Understanding your retirement plan’s fees is not only a good practice; it’s a fiduciary requirement as prescribed by the U.S. Department of Labor (DOL) under the Employee Retirement Income Security Act (ERISA). The traditional enforcement mechanism has been DOL plan audits. More recently, high-profile litigation has driven plan sponsors to evaluate their plan fees. These fees can be grouped into several categories: record keeping, administrative, legal, plan advisory, investment, and education and communication. The principal reason fees have been thrust into the limelight is that
plan participants often bear most, if not all of the cost of running the plan. This article does not discuss how to determine if fees are reasonable, but instead explores a relatively new debate over which fee assessment methodology is fairer. Since DOL has been silent on this issue, it affords the plan sponsor the opportunity to determine the most appropriate structure for their plan based on their demographics.
There are two basic retirement plan fee structures: per capita hard dollar fees and fees charged as a percentage of assets. Determining whether to charge per participant hard dollar fees or fees as a percentage of assets is a philosophical decision, with each scenario possessing distinct positive and negative attributes.
Hard Dollar Fees
Under a per capita hard dollar fee scenario, each participant pays the same hard dollar fee deducted from his or her account, usually monthly or quarterly. On the surface this may seem to be a very desirable approach. It is easily understood by participants and everyone pays the same amount irrespective of their individual account balance. This seems logical since the same services are offered to all participants and the expense to the record keeper is the same whether it is an account with a $200,000 balance or a $5,000 balance.
However, if you consider the hard dollar fee relative to each participant’s account balance, a different perspective emerges. For example, if the annualized participant hard dollar fee is $100, the fee for an individual with a $200,000 account balance is proportionally much lower than for an individual who has $5,000 in his or her account (illustrated below). The optic becomes more revealing when extrapolating this one example across a plan demographic with a sizable executive and/or professional population generally with high account balances, along with a sizable lower paid population with generally lower account balances (such as a hospital or manufacturer).
Participant A | Participant B | |
Account Balance | $200,000 | $5,000 |
Fee | $100 | $100 |
Fee Percentage | 0.05% | 2.0% |
Asset-Based Fees
An alternative fee structure is one in which the charge is calculated
as a percentage of a participant’s accumulated account balance. Under this method, the fee a participant pays
(in total dollars) increases as his or her account balance grows. There is a legitimate argument that this
approach does not seem equitable because those with the highest account
balances are paying a higher fee and yet receive the same services as other
participants in the plan. However, this
payment methodology is consistent with other plan fees, most notably the underlying
mutual fund investment management fees. Participants
are accustomed to paying these fees, which are expressed as a mutual fund
expense ratio that often can range from 0.05% to 1.25%.
If we return to the illustration we used for hard dollar
fees, with same account balances, but apply a fee of .25%, the resulting fee
structure is completely opposite: participant A pays a significantly higher fee;
40 times higher than participant B (illustrated below).
Participant A | Participant B | |
Account Balance | $200,000 | $5,000 |
Fee | $500 | $12.50 |
Fee Percentage | 0.25% | 0.25% |
Summary
Clearly both of the fee structures discussed in this article
have pros and cons. There are also
various combinations of the above methods that may be a better fit for your
organization. Remember, there is no
“right way,” so the plan sponsor must determine the most appropriate fee
structure based on their demographics and corporate philosophy.
The decision of how fees are allocated is a fiduciary
decision so it is important that plan sponsors understand the different options
and how fees are assessed in their plan.
It is the plan sponsor’s responsibility to regularly review and
benchmark plan fees to determine if they are appropriate given the type, frequency,
and quality of the services delivered. Once
the total fee required by the various constituencies is determined, the process
of allocating those fees comes next. It
is a complex and ever-evolving process; and one that should be taken seriously.
If you have any questions, or would like to begin talking to an advisor, please get in touch by calling (800) 388-1963 or e-mail us at hbs@hanys.org.