Since most retirement plan administrative costs are paid by “the plan” and not the employer, there is a direct pathway between cost efficiency and participant returns. And, when we say that “the plan” pays the costs, we are really saying that “the plan participants” are paying the costs. If you’re shaking your head, just think about it. If the employer isn’t paying the costs and if there’s not a quarterly participant account debit, where’s the money coming from?
Plan economics 101: Every plan has its own economics — administrative money coming in and administrative money going out. If there’s not enough money coming in, your vendor will let you know. But, if the inverse is true, how would you know if your plan is generating more administrative revenue than the vendor should reasonably receive?
The cost side of the equation: It costs a certain amount of money for a plan vendor to do a competent job of recordkeeping and administering your plan and providing any ancillary services you may have contracted for. Depending on the size of your plan and the breadth of services provided, the cost per-head could range from around $60 to upwards of $125 annually. Some vendors like to quote their fee in basis points (as a percentage of plan assets), but you can convert this into a per-head cost by dividing the total cost by the number of balances in the plan.
It may be reasonable to pay at the upper end of the range to a vendor providing an exhaustive suite of education and other services, even though a bare bones job could be had for less. This gets into the topic of reasonableness determination, which we have addressed previously. (See: “4-0-What? (b)What?”) Typically, a vendor’s costs are impacted more by headcount than anything else. It’s ten times as expensive to mail statements to 1000 participants as to 100 – same logic applies to call center and website usage, etc. In general, a vendor shouldn’t charge more just because the plan has more assets in it, as that doesn’t drive the workload.
(It’s worth stating that it might be appropriate for an adviser to receive asset-based compensation for incentive reasons or if they are accepting fiduciary liability with regard to the plan’s assets.)
The revenue side of the equation: Many, if not most, retirement plan investments generate something known as “revenue sharing”. This is a very important concept to understand. Equipped with this understanding, you will be a more effective fiduciary and better able to help your employees achieve satisfactory outcomes.
Revenue sharing commonly comes in two forms: “12b-1 fees” and “sub-TA credits”. What are 12b-1 fees? These are payments made by mutual funds to intermediaries, and are included in a fund’s expense ratio. They vary, but a rough guide would be as follows:
- Pure no-load funds don’t pay anything;
- Bond funds often pay 10 or 15 basis points (10 to 15 one-hundredths of a percent of the asset amount); and
- Stock funds commonly pay 25 basis points (one-quarter of a percent annually of assets).
Often called “trails” or “service fees”, these commonly go to the broker that sold the investments to the plan. If they are being paid to a broker, it is a fiduciary obligation of yours to ensure that the amount of comp being paid is reasonable in relation to the services being provided to the plan.
If your plan’s 12b-1 fees are being paid directly to a broker, you need to visit the issue of “levelized compensation”. If they receive more comp from one investment option than another, and it they have the ability to influence the flow of assets, you can see the potential conflict of interest. So can the Department of Labor, so you need to be careful about those situations.
Other times, there is no broker, and these payments are retained by your plan vendor. That’s not necessarily a problem as long as you know the vendor’s total compensation from plan assets and make an informed decision that it is a reasonable amount for the services being received.
Knowledge is power, and 408(b)(2) is making it easier for you to gain this knowledge. You still need to know how to put it into perspective, but the facts are a good place to start.
The other form of revenue sharing is something called sub-TA credits. Sub-TA credits are perfectly legitimate payments from investment providers to retirement plan recordkeepers. They are essentially a sub-contracting fee to cover work being done by the recordkeeper instead of the investment provider. For example: Let’s say 100 of your plan participants have a position in the XYZ Growth Fund. Normally, the XYZ Fund Company would have to send out 100 quarterly statements and have capacity in their call center and website to handle inquiries. Instead, within your retirement plan, your recordkeeper tracks the balances, sends out the statements, staffs their call center, etc. XYZ only needs to maintain one omnibus account for your plan. Fund companies work our arrangements with recordkeepers to compensate them for doing this work.
How can this impact participant outcomes? Not only do different funds have different revenue sharing arrangements, but different share classes of the same fund can have widely ranging revenue sharing. If you don’t tightly manage this aspect of your plan, you may be allowing your participants to be overcharged by 25 or 50 or even 75 basis points annually in exactly the same fund. This means their rate of return would be 25 or 50 or 75 basis points lower per year than it should be. Compounded out over the years, this could make a meaningful difference in their retirement outcome.
Putting it all together: Your first step is to review your 408(b)(2) disclosures and to engage your vendor in a constructive dialog. Understand how much they are getting paid and what they are doing to earn that pay. Best practice would be to benchmark their pay to ensure its reasonableness. (Cheaper isn’t necessarily better – it’s value that you are evaluating.)
When you understand the cost side of the equation, it’s time to move on to the revenue side. Study your fee disclosure documents to see how much revenue sharing is being paid.
Compare the two figures and see where you stand.
A common trap is to think if there are no billables, everything is okay. We often hear people say, “It’s free.” What’s wrong with that? The employer may be okay with zero billables, but under ERISA, the plan’s fiduciaries (all plan-level decision makers) are held to the exclusive benefit rule. All plan business must be conducted with the interests of the participants in mind. If the vendor is collecting more revenue than is reasonable to run the plan, they are making an “excess profit” and this is directly impacting your participants’ rate of return, and consequently their retirement security.
The “ERISA account” is now the gold standard. This is an account that collects all of the plan’s revenue sharing payments and then disburses them as directed to cover the plan’s costs. You can’t get more transparent than this. The fiduciaries can look into this account and adjust the share classes of the plan’s investments periodically to balance the plan’s revenue and costs. Any excess revenue can be used to offset audit or other qualified plan expense or it can be paid back to the participants, rather than going to the vendor as bonus revenue.ERISA accounts are available to plans of all sizes.
In conclusion, you can turn 408(b)(2) from a time-consuming pain [lemons] into enhanced retirement security for your employees [lemonade]. When you understand and take control over your plan economics, it helps you as a fiduciary and it helps everyone with a balance in your plan.
Jim Phillips, President, and Patrick McGinn CFA, Vice President, Retirement Resources
Patrick and Jim have over 50 years of combined investment and retirement plans experience. Retirement Resources in a Registered Investment Advisor that helps employees retire with greater security, while helping employers manage workload, costs and fiduciary liability.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
« S.C. Bank Hires Retirement Services Division Manager