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The particular circumstances will often make one model a more logical choice than the others
extensive scrutiny of fees and the
need for fee transparency, organizations are seeking the most equitable way to allocate defined contribution retirement plan expenses. While the U.S. Department of Labor (DOL) requires plan fiduciaries to closely monitor fees and ensure that they are competitive and reasonable, it has not specified a method by which fees must be allocated among participants.
The simplest way to pay for recordkeeping expenses is to have the organization pay all of the fees directly. However, paying for the administration of the retirement plan adds an expense to the bottom line, which most plan sponsors have, instead, chosen to pass onto their participants. There are other options available to allocate plan expenses among participants, and below we explore the three most popular models.
Participant Fee Allocation Models
The first two models use revenue sharing as a key component in the payment of recordkeeping fees. Revenue sharing amounts are fees built into the expense ratios of the plan investments, used to offset plan expenses.
• Expense reimbursement account (ERA). In this model, also known as a revenue credit account, the recordkeeper charges a flat rate for its services (typically expressed as a percentage of plan assets, e.g., 0.20%). Revenue sharing amounts in the plan investments are then applied to these fees.
If the total revenue sharing is insufficient to meet the cost, the recordkeeper charges an additional fee to cover the shortfall. The organization may elect to pay this amount directly or to pass it on to participants.
If the total revenue sharing exceeds the required revenue, the excess amount is allocated to the plan’s ERA. The organization can then use this excess revenue sharing to pay for legitimate plan fees, such as auditors, legal counsel, advisors, communication initiatives and other plan expenses, or return the excess amount back to participants.
• Fee levelization. In this model, the recordkeeper applies the required revenue to each individual investment option. If the investment has exactly the required revenue amount (0.20% in our example) in revenue sharing built into its expense ratio, then the fees match. If revenue sharing in the fund exceeds required revenue (e.g., 0.25%), the recordkeeper credits each participant who has assets in the fund with the amount of the excess (in our example, 0.25% - 0.20% = 0.05% credit returned to participants). If the investment provides less than the required revenue amount, the recordkeeper adds a “wrap” fee in the amount of the shortfall to the accounts of each participant using the investment.
• Flat dollar payment. A third method for covering recordkeeping fees is to charge a flat dollar amount to each participant. The recordkeeper charges a fee and deducts the stated amount from each account either annually or quarterly, and the participants see this amount on their statements.
Evaluation of the Models
The ERA model is likely the most widely used. These fees are disclosed to participants on an annual basis; however, many participants do not review their statements in detail, and thus may not be aware of the recordkeeping costs to administer the plan.
Another challenge with the ERA approach is the variability of the revenue sharing built into the investments. Not every investment contributes the same revenue sharing amount towards meeting plan expenses. If participants begin transferring assets into an investment that has very little revenue sharing, the overall fee collection for the plan will decline, potentially causing a shortfall. Also, when replacing an investment in the lineup, the organization needs to be mindful of the revenue sharing amounts available in the new investment, relative to the one being replaced. This requires that the organization work with its advisor to select the appropriate investments for the plan, and the necessary share classes of each investment, so that the revenue sharing amounts will be sufficient to cover the recordkeeping costs.
The fee levelization model solves both the overall plan collection problem, as well as the individual participant allocation concern. Each investment option contributes exactly the required revenue amount when combined with the associated wrap fee or fee credit. Regardless of how participants allocate their assets or what investment is added to the lineup, the revenue sharing received by the recordkeeper will be exactly enough to pay for its fees.
However, this model can cause confusion and concern for participants as they encounter the associated fee credits and/or wrap fees on their quarterly statements. Plan sponsors need to distribute communication materials to help explain the statement listings, responding to inquiries that arise.
Plan sponsors can simplify this fee levelization scenario by selecting an array of investment options that has no built-in revenue sharing. With zero revenue sharing, the recordkeeper needs to charge the full required revenue amount to each investment. This is typically easier for participants to grasp, as they see the full amount of their share of the recordkeeping fees with each statement, rather than a series of credits and debits. However, constructing a lineup of entirely zero revenue sharing funds may not be possible, and depends on the investments available on the recordkeeping platform.
Plan Sponsor Decisions
There is no one correct answer in making the judgment as to which fee allocation model to select. With the lack of guidance from the DOL, the circumstances and individual perspective of an organization will often make one model a more logical choice than the others.
Contemplating a consistent policy related to plan fees can assist plan fiduciaries in fulfilling their plan oversight responsibilities, while also providing continuity in future decision making should there be turnover among the fiduciary committee members.
Earle Allen has more than 20 years of experience as an employee benefits consultant. At
Cammack Retirement, he focuses on providing services for defined contribution plan clients and serves as compliance manager for the firim’s New York office. © 2016 Cammack Retirement. All rights reserved. Republished with permission. Hyperlinks added by SHRM Online. A slightly longer version of this article appears on the Cammack Retirement website as
Fee Allocation in Retirement Plans.
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