News

Is Fee Levelization Right for Your 401(k) Plan?

April 19, 2013 | Alison Kellner © Cammack LaRhette Consulting

In the past, the average retirement plan participant may have thought that their 401(k) plans were free, but now that the fee disclosure regulations have taken effect, participants are made aware of the exact costs of investment management and administrative services on their quarterly statement. Revealing these formerly hidden costs likely raises several new questions for plan sponsors.

Frequently, an additional administrative expense to cover plan costs is added to the participant’s total fees from the investment. These fees are often charged in the form of revenue sharing built into the expense ratio of many retirement plan mutual funds. As plan sponsors receive more details about the source of particular fees—especially administrative ones—they have begun to ask questions about attaining more equitable distribution of fees among their participants’ accounts.

Revenue Sharing

Revenue sharing is a method of plan expense collection in which a mutual fund company charges a fee, and then refunds a portion to the plan’s recordkeeper to cover administrative expenses. These expenses are incurred by the recordkeeper for providing administrative services such as maintaining participant account records, providing quarterly statements, fielding participant inquiries through a call center and maintaining a website for participant and plan sponsor usage.

Building service fees into investment options and paying them through revenue-sharing amounts covered the fees “behind the scenes.” This method has worked well. Plan administration is expensive, and sponsors appreciate a mechanism that allows users to pay for services of which they are the primary beneficiaries and users. Given participants’ reactions to even nominal fees listed on their quarterly statements, incorporating administrative fees into the investment expense made internal administration and communication much simpler.

However, the revenue-sharing system has drawbacks. Not all mutual funds charge/pay the same level of revenue sharing. Some of the funds have no revenue sharing, whereas others may have as much as 0.50 percent or more. Participants who invest in a mutual fund which charges a higher revenue-sharing fee ultimately pay more of the administrative costs for the plan, and unknowingly support their co-workers’ plan costs.

Levelized Fees

Because of this imbalance, plan sponsors have been seeking a way to allow for more equitable sharing of plan expenses. Recordkeepers can administer programs whereby each investment option has the same revenue-sharing percentage amount, which allows all participants to bear a proportionate share of the administrative costs, regardless of funds used or revenue provided.

The first step of implementing such a program is for the recordkeeper to confirm the program’s “required revenue,” or administrative costs. This amount is typically quoted in terms of a percentage of assets, and is then compared to the percentage of revenue sharing available in each investment. If the fund’s revenue-sharing amount exceeds the required revenue, the recordkeeper provides a credit on the assets in the amount of the excess revenue received. All participants using the fund share that credit. If the fund’s revenue sharing falls below that required revenue amount, an additional fee is charged in the amount of the shortfall on all assets in the fund. Both this potential fee and credit appear on the participant’s quarterly statement.

Below is an example of fee levelizing using three investment options in a retirement plan. In this example, the plan’s required revenue amount is 0.40 percent.

Fund Name	Revenue Sharing	Required Revenue	Plan Credit or Fee	Revenue
ABC Fund	0.40%	0.40%	0.00%	0.40%
DEF Fund	0.10%	0.40%	+0.30%	0.40%
XYZ Fund	0.45%	0.40%	-0.05%	0.40%

ABC Fund has revenue sharing of 0.40 percent. This matches the plan’s required revenue of 0.40 percent, and thus the additional plan service fee will be 0.00 percent.
DEF Fund has revenue sharing of 0.10 percent. Because this is 0.30 percent below the required revenue, the recordkeeper will charge a service fee of 0.30 percent.
XYZ Fund maintains revenue sharing of 0.45 percent. Since this exceeds the required revenue, there will be a service fee of -0.05 percent (thus a service credit), meaning the participants in this fund will be credited with the extra revenue.

This method of assessing additional plan service fees or credits on individual investments allows the administrative costs to be levelized. In turn, participants pay the same fee for administrative services that are proportionate to their assets in the plan.

Flat Dollar Future

Level fees have the potential to create a “fair” system for collecting administrative plan costs. One option for creating a more level fee structure is to charge each participant an equal dollar fee rather than an equal percentage. A flat-dollar amount, regardless of savings balance or investments, could alleviate the possibility of Participant A paying more than Participant B in the same plan level. Because participants will see fee amounts listed on quarterly statements under the new format, they may be more accepting of equal flat-dollar fees charged in the future.

Conclusion

The retirement industry is ever-changing, and plan sponsors are always searching for the most efficient way to run their participants’ plans. Revenue sharing has worked in the past, but many participants were essentially turning a blind eye to the fees involved. With new disclosure regulations, participants are more aware of the charges to their accounts. As additional transparency reveals plan fees, savvy sponsors will have a unique opportunity to shape their future methods of fee allocations for participants.