Magazine

DC Plan Q&A | Published in September 2016

Evaluating Fees and Expenses

What is proper and what is not?

By Lisa H. Barton | September 2016
Art by Aya Kakeda

There are a variety of plan fees and expenses that affect a defined contribution (DC) plan. The following questions and answers provide an overview of the guidance and processes a plan sponsor needs to follow to be in compliance.
 
Q: What fees are properly payable from 401(k) plan, or other qualified plan, assets?

A: The Department of Labor (DOL) has provided guidance outlining what types of expenses may be paid from plan assets, in publications including Field Assistance Bulletin (FAB) 2003-3 (May 2003), Advisory Opinion 2001-01A and its booklet “A Look at 401(k) Fees for Employees.” A description of some of these expenses follows.
 
Administrative service fees. Fees and expenses associated with administration of a 401(k) plan may be paid from plan assets. Included would be plan recordkeeping fees, accounting fees, and insurance and bonding fees; trustee and custodial expenses; costs for participant communications, Internal Revenue Service (IRS) Form 5500 preparation, and legal services relating to fiduciary/administration issues, etc.
 
Implementing plan sponsor decisions. Fees related to the implementation of certain plan sponsor decisions may be payable from plan assets. These include fees for drafting required plan amendments to maintain tax-qualified status, nondiscrimination testing, preparing IRS determination letters, making plan design changes, implementing a plan termination, providing actuarial services, etc.
 
Once a plan fiduciary has determined whether or not a particular fee may be properly paid from plan assets, the fiduciary must also confirm that the expense is reasonable and the terms of the plan document permit payment of that type of expense.
 
Q: What types of expenses are not properly payable from 401(k) plan assets?
A:
Fees and expenses associated with plan sponsor or “settlor” decisions may not be paid from plan assets. Examples are plan design activities such as legal or consulting expenses in connection with deciding whether or not to adopt an amendment—plus any cost analysis to determine the financial impact of the change—and actuarial services related to forecasting future minimum required contributions for budgeting purposes.
 
Q: Why should 401(k) plan fees be reviewed and evaluated, and what is the first step?

A: Evaluating 401(k) plan fees is important because the Employee Retirement Income Security Act (ERISA) generally requires that any expenses paid from plan assets must be “reasonable” in light of the various services provided to the plan. Specifically, ERISA Section 404(a)(1)(A) expressly says a fiduciary “shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and for the exclusive purpose of providing benefits to [those individuals], and defraying reasonable expenses of administering the plan.”
 
Thus, when reasonable expenses are incurred for the exclusive benefit of plan participants and beneficiaries, plan assets may generally be used. Therefore, plan fiduciaries must first determine if the plan fees/expenses are appropriately payable by a plan. Once this has been done, the next determination is whether the expenses from the plan are reasonable.
 
Additionally, the plan must be reviewed to confirm whether its terms permit the expenses to be paid from plan assets, and the participant fee disclosures must be reviewed to confirm that proper disclosure has been made.
 
When determining whether expenses are reasonable, a plan fiduciary must understand all direct and indirect compensation that is being paid to service providers. This includes recordkeeping fees, revenue-sharing payments, investment consulting fees, etc. Reviewing the ERISA Section 408(b)(2) disclosure will help with this determination.
 
The fees must be evaluated in terms of the services being provided. While there is no means to confirm without doubt that particular expenses are reasonable, determining how the fees and services compare with those at peer plans can help fiduciaries make an informed decision. Involving a consultant to assist in comparing the plan’s expenses with those at other, similarly situated plans is one way to help evaluate reasonableness. Some plan fiduciaries undertake a full or partial request for proposals (RFP) with potential service providers. Regardless of the method used, it is very important that plan fiduciaries consider undertaking a prudent process whereby the information is evaluated and the decision is documented.
 
Q: What is an example of a fee evaluation process?

A: Any fees that are paid from plan assets should be evaluated, as they are held to the “reasonableness” standard under ERISA. These include fees associated with the plan investment options as well as for any administrative, recordkeeping or investment consultant services. There is no exact way to evaluate plan fees, and the method will vary based on the specific plan. However, below is an example of a step-by-step evaluation process.
 
1) Fully understand the fees paid from plan assets. This can be accomplished in several ways, one of which is to review the following information:

  • The ERISA 408(b)(2) disclosure, to determine fees paid to service providers;
  • Any audit and legal expenses paid by the plan; and
  • Investment option expense ratios and fees.

2) Evaluate investment options. While not required, hiring an investment consultant can significantly assist with this process. This step involves, for example, reviewing investment share classes available, based on the asset size of the plan, and any revenue-sharing payments. Documenting why specific investments and share classes are selected can be important if multiple share classes are available. Ongoing monitoring to review when different share classes become available is something further to consider.
 
3) Evaluate fees paid from plan assets. For example, review recordkeeping and other participant fees in light of the services being provided. Once a decision is made, evaluate the participant fee disclosure, and make any necessary changes.
 
Q: Why is establishing a process important, and what is an example of an ongoing process?

A: A process is important because documented fiduciary conclusions and actions provide support for the decisions that are made. While there is no specific right or wrong way for how the evaluation should take place, establishing a process will give fiduciaries a systematic and consistent way to monitor fees. Evaluating the fees periodically is important because, often, the amount of plan fees is tied to the size of the plan, and the plan may become eligible for fee deductions as the assets increase.

Lisa Barton is a partner in the employee benefits and executive compensation practice at Morgan Lewis. Her work encompasses all aspects of employee benefits and executive compensation arrangements, including the design, drafting and operation of tax-qualified retirement plans, health and welfare plans, nonqualified deferred compensation plans and equity compensation plans. She advises clients with respect to compliance with the Internal Revenue Code, Employee Retirement Income Security Act, COBRA and other federal and state laws affecting employee benefit plans, and often represents clients before the federal agencies responsible for regulation of these programs—e.g., the Internal Revenue Service, Department of Labor and Pension Benefit Guaranty Corporation. If you have any questions about your defined contribution plan that you would like Lisa to answer, please send them to jhartnett@assetinternational.com.
NOTE: This feature is to provide general information only, does not constitute legal counsel, and cannot be used or substituted for legal or tax advice.

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