Understanding and Evaluating Retirement Plan Fees | Part One: A Holistic Approach
With retirement plan fees serving as the centerpiece of the Employee Retirement Income Security Act of 1974 (ERISA) fiduciary breach lawsuits, understanding fee dynamics is critical for plan sponsors and fiduciaries. Regardless of plan size or defined contribution plan type—401(k), 403(b), or 457(b)—fees have become a primary focus and concern of plan fiduciaries.
The Department of Labor (DOL) has been very clear about a fiduciary’s responsibility. According to the DOL, understanding and evaluating plan fees and expenses associated with plan investments, investment options, and services are an important part of a fiduciary’s responsibility. Among other duties, fiduciaries have the responsibility to ensure that the services provided to their plan are necessary and that the cost of those services is reasonable.
Looking at fees holistically can better help retirement plan fiduciaries fulfill their duties. The three types of fees that retirement plan fiduciaries need to understand and evaluate are:
- Investment fees
- Recordkeeping and administrative fees
- Other service provider fees
For plan fiduciaries, it is prudent to document the process for reviewing and managing fees and address items such as:
- Benchmarks used when evaluating fees
- Frequency with which fees will be reviewed
- Method for allocating various fees—For example, will the fees be borne by the employer, the plan, or participants? How will the costs be distributed?
Investment fees and performance should be reviewed on a regular basis. As part of this review, it is important that investment fees not be evaluated in isolation, but in conjunction with performance.
Investment fees should be compared to peers in the same investment category (e.g., large-cap blend) and in conjunction with investment performance compared to category peers and the index (e.g., S&P 500 Index for a large-cap blend fund). In some instances, the fund may have a custom benchmark defined by the investment manager, which should be used for comparison purposes.
As part of a fiduciary’s responsibility to review investment fees, it is important to evaluate the investment option’s share classes in an effort to understand the net investment fee of each fund (i.e., total fund expense minus any revenue sharing), which may be different from the stated expense ratio.
There is an alphabet soup of share classes for mutual funds—plus collective investment trusts (CITs), in some cases—available to retirement plan sponsors. This plethora of share classes was developed to provide various pricing mechanisms and expense ratios and allow plan sponsors to use a portion of investment expenses to pay for recordkeeping and administration services.
Recordkeeping and Administrative Fees
Recordkeeping and administrative fees should be reviewed regularly to assess whether fees are reasonable for the quantity and quality of services provided. Typically, best practice is considered benchmarking these fees and services every one to three years, with a more formal recordkeeper search and selection process conducted approximately every three to five years.
Recordkeeping and administrative fees should be evaluated and compared to plans of similar size and type that are receiving analogous services. While each plan is unique—making an apples-to-apples comparison imperfect—evaluating fees against similarly situated and sized plans provides a good reference point in helping to determine if plan fees are reasonable.
Other Service Provider Fees
Other service provider fees should be evaluated on a regular basis, including audit fees, legal fees, and investment advisory and consulting fees. Similar to recordkeeping and administrative fees, if concerns exist regarding the quality of service being provided or the level of fees being paid, a request for information (RFI) or request for proposal (RFP) should be conducted.
Ultimately, conducting a sound fiduciary process is the most important consideration. Performing regular reviews, documenting the process and details that lead to decisions, and providing a forum to discuss plan issues and consider alternatives protects fiduciaries and benefits plan participants.
In part two of our series on retirement plan fees, we take a deeper dive into investment costs to explore what comprises a fund’s expense ratio, how to benchmark different asset classes, and why share class selection is important to a plan sponsor’s overall fee methodology.