providers. Employers can directly provide or negotiate separately for some or all of the various services and investment alternatives offered under their retirement plan. In this “unbundled” approach, the expenses of each provider are charged separately – from the investment manager, custodian, third party administrator and recordkeeper, for example.
In a bundled arrangement, some or all of the various services and investment alternatives may be offered by one provider for one fee. That provider would then pay out of that single fee to any other service providers it may have contracted with to provide services. Generally, a bundled approach results in lower costs than an unbundled product.
Some plan sponsors use an arrangement that combines a single provider for administrative type services with a number of providers for investment options.
Types of Fees
Your plan’s fees and expenses will generally fall into three types: administration, investment and individual fees.
The necessary day-to-day services such as recordkeeping, accounting, legal, custodial and trustee services are normally included in administrative fees. However, other items such as telephone voice-response systems, customer service representatives, electronic access to the plan or retirement planning software may also be included.
The cost of administrative services can be deducted directly from the investment returns, paid by the plan sponsor or charged directly against the assets of the plan – either proportionately by individual account or as a flat fee for each participant. In general, the more services provided, the greater the fees.
The largest segment of retirement plan fees and expenses is found in investment management. Since these fees are generally deducted from investment returns, and statements normally list net investment returns (after the fees are deducted), you may not see them. Included in investment fees are sales charges, also known as loads or commissions, the transaction costs for buying and selling shares. There are many ways to calculate commissions depending on the particular investment product, such as front-end load, where you pay the fee upon investing in a fund, or back-end load, where you pay the fee when you sell shares. Management fees are ongoing charges for managing the assets of the investment fund are usually set at a percentage of the amount of assets invested in the fund. The level of management fees can vary greatly depending on the investment manager and the nature of the product, such as share class and associated risk/return. When funds are actively managed, the advisor continually researches, monitors and actively trades the holdings to seek a greater return. Actively managed funds generally have higher fees. When funds are passively managed, they require less research and management and therefore results in lower fees. Keep in mind that neither active management nor higher fees necessarily guarantee higher returns.
Individual Service Fees
Individual participants in the plan can incur service fees if they take advantage of an optional plan feature, such taking as a loan from the plan or executing self-directed investment direction. Since these are very specific choices made by an individual, it stands to reason that the costs associated with the action is associated with that individual’s account specifically.
In addition to the fees mentioned above, some providers may charge separately for recordkeeping, furnishing statements, toll-free telephone numbers or providing investment advice. These fees can be stated as a flat rate or as a percentage of the amount of assets invested.
Variable annuities purchased through insurance companies can also have insurance-related fees or surrender and transfer charges, so be sure to review the terms of the sales contract. Some mutual funds are advertised as “no load” funds, which does not necessarily mean that no costs are associated with that fund. Charges known as 12b-1 fees may be charged by these mutual funds. 12b-1 fees are ongoing fees paid out of the fund assets for items such as broker commissions, advertising to promote the funds to investors and payments to various service providers in a bundled services arrangement.
How to Review Fees
The myriad of fee structures creates confusion for plan sponsors in determining costs and the best alternative in administering a plan. Because of this, the Department of Labor is working to create greater transparency in fees paid by a plan by requiring additional disclosures relating to fees paid with the Form 5500 filing. Providing these additional disclosures alone does not meet the plan sponsor’s fiduciary responsibilities relating to fees. Review the fees paid by the plan and determining whether those fees are reasonable is also required to fulfill fiduciary responsibilities.
In addition to the plan sponsor meeting periodically with advisors to review fee and other information, it is a best practice to have an independent benchmarking report prepared. An independent benchmarking report is a tool that can gauge your plan against other plans of similar size in terms of plan parameters/features, participant success measures and fees. Since there are several providers of benchmarking reports, use caution in the service selected to ensure it is the most objective and providing data that truly results in an apples to apples comparison between your plan and other plans.
Monitoring retirement plan fees is just one of the many responsibilities of a plan fiduciary, albeit an important one. Higher fees are certainly not a guarantee of higher returns for plan participants, and could be detrimental to reaching retirement goals. By using the tools available to you, your retirement plan can work to receive maximum services at reasonable fees – helping both you and plan participants reach your goals.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.