Plan sponsors should know the true cost of their investment options, Tom Gonnella, executive vice president at Lincoln Trust Co., in Denver, Colorado, tells PLANADVISER. Investment expenses are the single largest expense in a defined contribution plan—as much as 84%, according to industry estimates, he says. “It’s crucial to keep an eye on fees and know where your plan ranks compared to industry averages.”
Gonnella warns a source of bloated fees is annuities. Plans are charged the underlying fund expense plus a separate annuity wrap fee. “It’s a challenge to analyze annuity contracts, which are pretty thick, to understand information on wraps,” he says. “The information is buried way in the back of the contract; plan sponsors will need to have an adviser with expertise in this area.”
Some disclosure reports may not clearly spell out fees or may identify them with such terms as “indirect compensation,” according to Gonnella. The fact that participant disclosures require fees to be expressed as an expense ratio per each $1,000 invested in a fund makes disclosing wrap fees a challenge, Gonnella conends. He says if a provider is an insurance company, there may be small print in the disclosure offering a caveat for this inaccuracy.
"The best thing for plan sponsors [to do] is to go to their providers and ask if there are wrap fees and for more detail,” Gonnella says. “Plan advisers or providers may be able to do a series of calculations to provide an ‘all-in’ cost for the plan.” If plan sponsors do not get this information, at least they can document that they asked.
Gonnella notes that in most cases, plan sponsors and participants will need to do a series of calculations to determine the actual cost of the plan. For example, participant disclosures offer a basis point fee for every $1,000 invested in each fund. A participant will have to do some division and multiplication to get fee expenses, then calculate total costs from all service providers. According to Gonnella, Lincoln doesn’t imagine many participants going to all this trouble. Lincoln provides a report that does all the calculations for them.
Plan sponsors will have to add together costs from all service providers—recordkeeper, auditor, advisers, third-party administrator (TPA), etc.—as well as investment costs to get the ‘all-in’ cost of the plan. If true investment costs are unknown, a big piece of the puzzle is missing, Gonnella points out.
Plan sponsors should also know the total compensation paid to their recordkeepers. Gonnella notes recordkeepers can accept fees and payments from a variety of sources. If the recordkeeper offers proprietary mutual funds, plan sponsors and/or participants are likely paying investment management fees, and may be paying revenue sharing payments. “Even fees for separately managed accounts and annuity wrap fees might be part of the compensation package,” he says.
Gonnella adds that revenue sharing is a critical component to any retirement plan. Many of Lincoln’s clients use institutional funds, so there is no commission being paid, but others are in funds that have revenue sharing. Plan sponsors may not know if a fund has a relationship with their recordkeeper and if revenue—12(b)-1 fees or sub-transfer agency agreements—is being paid to them. Those monies should be credited back to the plan, Gonnella says, but it is not easy to find those numbers. Plan sponsors and participants need to know if their investment funds pay revenue sharing to the recordkeeper, and if so, how much is paid and to whom.
Gonnella contends plan sponsors are better off finding a platform that does not keep any revenue sharing, but most recordkeeping platforms can’t say that; it’s how they get paid.
Plan sponsors should consider how their recordkeepers charge fees—some use an asset-based fee structure, some charge per head plus a small asset-based fee. If a plan sponsor firm is growing and sees assets growing, it wants a recordkeeper that charges a flat fee or per head fee instead of an asset-based, Gonnella says. If they have a lot of employees with low assets, they should find a pricing structure that benefits the plan sponsor and participants.
Knowing plan fees and making sure they are reasonable is a fiduciary requirement of plan sponsors. Many are looking to a third party to help protect them from liability, and the industry will see more and more of that in the future, Gonnella contends.