In order to make good investment decisions, it’s important to be informed. Yet one of the more impactful components of any retirement plan is also the area where employers and participants tend to feel least clear: plan fees. While fees are not the only consideration when creating your portfolio or selecting service providers to the plan, high retirement account fees can erode retirement savings for participants and create fiduciary i.e. personal) liability for you, the plan sponsors.
Despite the risks, many sponsors don’t take the time to carefully examine their plan fees or, worse yet, needlessly increase their risk by overpaying service providers who may be charging “hidden” fees. What you don’t see can hurt you, but what questions should you ask to prevent these pitfalls?
First, let’s understand what services are being provided to a typical retirement plan. There are three general categories:
All of these services are necessary to successfully operate a qualified retirement plan. While there is nothing wrong with getting paid, the challenge is to understand how these service providers get paid, the reasonableness of the fee in light of the value of the services and whether the fee has been disclosed. Unfortunately, it is often not as simple as just asking the service providers, because these fees can be embedded in the expense ratios of the mutual funds offered in the investment lineup.
Given all this, how can you get to the bottom of what you’re actually paying and what you’re getting in exchange for those mutual fund fees?
You should have just received year-end fee disclosures that list all of the expenses paid by the plan. Those notices and the plan’s benefits statements will help you understand the total plan-related fees charged to their account. The plan administrator should be able to provide a list of all direct service charges. All of the expenses paid by the plan or individual participants should be clearly itemized; if they are not, you should probably ask why.
Very large employers get the benefit of being able to invest in institutional share classes, which often have lower costs. Share classes are classifications of different stocks or mutual funds that come with their own rules and benefits.
Some mutual funds create a share class specifically for smaller retirement plans, called Sub-TA fees, which include the fees paid to recordkeepers, plan administrators or other providers. In other words, the providers’ fees are aggregated with the mutual funds’ expenses and therefore make it impossible for plan sponsors to separately identify and benchmark them. However, you can ask for them to be itemized separately.
If you don’t know or understand your share class, you should find out. If you are in one with a high cost, you can insist that your plan be placed in one with lower expenses.
If your plan provider is an insurance company, there is a good chance your plan’s investments are variable annuities and not mutual funds. Variable annuities are mutual funds owned by an insurance company “wrapped” or protected by an insurance policy. Therefore, you’ll encounter increasing expenses with “wrap fees,” surrender charges or sales commissions in the process. Those fees can turn a low-cost mutual fund into an expensive and illiquid investment.
The same could be true for plans supported by a mutual fund provider, which has a built-in incentive to use its own funds as part of the investment lineup. Conflicts of interest are not inherently wrong, but they must be disclosed so that the plan sponsor can make informed decisions.
While the word “kickback” may make you cringe, revenue sharing is just that—a payment made by a mutual fund to compensate service providers that use their funds. Salespeople, brokers and insurance agents may receive finders’ fees for bringing new business to the mutual funds or negotiated loyalty incentive compensation. Regardless of the type of fee, they are all revenue sharing and they increase the investment’s expenses and reduce investor returns.
Sometimes these mutual fund fees are disclosed as 12(b)-1 fees, which are distribution fees paid for the marketing and distribution of fund shares. But sometimes, fund companies pay different levels of fees through multiple share classes.
You should ask your investment advisor or read the prospectus. Don’t overlook footnotes about how your plan expenses “may not include any contract-level or participant recordkeeping charges. Such charges, if applicable, will reduce the value of a participant’s account.” That is likely a red flag telling you there may be hidden fees. Ask your investment advisor whether it is receiving 12(b)-1 fees, the annual value of those fees, and whether your same mutual funds can be purchased for a different share class with lower revenue sharing fees.
These fees can be especially difficult to understand, yet they are one of the largest expenses that a participant can bear. Every time a mutual fund manager buys or sells the underlying securities within a mutual fund, there is a cost to the trade.
Actively managed funds have higher transaction costs than passive funds, like index-based funds, and the participant’s returns are reduced by the cost of those trades. While transaction costs cannot be avoided entirely in actively managed funds, they can include brokerage commissions and other compensation paid to the service provider that should be scrutinized. Transaction fees can be found (often with some difficulty) in the fund’s Statement of Additional Information (SAI) and annual report.
So how are the fees justified? There is nothing wrong with compensating service providers. Again, they perform necessary services to successfully operate a qualified retirement plan. But sponsors must ask what services justify these fees and whether the provider yields material results for participants and beneficiaries.
In short, the question fiduciaries should be asking is: Do these fees exist to pay for reasonable, legitimate and valuable services that benefit participants and enhance their retirement security? Or do they exist to support the financial services industry at the expense of participants?
You can avoid these issues altogether by investing in lower cost mutual funds, like Exchange Traded Funds (ETF) or Target Date Funds (TDF). ETFs give you the ability to invest in a collection of stocks or other securities, while TDFs are lifecycle funds that use “professionally determined investment mixes” that grow assets over different time spans, typically becoming more conservative with time.
Or, consider using service providers that are not financially incentivized to use certain mutual funds as plan investments. You should be asking yourself the ultimate question regularly: Have I properly investigated and paid only those fees that were appropriate and reasonable? Hopefully after addressing the questions above, your answer will be “yes.”
[Editor’s Note: Please see this related webinar you can attend: Accredited Investors, and their legal and financial advisors: Goal Based Investing – Planning for Key Life Events and mutual funds]
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Allison Brecher is general counsel at Vestwell, a fintech startup innovating the retirement plan market. She brings over 15 years of legal and regulatory experience to Vestwell, having handled high profile and complex litigation involving employee benefits, ERISA, regulatory matters, data privacy, and electronic discovery. Previously, Allison was Senior Assistant General Counsel and Director of…
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