What`s Your Fee Policy? - Plante Moran Financial Advisors

{What’s Your Fee Policy?}
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Going beyond 408(b)(2)
WHAT’S YOUR FEE POLICY?
Going Beyond 408(b)(2)
by Steven Gibson | 734.302.6966
[email protected]
Don’t worry. Although this is
important, this isn’t another
article about determining your
retirement plan costs and whether
they’re reasonable.
Instead, our goal is to explain that a plan sponsor needs to do more regarding
fees than simply calculate the overall cost of each service provider and determine
reasonableness. How funds are selected and fees are paid can have a major impact
on participant account balances. How the providers’ fees are determined can impact
the overall cost of the plan as it grows or shrinks. With that in mind, let’s take a look at
some major decisions plan sponsors need to make in order to select an appropriate
cost structure for their plan.
First Things First: The Importance of Having a Fee Policy
It’s important for all plan sponsors to have a fee policy. What is a fee policy? As its
name suggests, a fee policy is a policy that describes the reasoning and methodology
used for fee-related decisions within a retirement plan. It covers how plan providers
are paid, how revenue sharing is handled, how fees are assessed to participants, and
more. It helps to control and potentially reduce plan costs and displays prudence and
due diligence on behalf of the plan sponsor. Whether it’s a formal policy or part of a
discussion and documented in the minutes, it’s an important matter for plan sponsors
to address.
A fee policy describes the
reasoning and methodology
used for fee-related decisions
within a retirement plan.
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GOING BEYOND 408(b)(2)
Provider Fee Structures
One of the first decisions a plan sponsor must make is how to pay each plan provider.
Many service providers have the ability to quote their fees in a variety of different formats.
A provider can charge asset-based fees, per-participant fees, and/or fixed fees. Each
method has its advantages and disadvantages, some of which are summarized below.
FEE STRUCTURE/EXPLANATION
Asset-based fees
Per-participant fees
Fixed fees
Asset-based fees are those based on a
percentage of assets. The most common
forms are a fixed asset-based fee (e.g.,
10 basis points (bps) on all plan assets)
or a tiered fee schedule (e.g., 10 bps on
the first $10 million of assets, and 5 bps
on the next $20 million of assets).
Per-participant fees are those based on the
number of participants in the plan. The most
common forms are charged on the number of
active participants or on the total number of
participants with account balances.
Fixed fees are those of a stated dollar
amount, typically seen as a base fee or
per-service fee. Providers of small to
mid-sized plans (less than $100 million
in assets) usually will not quote an entire
plan in a fixed fee. It’s more commonly
seen in large to mega-sized plans.
May be BENEFICIAL when
Plan assets expected to remain stable or
decrease
or
Number of participants expected to
increase
Plan assets expected to increase
or
Number of participants expected to remain
stable or decrease
Number of participants expected
to increase
or
Plan assets expected to increase
May be UNSUITABLE when
Plan assets expected to
rapidly increase (like before an acquisition)
Participant count expected to rapidly
increase (like when adding automatic
enrollment)
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Plan assets expected to rapidly decrease
(like before an owner withdrawals 50% of
plan assets)
GOING BEYOND 408(b)(2)
Below are two examples of how provider fee structures can affect the overall cost of a
plan as the plan size grows/shrinks and the number of participants grows/shrinks. The
initial assumption is a $50 million plan with 500 participants. The fixed fee, asset-based
fee, and per-participant fee all initially provide the same amount of revenue to the
service provider.
The demographics of the plan and company expectations play an important part in
selecting the most appropriate fee structure. Plan sponsors should reach out to each
service provider to determine if there are additional ways in which their fees could be
calculated. Once that information is known, plan sponsors should choose the best
method and document the process and reasoning in their fee policy.
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GOING BEYOND 408(b)(2)
Selecting Share Classes
In addition to deciding on the fee structure of the providers, the plan sponsor should
determine how fees are paid. Fees can be paid (1) through fund expenses via revenue
sharing, (2) outside of fund fees via direct-billed fees, or (3) from a combination of the two.
The specific share classes of investment options used in the plan will vary depending on
how the plan sponsor would like to pay fees. Share classes are alternate fee structures of
one single fund. Let’s look at some expense structures of a single large mutual fund.
In this example, some share classes have a much higher expense than the lowest option
at 0.34%. This is because all of the options other than the R6 contain revenue sharing
(a combination of the 12-b and other fees of the above example). Revenue sharing is
when fund companies refund some of the expenses of their fund to
...the plan sponsor should
providers operating a plan to pay for administrative expenses. Revenue
sharing includes items such as 12b-1 fees, subTA fees, plan expense
determine how fees are paid.
payments, and more.
When selecting the share classes to be used in the plan, plan sponsors
have a variety of options. Here are some common methodologies:
Selecting the lowest expense excluding revenue sharing
This involves using the share classes with the lowest prospectus net expense without
taking into consideration revenue-sharing amounts. This approach gives participants
access to the lowest-cost fund. It’s likely the revenue sharing won’t be enough to fully
compensate the provider, so the remaining fees will be billed directly to the plan or
plan sponsor. Direct-billed fees will be discussed later in this article.
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GOING BEYOND 408(b)(2)
Selecting the lowest expense net of revenue sharing
This involves using the share classes with the lowest expense ratio of an investment option
after subtracting out the revenue sharing. This approach may provide the lowest overall cost
to the plan, but some participants may be subsidizing some fees for other participants. The
drawback can be negated when the provider has the ability to credit revenue sharing back
to the participants based on their investments or has the ability to perform fee leveling.
Crediting back to the participant means that if a fund shares revenue, the provider will
receive the money and insert it back into the participant’s account that was invested in
that fund. Fee leveling charges provider fees differently for participants in different funds
based on the amount of revenue sharing received by the provider to
This approach may provide the
offset fees. Below are examples of a traditional fee method and both
equalization methods, assuming a 30 bps provider fee. Each equalization
lowest overall cost to the plan.
method essentially eliminates participant fee inequalities.
EXAMPLE OF TRADITIONAL FEE METHOD (ASSUMES EQUAL MONEY IN EACH FUND)
Expense Ratio
Revenue Sharing
Revenue Sharing
Goes To
Direct Provider Fee Total Participant
Administration Fee
Fund A
0.45%
0.00%
Provider
0.12%
0.12%
Fund B
0.60%
0.25%
Provider
0.12%
0.37%
Fund C
1.00%
0.30%
Provider
0.12%
0.42%
EXAMPLE OF CREDITING REVENUE SHARING
Expense Ratio
Revenue Sharing
Revenue Sharing
Goes To
Direct Provider Fee Total Participant
Administration Fee
Fund A
0.45%
0.00%
Participant
0.30%
0.30%
Fund B
0.60%
0.25%
Participant
0.30%
0.30%
Fund C
1.00%
0.30%
Participant
0.30%
0.30%
Expense Ratio
Revenue Sharing
Revenue Sharing
Goes To
Direct Provider Fee Total Participant
Administration Fee
Fund A
0.45%
0.00%
Provider
0.30%
0.30%
Fund B
0.60%
0.25%
Provider
0.05%
0.30%
Fund C
1.00%
0.30%
Provider
0.00%
0.30%
EXAMPLE OF FEE LEVELING
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GOING BEYOND 408(b)(2)
Selecting the desired overall revenue sharing amount
This involves selecting the share classes based on fund assets to yield a specific dollar
amount or percentage of revenue sharing in order to pay all fees directly through the
funds. In this case, a plan sponsor will primarily use funds with higher expense ratios
with larger amounts of revenue sharing. If using this particular structure, a plan sponsor
should choose share classes that have as similar as possible revenue-sharing amounts
that will yield the appropriate payment to providers. Plan sponsors should periodically
check how much money is being generated via revenue sharing to ensure providers
don’t receive more than what’s required to operate the plan. Provider payments will
change as participants shift their investment elections and as the overall plan size
changes. Anytime the revenue generated from the funds exceeds what a provider
needs to operate the plan, the share classes selected should be revisited as changes
may need to be made.
Direct-Fee Payment Options
Another important item plan sponsors will need to determine is how they’d like to pay
any direct fees (i.e., those fees not covered by revenue sharing). If the desire is to use
low-cost or institutional mutual funds, then most likely there won’t be enough revenue
sharing from the funds to cover all the fees to operate the plan, and there will be direct
fees. Direct fees can be paid through numerous methods. The plan sponsor will first need
to determine if the company will pay the fee, if it will be deducted from plan assets, or a
combination of the two.
Direct fees applied to participants’ accounts can be calculated as an equal dollar amount
across all participants (per capita), as an equal percent of assets across all participants
(pro rata), or a mixture of the two. Generally, per capita fees tend to be more beneficial
for higher account balances while pro rata fees are more beneficial for smaller balances.
If a plan sponsor decides to pay the provider fees on a per capita basis, and the fee is
$50 per participant, then a $5,000 account-balance fee would be 1 percent while a
$500,000 account balance fee would be 0.01 percent.
PARTICIPANT ACCOUNT BALANCE
PER CAPITA FEE
FEE AS A % OF ACCOUNT BALANCE
$5,000
$50
1.00%
$500,000
$50
0.01%
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GOING BEYOND 408(b)(2)
If the same plan sponsor decides to pay the provider fees on a pro rata basis, and the fee
is 0.30 percent, then a $5,000 account balance would incur a $15 charge, and the $500,000
account balance would incur a $1,500 charge.
PARTICIPANT ACCOUNT BALANCE
PRO RATA FEE
FEE FOR ACCOUNT BALANCE IN $
$5,000
0.30%
$15
$500,000
0.30%
$1,500
While both methods are calculated equally across all participants, the end results can
vary tremendously. Having a mixture of the two fees, such as having a small per-capita
fee and having the remaining fee deducted on a pro rata basis, can often yield favorable
results. The mixture would be less expensive to smaller account balances than a straight
per capita fee and would be less expensive to higher account balances than a straight
pro rata fee. Different providers can handle different methods of fee structures, so it’s
important to ask the provider for all of the available options. A comprehensive fee study
tailored to the individual plan can assist the plan sponsor in making a prudent decision.
Many providers also allow for charging terminated participants differently than active
participants provided that the fees charged to the terminated participants are reasonable.
For example, a plan sponsor could charge a higher per capita fee to terminated
participants to cover fees paid by the plan sponsor and have the remaining fee deducted
pro rata from active participants.
Conclusion
As fiduciaries, plan sponsors are responsible for making decisions related to selecting
an appropriate fee structure. Establishing a comprehensive fee policy is a crucial step in
making those decisions. It shows procedural discipline with regard to reviewing plan fees.
Much like an investment policy, it also helps to maintain consistency of its policies
by future committee members.
OTHER FEE POLICY CONSIDERATIONS
The key to developing a fee policy is to look at all of the various scenarios to determine what makes sense for a
particular plan. There’s not a one-size-fits-all solution. Other items that could customize your fee policy are:
1. How are fees communicated to participants?
2. How will forfeitures, if applicable, be used to offset any fees?
3. How often should fees be benchmarked?
4. What sources will be used to benchmark fees and determine reasonableness?
5. How will fee-related decisions be documented?
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GOING BEYOND 408(b)(2)
About Plante Moran
Institutional Investment Consulting
Our equation for success is simple: we have the depth and breadth of resources to support you in
your important role as a fiduciary. Since we are also a fiduciary, when we offer advice, you can rest
assured it is with your participants’ best interests in mind. It is an enormous responsibility to make
decisions that impact the retirement plan of others; our team understands that responsibility and
is ready and able to assist.
OUR KEY PROFESSIONALS
Susan Shoemaker
Partner
248.223.3722
[email protected]
Dori Drayton
Partner
616.643.4030
[email protected]
Jeremy Chambers
Associate
248.223.3655
[email protected]
Laura Tessmer
Associate
248.223.3567
[email protected]
Steven Gibson
Associate
734.302.6966
[email protected]
Jeremy Tollas
Associate
616.643.4072
[email protected]
Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data
obtained from recognized statistical services or other sources believed to be reliable. However, some or all information has not been verified
prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes
only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current
market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or
quantitative analysis may not agree.
Plante Moran Financial Advisors (PMFA) provides this information this update to convey general information about our services and not for the
purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You
should consult a representative from PMFA for investment advice regarding your own situation.
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