Fee Leveling, Simplified
In last week’s Top of Mind, we attempted to simplify the concept of revenue sharing in retirement plans. This week, I will attempt to build upon that by demystifying the even more elusive practice known as fee leveling.
What is fee leveling? Last week, we explained how different participants might pay different costs for recordkeeping and administration of the plan, depending on the amount of rebate, or “revenue sharing” that they receive from the funds in which they invest. Fee leveling attempts to ensure that all participants pay the same amount of recordkeeping and administrative fees, regardless of the funds in which they invest.
Below is an example of fee leveling in action to demonstrate the concept. Let’s use the same simplified example from our last Top of Mind, where a participant is 100% invested in one retirement plan fund
In this example, the fund costs 0.5%, or $50 per $10,000 invested. The fund’s total revenue sharing, or rebate, is $15 per $10,000 invested; however, the total administrative costs that are paid by the plan only amount to $10 per $10,000. Thus, in theory, this participant’s “net rebate” or “cash back” to his/her retirement account is $5 per $10,000 invested.
Now let’s add a second individual, who is 100% invested in a different fund that has no rebate, or revenue sharing:
I left the cash back as unknown because, in different retirement plans, the issue of what to do when a fund’s rebate is not sufficient to pay administrative costs is handled in different ways.
Amazingly, in some plans, this participant would still receive cash back. The reason for this is that sometimes excess revenue is calculated on the plan level, as opposed to the individual level. If the aggregate net rebate for the entire plan is, say, $5 per $10,000 invested, each participant receives just that, regardless of the funds in which he/she is invested. Quite the deal for a participant invested in inexpensive index funds!
In another approach, the participant in the example would not receive any cash back, recognizing that the participant’s investments did not pay any rebates. However, even in this scenario, the participant would end up paying less than others whose funds provide rebates, since this participant paid precisely zero of the $10 per $10,000 in administrative costs.
Fee leveling attempts to address this inequity by ensuring that all participants pay the same administrative costs, regardless of their investments. Here’s how it works, using the two participant examples above:
In order to ensure that the participant in Fund A and the participant in Fund B both pay $10 per $10,000 in administrative fees, instead of the latter participant receiving cash back, the participant’s account in Fund B is actually charged $10 per $10,000 to pay for the administrative fee that the fund is not paying for via a rebate. In both cases, the participants are paying the same $10 per $10,000 in administrative fees, albeit in very different ways. This is how fee leveling works.
Fee leveling can be complicated to track, given that participants often invest in multiple funds and may even change investments from time to time. Although, with the popularity of target date funds on the rise, many participants are now investing in a single target date fund, which simplifies the calculation.
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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