Helping 401(k) plan sponsors navigate the fees they're paying to service providers and the various mechanisms through which to pay them is becoming an increasingly important component of 401(k) advisers' jobs.
Fee-disclosure regulation
handed down by the Labor Department and a
barrage of litigation targeting excessive 401(k) fees has contributed to more intense scrutiny on plan cost and fee allocation. A lot of plan sponsors don't have a solid grasp on fees; a recent Fidelity Investments
survey indicates nearly 4 in 10 don't clearly understand their plan costs.
Guiding a sponsor through fee allocation to service providers is “one of the most valuable services advisers can provide today,” said Jason Roberts, chief executive of the Pension Resource Institute.
It's also a complex undertaking. After figuring out what level of compensation would be reasonable for the value of a given plan service — record keeping, administration, trust, custody, advisory and legal, for example — there are a number of ways to pay for it.
The ultimate choice "will very much depend on the sponsor. There are a lot of variables,” said Sam Campbell, director of research at FUSE Research Network.
REVENUE SHARING
Revenue sharing has traditionally been the predominant method of payment. That practice involves directing a portion of a mutual fund's expense — typically 12b-1 and sub-transfer-agency fees — to service providers, meaning participants pay for the plan administration indirectly through the plan's investments.
Nearly 52% of defined-contribution plans use revenue sharing to fully or partly pay administrative fees, according to consulting firm Callan Associates. However, that's down from about 67% in 2012.
Some critics say revenue sharing isn't a transparent way for plan sponsors to pay for plan administration, and question the use of participant money to compensate service providers.
“The common model still, unfortunately, is plans use funds with revenue sharing, and revenue sharing offsets the cost of the plan,” said Robert E. Pike, president and chief executive at Stratford Advisors. “However, who does the money belong to? The money paid through revenue sharing would otherwise go to the participants.”
Others believe revenue sharing to be a valid way to compensate providers, as long as fiduciaries
monitor revenue sharing payments to ensure they're reasonable. That's important given that much of the 401(k) litigation has alleged excessive administration fees paid via revenue sharing.
Ultimately, the plan sponsor's philosophy guides the use or non-use of participant money to pay for some or all plan services, Mr. Pike said. Nearly 79% of sponsors at least partially use participant money to pay a plan's administrative fees, according to Callan.
EMPLOYER PAYS
Plan sponsors can decrease their liability by using corporate assets, rather than plan assets, to pay for administrative services, because only plan assets fall under the purview of the Employee Retirement Income Security Act of 1974, Mr. Pike said.
Further, if an employer can afford to do this financially, it would boost participants' retirement benefits by keeping their money in the plan. However, many employers don't understand that they don't have to pay from plan assets, Mr. Pike said.
EQUAL DISTRIBUTION
Due to varying levels of revenue sharing paid through mutual funds, some question whether revenue sharing is an equitable way to levy administrative charges. Actively managed mutual funds, for example, typically have more revenue-sharing fees built into their expense ratios when compared to index funds, a dynamic that could result in certain participants paying a greater share toward administration than others. Share class matters, too — institutional shares tend to pay less than A shares, for example.
That's led some providers such as Transamerica to develop technology that allows all participants in a 401(k) plan to pay an equal amount of revenue sharing, regardless of investment selection.
Transamerica, through its Fund Revenue Equalization program, is able to credit revenue sharing to a participant's account in the event an individual pays too much, and debits the account if not enough has been paid. The accounting occurs on a daily basis, and credits/debits are applied monthly.
“They all end up paying the exact same amount to support the cost of the plan,” said Jason Crane, managing director of retirement plan sales.
Equitable fees and fee transparency are trends occurring broadly across the 401(k) market, according to Emily Wrightson, consultant at Cammack Retirement Group.
The Cammack 401(k) plan, for example, utilizes zero-revenue-share funds and wraps the plan with an asset-based fee to pay for plan administration, which assesses the same basis-point cost for all participants. Plans also can charge participants a flat fee in dollars, rather than an asset-based fee, to level the fees for participants.
Mutual funds that strip out revenue-sharing costs, such as an R6 share, are becoming widely available and have been garnering more assets in the past few years.
According to data from FUSE Research Network, more than 40 asset managers offered R6 shares as of third-quarter 2015, whereas there were only 12 in 2011. Over the same period, assets in those funds ballooned 344% to approximately $315 billion, from $71 billion.
Of course, switching to a zero-revenue-share lineup and stripping out administration as a separate line item on participant statements could lead to a few headaches for employers. Even if participants previously had been paying for plan administration, they may not have been aware (if fees were assessed through revenue sharing) and the appearance of a “new” cost could cause backlash, experts said.
“Plan sponsors are reluctant to go down that road because now they have however many employees storming the castle asking why the plan is more expensive,” Mr. Roberts said.
That's why a strong, adviser-led communication campaign to educate participants on plan improvements, the additional value being delivered as a result and the appearance of more expenses on statements is imperative, Mr. Roberts said.
