Awareness of Fee Levelization Is on the Rise

Experts are beginning to advise plans sponsors to level the playing field when it comes to recordkeeping fees and other recurring expenses. 

Charging retirement plan participants equitable fees is an issue that retirement plan advisers need to champion, experts say, because plan sponsors are largely unaware of the matter and service providers, particularly recordkeepers that receive revenue-sharing payments, are not very eager to address it.

It is also a fiduciary responsibility, notes Fred Reish, a partner with Drinker Biddle & Reath in the Los Angeles office. “While there are no requirements to charge equitable fees, in Field Assistance Bulletin (FAB) 2003-03, the Department of Labor (DOL) indicated that allocating plan expenses is a fiduciary decision that requires fiduciaries to act prudently,” Reish says. “Whatever allocation method is used, the failure by fiduciaries to engage in a prudent process to consider an equitable method of allocation of plan costs and revenue sharing would be imprudent and a breach of fiduciary duty.”

In a white paper, “Deciding What is Reasonable: Assessing Fees Using Value and Outcomes,” TIAA-CREF concurs that scrutinizing how fees are charged to each participant is a best practice that advisers should be bringing up before their plan sponsor clients. “With greater scrutiny around plan-level fees, a new question is emerging around the fairness of how these fees are charged to participants,” the paper explains. “There are currently no statutes requiring fees to be assessed equitably across plan participants, but regulators are studying this closely.”

Many if not most plans are populated with funds that use revenue-sharing payments to pay recordkeepers, says Brian Menickella, managing partner with The Beacon Group of Companies in King of Prussia, Pennsylvania, whose own firm has eliminated revenue share classes for all of its clients over the past several years. “There are not that many advisers or plan providers that use a pure revenue-sharing-neutral platform,” Menickella says. “But that is going to have to change because landmark cases like the Supreme Court case of Tibble v. Edison are all targeting revenue sharing. Fee levelization is where the industry as a whole is going to end up.” It may take one to three years for it to become a reality, but Menickella is certain this is the direction the retirement plan industry is headed.

The recent Bell v. Anthem lawsuit is a clarion call for advisers and sponsors to take a harder look at fees, Menickella says, noting that in this suit, the plaintiffs charge Anthem’s pension committee for breaching its fiduciary duties by selecting a Vanguard fund charging 4 bps, when an identical institutional fund charging 2 bps was available.

Complicating matters further is the Department of Labor’s (DOL’s) pending fiduciary rule, “which some feel will outlaw revenue sharing,” Menickella says. Chad Carmichael, principal consultant with North Highland in Charlotte, North Carolina, agrees: “While there already is pressure on fees, the DOL fiduciary standard will put even more scrutiny on this. In a lot of cases, fees are not equitable.”

NEXT: Levelizing revenue-sharing fees

Not all funds charge revenue sharing, and those that do vary widely, according to a Summit Financial Corporation white paper, “Revenue Sharing Impacts Company Retirement Plans.” Summit says that “the amount of revenue sharing varies from fund to fund. Some funds make no revenue sharing payments at all, while others make significant payments. Depending on a participant’s investment mix, he or she can be shouldering a disproportionate amount of the plan’s administrative costs [for] plan services, which are equally available and accessed by all participants.”

One way sponsors have tried to levelize revenue-sharing fees is by remitting the fees back to an Employee Retirement Income Security Act (ERISA) bucket to subsidize plan administrative costs, Carmichael and Menickella say, but they feel it is not a preferred method because there is still a disproportionate percentage of expenses shouldered by certain subsets of participants.

Another method is to rely on recordkeepers to handle fee levelization whereby a sponsor calculates plan administration overhead and how many basis points each participant should equally shoulder to cover the cost of the plan, Reish says.  Any revenue sharing fees in excess of that are paid back to participants, or, conversely, any participant falling short of that target is charged to levelize fees, he says. This way, regardless of what revenue sharing fees participants are, or are not, charged, all participants pay their proportional cost of the plan. “This is seen as transparent, conflict-free and fair to participants and provides protections to fiduciaries in fulfilling their 401(k) responsibilities,” Reish says.

However, levelizing fees is a fairly complex process, which is why not all recordkeepers offer this as an option, TIAA-CREF says. Sponsors “may also find that from an efficiency perspective, the added costs and effort associated with fee levelization may outweigh the benefits,” TIAA-CREF says.

The best way to succeed in charging participants equitable fees is to avoid funds with revenue sharing fees altogether, Carmichael says. Brian Catanella, senior retirement plan consultant at UBS Institutional Consulting Group in Philadelphia, agrees. “We work with clients to provide the potential for more equitable costs per participant by seeking share classes that provide no revenue where appropriate and when available,” Catanella says.

NEXT: Per-participant fees and fees as a percentage of assets

Plans without any revenue sharing fees typically rely on one of two methods for charging participants for plan administrative costs, says Chad Parks, CEO of Ubiquity Retirement + Savings in San Francisco. They either charge a fee per participant or a fee as a percentage of assets, he says. While arguments can be made that either one is imbalanced, they are an improvement over revenue-sharing fees, Parks says. “The DOL has to start somewhere. Fee levelization without incentiving people is a good first step.”

As to why there are drawbacks to each, TIAA-CREF explains that “what may seem like a fair approach for all may benefit some employees over others.” For example if a sponsor were to charge each participant an annual per capita fee, say $75, a participant with a $5,000 account balance would be paying 1.5% of their assets, whereas a person with a $500,000 account balance would be paying a mere 0.02%. Carmichael is of the opinion that this method “is fair because it goes to the administration of the plan, and it is just as costly for a plan provider to administer a $500,000 account as a $5,000 account.”

Fees based on a pro rata percentage of assets vary widely, TIAA-CREF says. For example, a 10 basis-point fee for a participant with a $500,000 balance would result in $500 in plan fees, whereas a participant with a $5,000 balance would only pay $5. Bob Ward, chief revenue officer of Vertical Management Systems in Pasadena, California, thinks this a fair approach “so that participants with small balances are not paying a disproportionate amount of money, compared to those with larger balances. Tiered asset-based pricing schedules can also be used, so participants with large balances get a price break as their account sizes grow. The solution requires that these participant-level calculation and billing features need to be available in the recordkeeping system.”

Parks says that sponsors might want to be wary of a pro rata approach, since “most plan providers prefer the percentage-of-assets model because it grows as assets grow, and they prefer to have employees pay it because they don’t notice it.”

Regardless of the approach that a sponsor decides on, ensuring that clients have this conversation is key, as an Aon Hewitt survey shows that charging equitable costs is on sponsors’ minds. Thirty-three percent of sponsors say they have already taken steps to ensure that fees are assessed to participants in a more equitable manner, according to “2016 Hot Topics in Retirement and Financial Well-Being.” Another 14% say they are very likely to do so in 2016. Another 79% say they are very likely to review total plan costs this year.

“Between the 408(b)(2) fee disclosure and now the growing focus on fee levelization, there is not much room to hide,” Parks says. Ensuring that fees are fair is just another way, he says, “to champion the participants.  This can hopefully be the beginning of a more robust conversation.”