We've talked a lot about fees in defined contribution (DC) retirement plans lately: the disclosure regulations effective in 2012 have caused quite a stir, and for good reason. For plan fiduciaries, ensuring that retirement plan fees are reasonable and fair is a fiduciary duty, and understanding plan fees can have a significant impact on retirement savings for participants.
For example, if a participant's retirement investments or account is overpriced by one-quarter of 1% (25 basis points), and the participant has $5,250 in total contributions annually for 40 years, then that participant will have overpaid $40,056 in fees!
But simply knowing the base amount or formula stated by the recordkeeper is often not sufficient to truly understand the impact of fees in a retirement plan. It's also essential for plan sponsors to consider the different types of fees that occur in retirement plans: plan-level service fees, participant-level service fees, and investment fees. These fees interplay in ways that can have dramatically differing effects from participant to participant.
In order to understand retirement plan fees, it's important to understand investment expenses and the concept of revenue sharing. Each investment option has an expense ratio, which may contain two major fee components: an investment management fee that varies based on the attributes of the fund or its manager, and a shareholder service fee, which is often paid indirectly to the plan's service provider(s) in a process called revenue sharing. Expense ratios can vary substantially from fund to fund within a plan, so participants pay different amounts of investment expenses based on their allocations among those funds. Revenue sharing further complicates the matter because not all investment options have a shareholder service component, and those that do have different rates and policies.
Revenue sharing can be normalized among participant accounts in the plan through a process called fee leveling, wherein revenue sharing is allocated back to participant accounts on a per capita or pro rata basis, or back to the participants who held the funds that generated the revenue sharing. However, not all recordkeepers can administer all of these options.
Another issue to consider is who should pay the plan fees that exceed the amount of revenue sharing generated by the plan. Some employers choose to pay these fees, while some assess them to participant accounts, in which case they must decide whether to allocate those hard costs pro rata or per capita. Pro rata cost allocations protect smaller account balances, while per capita allocations protect larger account balances.
What's right for your plan? As the plan sponsor, it's your choice, but given the implications for fiduciaries and the impact on the retirement readiness of participants, it's important to understand the options, consider what's best for your plan, and document your decision.