Guide to Retirement Plan Fees
Part 3: Plan Participant Cost Allocation Strategies
If you’ve followed along with Part One and Part Two of our Guide to Retirement Plan Fees, you know what costs you can expect to incur through your retirement plan and what options you have in paying those costs. Now, you need to develop a strategy addressing how the costs you’ve elected to pay from the plans’ assets are charged to plan participants.
Historically, costs charged to the retirement plan were allocated across participant accounts based on their account size. The total costs to recover were divided by the total plan assets, and this was applied to each participant’s account. This process is referred to as a pro-rata allocation. It results in the larger account balances paying a disproportionate share of the fees in terms of dollars. Small account holders incur little in fees while large account holders effectively subsidize the costs of those smaller account balance participants.
Per Participant Allocation
An alternative to pro-rata allocation is a fixed, per participant charge. Costs are divided equally, and every participant pays the same fee. With this allocation model, however, low balance accounts pay a meaningfully larger percentage of their balance, hindering the growth of their accounts. Employers see this as a disincentive to participation and seek an alternative.
Most Equitable: Bifurcated Cost Allocation
Acknowledging the concerns with straight pro-rata or per participant cost allocation, a reformed process developed. This strategy follows a bifurcated – or “split” – methodology. A fixed, per participant fee is assessed annually to every participant, regardless of account balance. On average, this fee ranges from $40-$100 per year. The remaining expenses to recover are allocated on a pro-rata basis according to account balance.
The advantage of this “split” cost allocation methodology is transparency. All plan participants incur a base cost for participation (the per participant fee) and incur increasing fees as their account balance grows (the pro-rata fee). This is the most equitable method to recover plan expenses.
What about revenue sharing?
As described in Part One of our Guide to Retirement Plan Fees, the expense ratios for plan investments often conceal an additional cost for other plan service providers referred to as revenue sharing.
The amount of revenue sharing will vary based on what investments a plan participant selects. While we recommend plan sponsors eliminate revenue sharing whenever possible, that which remains can be incorporated into your cost allocation methodology.
You may consider using the revenue sharing to reduce the administrative fees collected through your allocation methodology. The flaw with this approach, however, is that it places an increased share of the administrative fee burden on the participants who invested in funds that pay revenue sharing. Therefore, we believe the best approach is to instruct your recordkeepering partner to return the revenue sharing payments directly to the participant accounts that invested in the funds which created the revenue.
Last, but Not Least: Participant Communication
No matter what cost allocation method your plan oversight group develops, your plan participants should be able to see and understand their cost for participating in the plan. Concisely communicate the cost allocation method you settle on and show participants how they can calculate their individual cost of participation. In the best case scenario, their participation cost should not change based on how they invest. Communication regarding cost could be delivered in the form of a presentation, video, or worksheet.
What to do next
Understanding the fees incurred, paid, and allocated by your retirement plan is not a one-time practice. As a plan sponsor and fiduciary, you have the responsibility to monitor plan fees on an ongoing basis. As you consider your fee allocation methodology, prompt your plan oversight group with the following questions:
- When was the last time we discussed how our retirement plan costs are allocated to plan participants?
- Can we demonstrate the existing allocation methodology follows a diligent and documented process?
- If a plan participant questions the fees paid, are we prepared to clearly outline the process we have in place to monitor and benchmark our plan’s fees?
- Are we effectively communicating this information to our participants?
Demonstrating a prudent process exists for monitoring and allocating costs to plan participants will not exempt you from an ERISA claim, but you will be positioned to deliver a strong defense. When you partner with the team of experts at Francis Investment Counsel, you can expect a clear cost allocation strategy supported by the experience to implement and communicate that strategy to plan service providers and plan participants. Reach out to one of our team members directly or fill out the form below for assistance.
Access our complete Guide to Retirement Plan Fees.
Tags: plan costs, retirement plan fees, retirement plan expenses, cost allocation