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| Summer, 2008 |
Plan Expenses: How Much is "Too Much?"
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Service fees … investment advisory fees … front-end loads … account maintenance fees … surrender and transfer charges … investment management fees … 12b-1 fees.
Among other duties, the Employee Retirement Income Security Act (ERISA) requires that those responsible for managing retirement plans ensure that the services provided to their plan are necessary and that the cost of those services is reasonable.
The Challenge of Apples to Oranges
Unfortunately, most companies reviewing proposals for a new or takeover plan do not have a system in place to compare plan expenses. They have no way of knowing if the expenses being paid on their 401(k) plan are "reasonable." And the investment companies don’t help; each provider has a different format for presenting the information, making an apples–to–apples comparison difficult.
While fee structures in 401(k) arrangements can be very complex, as a general rule, fees are calculated in four ways:
- Asset–based: Expenses are based on the amount of assets in the plan and generally are expressed as percentages or basis points.
- Per–person: Expenses are based upon the number of eligible employees or actual participants in the plan.
- Transaction–based: Expenses are based on the execution of a particular plan service or transaction.
- Flat rate: Expenses are reflected in a fixed charge that does not vary, regardless of plan size.
Note that fees may be calculated using one or any combination of these methods. Plan administration–related expenses can also be charged as one–time fees or ongoing expenses. One–time fees are typically related to start–ups, conversions (moving from one provider to another) and terminations of service. Ongoing fees are recurring expenses relating to continuing plan operation.
Active vs. Passive Management
In addition, funds that are "actively managed" (i.e., funds with an investment advisor who actively researches, monitors and trades the holdings of the fund to seek a higher return than the market as a whole) generally have higher fees than funds that are "passively
managed." Remember that neither active management nor higher fees necessarily guarantee higher returns.
Funds that are "passively managed" generally have lower management fees. Passively managed funds seek to obtain the investment results of an established market index, such as the Standard and Poor’s 500, by duplicating the holdings included in the index.
Weigh Your Options
Understanding and evaluating plan fees and expenses associated with plan investments and services are an important part of a fiduciary’s responsibility. Consider following these general guidelines to establish an objective process to aid in your decision making:
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Another Reason to Consider
Fees
In addition to the regulatory requirements,
appropriately managing fees and expenses is important for another reason:
It impacts investment returns and the eventual retirement balance of
participants.
Consider an employee with 35 years until
retirement and a current 401(k) account balance of $25,000. Let’s assume
investment returns average 7 percent over the next 35 years. If fees and
expenses reduce average returns by 0.5 percent, the account balance will
grow to $227,000 at retirement, even if there are no further contributions
to the account. On the other hand, if fees and expenses are 1.5 percent,
the account balance would grow to only $163,000. The 1 percent difference
in fees and expenses would reduce the account balance at retirement by 28
percent!
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Decide what you want. Before negotiating with service providers, think about the specific services you would like (e.g.,
legal, accounting, trustee/custodian, recordkeeping, investment management, investment education or advice). Include the types and frequency of reports you wish to receive, communications to participants, meetings for participants, and the frequency of participant investment transfers.
Request estimates. Once you have a clear idea of your requirements, you are ready to begin receiving estimates from prospective providers. Give each of them identical information about your plan and the features you want. This information should include the number of plan participants and the amount of plan assets as of a specified date. In addition, ask each prospective provider to be specific about which services are covered for the estimated fees and which are not.
Compare apples to apples. When making comparisons, use the same format for each prospective provider. The U.S. Department of Labor offers a downloadable 401(k) Plan Fee Disclosure Form on its website
(www.dol.gov/ebsa/pdf/401kfefm.pdf). The form can help you compare investment product fees and plan administration expenses charged by competing service providers, regardless of how a particular service provider structures its fees.
Ask the right questions. Make sure prospective providers know you are paying attention to fees and expenses. Ask questions such as, "How are you
paid?" "How do these fees compare to industry averages?" "How do they compare to other plans designed like
ours?"
Consider calling in the pros. There are a variety of firms that can assist in evaluating your plan fees and expenses. Accounting firms such as Bober, Markey, Fedorovich & Company are skilled at this type of evaluation.
Monitor. Once you have selected a service provider or investments, be prepared to monitor the level and quality of the services and performance of the investments to make sure they continue to be reasonable and that they suit the needs of your employees. For example, request that your provider conduct a performance analysis at least annually of investments utilized by the plan versus benchmarks and/or peer groups.
A Word About Quality
Remember, your fiduciary obligation is to make prudent decisions for participants based on facts—not get the cheapest rates and fees. Ultimately, you get what you pay for.
It is easy to focus on the dollar amount of fees and expenses. But the real question is what are you getting for the money? Will your advisor come onsite regularly to meet with new hires? Will your advisor come in once a year and provide a performance overview to management and employees? Will your advisor make appointments with individual employees to answer questions and address concerns?
The bottom line is that it’s okay to pay for service — just make sure you’re getting service that adds value to the plan and to your employees.
If you would like some assistance in assessing the level of fees being paid by or for your plan, please call your partner or manager contact with our Firm and we would be happy to help you.
Employee Benefits Advisor is produced quarterly by Bober, Markey, Fedorovich & Company’s Employee Benefit Plans Services Team. If you would like additional information about the services that we can provide to employee benefit plan sponsors or administrators, please call or email our team leader James E. Merklin, CPA, CFE, M.Acc. at (330) 762–9785 or
jimm@bobermarkey.com.
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