Retirement plan expenses - Getting better value, not just cheaper services
POSTED BY: Administrator Administrator AT Tuesday, November 30 at 12:00 AMDuring times of cost cutting, it's understandable that plan sponsors are looking for ways to save money on their retirement plans. Sponsors may be negotiating price discounts, fund and fee ratios, and employer contributions.
Yet, while containing costs is at the top of many sponsors' minds, using an inexpensive service provider isn't always the best option. Before taking a swing with the axe, make sure you're receiving the best value - not just the least expensive provider. Let's look at how plan expenses operate, whether it's from company pockets or plan assets.
Important background
In recent years, both the Department of Labor (DOL) and the IRS have investigated the use of plan fees and the reasonableness of plan expenses. As a result, some plans were found to be in violation for fee-related infringements. And, in some cases, DOL or IRS assessments were costly to plan sponsors.
Plan assets are designated for the exclusive purpose of providing a retirement benefit to plan participants, and plan sponsors cannot directly benefit from plan assets. In other words, excessive use of retirement funds for company purposes is against the law.
But plan sponsors may use certain retirement funds to pay allowable administrative and other plan-related expenses. The plan document, however, must authorize any payments for expenses; the payment must be in the plan participants' and beneficiaries' interest; and the amount paid from the plan must be reasonable. The "reasonable" test is somewhat subjective but ultimately boils down to common sense.
Investment fees
Investment fees make up most of plan expenses. They're sometimes referred to as the expense ratio within an investment and are paid to the firms that manage the participants' investments within the plan. For example, if a participant invests in mutual fund A, mutual fund company A can deduct fees from any income related to that fund to pay itself.
These fees can be tricky to locate because they're factored into the net total return that's often reported to participants. For example, if a particular fund has generated an 8% return for the year, but 1% of that return is used to pay the related investment fees, this results in a net total return of 7% and the fund will report an expense ratio of 1%. Common types of investment fees include:
Sales charges. Also known as loads or commissions; the investment advisor charges these fees to participants for buying or selling shares of an investment.
Management fees. These are the fees paid to the investment advisor managing the fund. They can vary drastically by manager and usually become more expensive as the investment manager spends more time actively managing the fund. However, as with any financial investment, higher management fees don't necessarily ensure better performance.
12b-1 fees. These fees represent continuous amounts paid from fund assets and are usually used to pay for things such as advertising, account servicing and broker commissions. They've been a hot topic in the past few years because of their reclusive nature.
Third-party administrators
In cases of hiring and paying fees to third-party administrators (TPAs), as plan sponsor you should make a reasonable attempt to understand local market prices for this service. Most important, research the integrity and ability of the TPA, as the TPA will guide you with respect to your fiduciary duties. Often, the TPA receives remuneration directly from the trust assets, which both the IRS and DOL allow. Generally, allowable expenses from a plan include costs of:
- Calculating and communicating benefits to participants,
- Nondiscrimination testing amending the plan to comply with tax law changes,
- Obtaining an IRS determination letter,
- Certain amendments and distribution and loan fee expenses,
- QDROs, and
- Administrative fees to vested participants.
Expenses that generally aren't allowed include costs of:
- Plan design changes, and
- Financial accounting, such as adhering to the requirements of FASB 87 (pension accounting) and FASB 88 (defined benefit pension plan settlements and termination benefits).
Along with the DOL, the IRS also carefully monitors plans for reasonableness and mirrors many of the DOL's actions.
Key questions
It's important that plan sponsors be aware of how any fee arrangement works. The DOL requires plan sponsors to periodically monitor fee changes.
Ask your service provider what fees are being paid directly from the plan and what it's going to cost the company out of pocket. Both TPAs and investment advisors must provide this information on request.
Where to learn more
Both the DOL and IRS Web sites offer excellent resources for plan sponsors when it comes to fees. Knowing what questions to ask is invaluable when making choices about retirement plan fees.
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