403(b) Curriculum Library


Fee Allocation: Which Methodology is Best for Your Plan?

Fee allocation within defined contribution plans continues to be a major topic of conversation among retirement plan oversight committees.  For the past several years, most plan sponsors have been focusing on the overall cost of their plan and the total fees paid out to plan service providers (e.g., recordkeepers, attorneys, investment advisors).  Their efforts have revolved around confirming that the fees in the plan are reasonable, based on the quantity and quality of the services provided.  Many plan sponsors undergo a regular benchmarking of plan fees to help with this confirmation.

Once it has been determined that the fees in the plan are reasonable, the next issue plan sponsors must tackle is how to allocate those fees.  In most cases, the participants, as opposed to the plan sponsor, share the majority, if not all, of the plan fees.  An issue over which plan sponsors are showing greater concern is whether these participant fees should be calculated based on a percentage of assets (and allocated pro rata) or whether all participants should be assessed the same flat dollar fee (i.e., per capita).  An important topic, this question has been raised in the recent complaints filed against the very large retirement plans of higher education institutions.

When fees are charged based on a percentage of assets, the participants with larger account balances contribute a greater amount towards paying for the overall cost of the plan.  For these participants, the percentage of the account balance paid may be the same as everyone in the plan, but the dollar amount is larger.  This is consistent with the methodology used for the allocation of investment fees.  An argument in support of this allocation method is that participants with larger account balances tend to be more active in their accounts, leading to more transactions both in the accumulation and de-cumulation phases of account ownership.  Since they are making greater use of the available services, they should contribute a greater amount towards the cost of administration.

When fees are charged on a per capita basis, every participant contributes the same number of dollars for plan costs.  This means that participants with smaller account balances pay a greater percentage of their total account in fees.  The rationale for charging everyone the same dollar amount is that everyone has equal access to the services available from the recordkeeper.  The person with the smaller account balance may be just as active in making transactions as the person with the large account balance, so there should be no difference in the fee amount charged to either.

What is the best approach for the allocation of fees?  It depends.  It is primarily a philosophical discussion as to which method is more reasonable and prudent for any given organization.  In some circumstances, where a flat fee is used, the plan sponsor has implemented $0 fees for participants with account balances below a certain threshold, charging a flat fee to the participants with balances over that amount.  The available options may be impacted by the capabilities of the plan’s recordkeeper and the allocation approaches they can offer.

It is important to remember that the Department of Labor has not stated that any one fee allocation structure or methodology is more appropriate than another.  Thus, there is no “correct” way to allocate fees, making it a little more of an art than a science.  Although the complaints in the lawsuits say that all recordkeeper fees should be based on a flat dollar amount, this does not seem like a reasonable assertion, if for no other reason than all mutual funds (the primary investment vehicle in these plans) charge expense ratios based on a percentage of assets.  Why should the recordkeeper charge flat dollar amounts when the mutual fund investment managers do not?

It is required that plan fiduciaries review fee structure and allocation on a regular basis to determine the most reasonable approach for their organization’s plan, and it is vital to ensure that any potential conflicts of interest are minimized.  Often, the members of the retirement plan committee are among some of the organization’s higher paid employees and certainly have the most familiarity with the plan, which can lead to higher account balances.  As these committee members decide whether it is more equitable to allocate fees on a pro rata basis (which would likely cost them more) versus a per capita amount (which would likely cost them less), they must dismiss their own personal situation and make a judgment in terms of the best interests of the plan participants as a group.  While this is not always the easiest task, it is a critical one in fulfilling their fiduciary responsibilities to the plan.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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