The Future Method of Expense Collection: Levelized

In the past, the average retirement plan participant may have thought that their 403(b) or 401(k) plans were free, but when new fee disclosure regulations take effect in August, participants will see the exact costs of investment management and administrative services on their quarterly statement. Revealing these formerly “hidden” costs will likely raise several new questions for plan sponsors.
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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 website for participant and plan sponsor usage, etc.   

Building service fees into investment options and paying them through revenue sharing amounts available in the funds 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% or more. Participants who invest in a mutual fund which charges a higher revenue sharing fee ultimately pay more of 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.   

For example, if the recordkeeper determined the require revenue is 0.40% and ABC Fund has revenue sharing of 0.40%, there will be no additional plan service fee. If DEF Fund has revenue sharing of 0.10%, the recordkeeper will charge a service fee of 0.30%. If XYZ Fund maintains revenue sharing of 0.45%, there will be a service fee credit of -0.05%, 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, each participant pays the same fee for administrative services that are proportionate to his/her 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 literally 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 will be well 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.  

 

Alison Kellner, Analyst, Retirement, Cammack LaRhette Consulting  

 

Note: This feature is for informational purposes only and should not be used for legal or tax advice. 

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