Investment fiduciaries and plan administrators of California public sector 457(b) and 401(a) plans are required by law to act as “prudent experts” for the sole and exclusive purpose of providing benefits and defraying “reasonable expenses” of administering the plan. We believe that these duties should cause plan fiduciaries to look beyond whether their plan investment fees and plan recordkeeping fees are reasonable in the aggregate – at the plan level. If you take a closer look at the various types of plan fees (and what they represent), you may decide that the current manner in which your plan “spreads” or allocates these fees no longer makes sense or no longer seems fair.
For this discussion, let’s focus on three typical sets of plan fees: investment management; investment advisory; and recordkeeping.
Investment management fees refer to the costs associated with operating and managing an investment option, such as a mutual fund, and are usually paid for on a “pro rata” basis – that is, in proportion to the participant’s relative investment in that option. For example, if mutual fund “A” has an investment management fee of 25 basis points (.0025), a participant with a $100,000 investment in that fund would pay $250 in investment management fees, while a participant with a $1,000 investment in the fund would pay $2.50 in investment management fees.
Investment advisory fees generally consist of the separate fees paid out of the plan to an independent investment advisor, or to an advisor offered through a “managed account” option. These fees are usually charged to all participants’ accounts on a pro rata basis, in the case of an advisor to the entire plan. A “managed account” is an option in many plans where the participant can elect to obtain a more customized investment approach, but generally must pay extra for the added services. Because use of a managed option is usually a participant choice, managed account advisory fees are charged a pro rata basis to those participants who utilize the managed account option.
Recordkeeping fees generally refer to the costs of keeping track of the day-to-day operations of a plan, including the allocation of employer and employee contributions, changes in account values, and changes in investment choices. Many plans allocate recordkeeping fees on a pro rata basis across all participant holdings. For example, a participant with a $250,000 account balance would pay 25 times as much in recordkeeping fees as a participant with a $10,000 account balance. A very large percentage of plans vary this basic fee allocation method by utilizing “revenue sharing” to pay some or all of the recordkeeping fees.
Revenue sharing involves the use of investment options that “carry” greater investment management fees (than institutional share classes). For example, while an institutional share class of a particular fund may carry an investment management fee of 25 basis points (.0025), a revenue-sharing class of the same fund might carry an investment management fee of 35 basis points (.0035). The difference – “extra” revenue – is then utilized by the recordkeeper to help pay its fees. Depending on the size and complexity of a plan and its investment lineup, various investment options will likely carry higher or differing levels of a revenue share “mark-up.” This means that participants who invest more heavily in those options with higher revenue sharing, will further subsidize those participants invested in options with lower or no revenue sharing. Finally, many recordkeepers offer stable value funds, which usually do not carry a revenue sharing component, but which by their nature make a substantial amount of money for the recordkeeper – effectively causing the stable value fund investors to subsidize other participants.
This lengthy background gives rise to a number of interesting and challenging questions for plan fiduciaries:
- If one accepts the characterization of day-to-day recordkeeping (apart of from loan and distribution “transactions,” which carry a separate charge) as primarily an accounting function – much like the services your bank provides with respect to your checking account – why shouldn’t these services be paid for on a per account (or per capita) basis? Most bank customers do not pay for the maintenance of their checking accounts based on how much they have on deposit – they pay a flat monthly fee.
- If your plan, like most plans, uses its independent investment advisor to choose, or help you choose, your investment line-up, don’t these services benefit all participants equally? Does it make sense – is it fair – to charge participants with larger accounts more for these services?
- If like many other governmental defined contribution plans, your plan has 20% to 40% of the plan assets invested in the stable fund option, are the participants invested in this option paying a disproportionate share of the overall recordkeeping fees?
There are no easy or clear-cut answers to these questions. In order to better understand these issues, and how “fair” your plan fees are, you need to start with a breakdown of the various fees paid from plan accounts and “how” these fees are charged to participants.
Jeff Chang is a partner at Best Best & Krieger LLP. He has four decades of experience skillfully evaluating benefit and retirement plan compliance to achieve maximum outcomes for public agency clients throughout California. He can be reached at email@example.com or (916) 329-3685.