Fee Allocation in Retirement Plans
The simplest way to pay for recordkeeping expenses is to have the organization pay all of the fees directly, eliminating any question about the fairness of fee allocation among participants. However, most organizations are under pressure to reduce expenses and do not want to assume these plan fees. Paying for the administration of the retirement plan adds an expense to the bottom line, which most plan sponsors have, instead, chosen to pass onto their participants.
There are numerous options available to allocate plan expenses among participants, each having its own positive and negative attributes. Below we explore the three most popular models and the associated benefits and drawbacks.
Participant Fee Allocation ModelsThe first two models use “revenue sharing”, also known as recordkeeping offset, as a key component in the payment of recordkeeping fees. Revenue sharing amounts are fees built into the expense ratios of the plan investments, used to offset plan expenses. Typically, recordkeeping fees are the primary expense covered by revenue sharing.
One fee allocation model incorporates the use of an expense reimbursement account (ERA), also known as a revenue credit account. In this model, the recordkeeper charges a flat rate, also known as “required revenue”, for its services (typically expressed as a percentage of plan assets, e.g., 0.20%). Revenue sharing amounts in the plan investments are then applied to these fees.
If the total revenue sharing is insufficient to meet the cost, the recordkeeper charges an additional fee to cover the shortfall. The organization may elect to pay this amount directly or to pass it on to participants. If the total revenue sharing exceeds the required revenue, the excess amount is allocated to the plan’s ERA. The organization can then use this excess revenue sharing to pay for legitimate plan fees, such as auditors, legal counsel, advisors, communication initiatives, and other plan expenses, or return the excess amount back to participants.
Another model that has been gaining in popularity is fee levelization. In this model, the recordkeeper applies the required revenue to each individual investment option. If the investment has exactly the required revenue amount (0.20% in our example) in revenue sharing built into its expense ratio, then the fees match. If revenue sharing in Cammack Retirement Group | ©2016 All Rights Reserved | For Plan Sponsor Use Only 2 the fund exceeds required revenue (e.g., 0.25%), the recordkeeper credits each participant, who has assets in the fund, with the amount of the excess (in our example, 0.25% - 0.20% = 0.05% credit returned to participants). If the investment provides less than the required revenue amount, the recordkeeper adds a “wrap” fee, in the amount of the shortfall, to the accounts of each participant using the investment. A participant with several different investments might experience multiple credits and debits based on the revenue sharing in each investment, relative to the required revenue.
A third method for covering recordkeeping fees is to charge a flat dollar amount to each participant. The recordkeeper charges a fee and deducts the stated amount from each account either annually or quarterly, and the participants see this amount on their statements. This is the simplest methodology to implement, as well as to communicate to participants.
Evaluation of the Models
The ERA model is likely the most widely used of the three. As described above, revenue sharing fees in the expense ratios are allocated towards the recordkeeping service expense. These fees are disclosed to participants on an annual basis; however, many participants do not review their statements in detail, and thus may not be aware of the recordkeeping costs to administer the plan. As such, there tends not to be many questions raised by participants with this model.
One challenge with the ERA approach is the variability of the revenue sharing built into the investments. Not every investment contributes the same revenue sharing amount towards meeting plan expenses. If participants begin transferring assets into an investment that has very little revenue sharing, the overall fee collection for the plan will decline, potentially causing a shortfall. Also, when replacing an investment in the lineup, the organization needs to be mindful of the revenue sharing amounts available in the new investment, relative to the one being replaced. This requires that the organization work with its advisor to select the appropriate investments for the plan, and the necessary share classes of each investment, so that the revenue sharing amounts will be sufficient to cover the recordkeeping costs.
Additionally, in the ERA model, participants do not share the cost of the recordkeeping fees equally. Depending on the individual investment allocation selected by a participant, they may be paying exactly the proportionate share of the plan fees, or an amount that is more or less than the required revenue.
For example, if the required revenue is 0.20%, and some participants select investments that pay 0.25% in revenue sharing, those participants are contributing 0.05% more than their proportionate share of the fees. Conversely, participants selecting investments that pay 0.10% in revenue sharing pay significantly less than their proportionate share. Due to this, under the ERA model, some participants pay the recordkeeping fees for others.
The fee levelization model solves both the overall plan collection problem, as well as the individual participant allocation concern. Each investment option contributes exactly the required revenue amount when combined with the associated wrap fee or fee credit. Regardless of how participants allocate their assets or what investment is added to the lineup, the revenue sharing received by the recordkeeper will be exactly enough to pay for its fees. Additionally, all participants contribute an equal proportionate share of the plan recordkeeping fees, regardless of their selected investments. While the dollar amount is not the same, participants do pay the same percentage as their proportionate share of the total plan assets.
However, this model can cause confusion and concern for participants as they encounter the associated fee credits and/or wrap fees on their quarterly statements. Plan sponsors need to distribute communication materials to help explain the statement listings, responding to inquiries that arise.
Plan sponsors can simplify this fee levelization scenario by selecting an array of investment options that has no built-in revenue sharing. With zero revenue sharing, the recordkeeper needs to charge the full required revenue amount to each investment. This is typically easier for participants to grasp, as they see the full amount of their share of the recordkeeping fees with each statement, rather than a series of credits and debits. However, constructing a lineup of entirely zero revenue sharing funds may not be possible, and depends on the investments available on the recordkeeping platform.
Plan Sponsor DecisionsIn most cases, philosophical perspectives will drive the organization’s decisions. The ERA model leads to participants paying a disparate portion of the overall plan costs. With the fee levelization model, participants pay an equal proportionate share of the recordkeeping fees. However, this means that the participants with larger account balances contribute greater dollar amounts than those with smaller balances. In our example, a participant with a $100,000 account balance pays $200 per year; whereas a participant with a $10,000 account balance pays only $20 per year. While it is possible that the participant paying $200 may utilize more of the recordkeeper’s services than the participant paying $20, it is unlikely to be ten times the amount of services.
With this in mind, some plan sponsors gravitate towards the flat fee model. Since each participant has the same access to the recordkeeper services, it is easy to philosophically justify having everyone pay the exact same amount. However, under this model, participants with lower account balances pay a significantly greater portion of their balance when paying the flat fee. In a plan with a $100 annual recordkeeping fee, participants with a $10,000 balance pays 1% of their assets for fees (on top of the investment expenses), whereas participants with a $100,000 account balance pays 0.10%. To combat this issue, some organizations work with the recordkeeper to establish a minimum participant account balance, (e.g., $20,000) before implementing the annual fee.
There is no one correct answer in making the judgment as to which fee allocation model to select. With the lack of guidance from the DOL, the circumstances and individual perspective of an organization will often make one model a more logical choice than the others. All of these fee arrangements are viable options, as long as the total amount of fees paid are aligned with the value of the services provided, and the allocation of fees among participants is reasonable.
Organizations should speak with their advisors about what model makes the most sense for their organization, and then they may choose to develop a fee policy. Things to consider for a fee policy include who pays for the plan fees (participants or the organization), how those fees are allocated, and how the retirement committee monitors those fees. Contemplating a consistent policy related to plan fees can assist plan fiduciaries in fulfilling their plan oversight responsibilities, while also providing continuity in future decision making should there be turnover among the fiduciary committee members.
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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