Insights


Alternate Fee Calculation/Allocation Models

By now, most retirement plan sponsors have an understanding of the two primary methods used by recordkeepers  to charge fees to plans and participants:

  • As a percentage of plan assets - Typically expressed in hundredths of a percent, or basis points (e.g., ten basis points = one-tenth of one percent).  Under this method, participants with larger account balances are charged a higher fee, in terms of dollars, than participants with smaller account balances.
  • As a flat dollar amount per participant account balance - Otherwise known as a per-head or per capita charge (e.g., $50 per head).  The same flat dollar amount is charged to each participant, regardless of account balance size.

If you are looking for some additional background or need a refresher on these two approaches, be sure to check out my colleague Earle Allen’s article on the subject. Both methods have their advantages and disadvantages, which is why some recordkeepers have developed additional methods for charging fees that are modified versions of the aforementioned or incorporate elements of both. This edition of Top of Mind takes a closer look at these emerging models.

While a number of alternative models have been proposed by recordkeepers, the ones that appear to attract the most plan sponsor attention are:

  • Modified flat fee - As pointed out in my last Top of Mind on the subject, the use of flat dollar amounts per head can erode retirement savings at a critical time - when one has just started the process. Thus, some sponsors who decide on a per-head approach have decided to waive the fee for balances under a certain amount (e.g., $1,000). Others do not waive the fee, but charge a lower dollar amount for smaller balances.  Of course, waiting or lowering this fee for smaller balances increases the per-head charge for everyone else, so that may not always be a desirable solution. However, this fee methodology is relatively simple to communicate to participants.
  • Basis point allocation of flat dollar fee - This method takes the modified flat fee a step further. The fee is calculated as a per-head charge (e.g., $50 per head on 1,000 account balances = $50,000), but then the total dollar amount is allocated on a pro-rata basis to participants based on account balance size.  For example, if there were $50,000 in total fees ($50 x 1,000 account balances) and my average annual account balance represents 1% of total plan assets, my fee for that year would be 1% of $50,000, or $500. In theory, this hybrid approach takes the best of both basic models (% of plan assets and per head) without the primary disadvantage of either (fees growing as plan assets grow in the % of plan assets model, negative small balance impacts in the per-head model).  However, the model doesn’t work well if there are a lot of small balance accounts (e.g., in auto-enrolled plans, plans with high employee turnover, and plans where small account balances are not cashed out), since the dollars charged to high-balance employees become too cost-prohibitive.  And communicating this fee structure to participants? Good luck with that!
  • Percentage of assets/basis point fee with a per-head cap - This is a percentage of plan assets model (e.g., 10 basis points), where the recordkeeper has agreed to cap total dollars it collects at a fee per head (e.g., 10 basis points, not to exceed $50 per head). The fee, in theory, could be capped per participant account (e.g., 10 basis points not to exceed $50) but the more common approach is to cap the plan fee based on total dollars collected (e.g., 10 basis points, not to exceed a total dollar amount of $50 x 1,000 participants or $50,000). Thus, each participant account is charged 10 basis points until the dollar cap is reached, at which point the fees are frozen until the fees are under the cap again due to, say, an increase in the amount of participants. This hybrid approach also addresses the primary disadvantages of both basic models. However, it is often difficult for recordkeepers to price such a model in a manner that is fair to both the recordkeeper and the plan sponsor, and the method can be difficult to administer. Participant communication for the percent of assets model is similar in complexity.

As you can see, calculating recordkeeping fees and charging them to participants is a matter that should be carefully considered by fiduciaries, especially in light of emerging methods in this area (though it should be noted that not all recordkeepers will be able to administer all of the models described above). The best model for one plan may not be the best model for another due to demographic plan differences, such as the number of small account balances. Working with the proper advisor should enable plan sponsors to find the methodology for fee calculation and allocation that is best for them.

Do you have a question regarding the ever-evolving world of fee calculation and allocation? Feel free to message me on Twitter or email me at info@cammackretirement.com.  

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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