THE DEPARTMENT OF LABOR (DOL) continues to focus on the costs of operating 401(k) plans. The concerns are well-placed because of the negative effect of high fees on employees’ retirement benefits. Also, this is an area where fiduciaries can, with virtual certainty, improve participants’ benefits.
On the first point, the negative effect, the DOL gives an example of a 1% per year “excessive” fee that, over a lengthy career, reduces benefits by more than 25%. Because expenses reduce benefits, fiduciaries are obligated by law to know and evaluate the costs paid by a plan, directly or indirectly, and to make sure that they are reasonable. While “reasonable” is not defined in ERISA, fiduciaries can protect themselves by engaging in a prudent process to evaluate the fees, the value of the services to the plan, and the cost of similar services in the marketplace.
On the second point, there is general agreement in the benefits community that lowering expenses is one of the most important issues for increasing benefits. While other activities—like selecting quality investments—can have a higher potential, or “hoped for,” effect, the lowering of expenses has the certain effect of reducing the cost drag on the plan and thereby improving the level of benefits.
What, then, should fiduciaries do to fulfill their legal responsibilities? As a practical matter, the process begins with asking the right questions.
In 2004, a working group of the DOL’s Advisory Council examined plan fees and developed guidelines for gathering the information needed to make an informal decision. In effect, their report gave us a list of the questions to be asked:
1.Plan sponsors should avoid entering transactions with vendors who refuse to disclose the amount and sources of all fees and compensation received in connection with the plan.
2.Plan sponsors should require plan providers to provide a detailed written analysis of all fees and compensation (whether directly or indirectly) to be received for its services to the plan prior to retention.
3.Plan sponsors should obtain all information on fees and expenses as well as revenue sharing arrangements with each investment option. Plan sponsors also should determine the availability of other mutual funds or share classes within a mutual fund with lower revenue-sharing arrangements prior to selecting an investment option.
4.Plan sponsors should require vendors to provide annual written statement with respect to all compensation, both direct and indirect, received by the provider in connection with its services to the plan.
5.Plan sponsors need to be aware that, with asset-based fees, fees can grow as the size of the asset pool grows, regardless of whether any additional services are provided by the vendor, and, as a result, asset-based fees should be monitored periodically.
6.Plan sponsors should calculate the total plan costs annually.
Once you have the needed information, the next step is to compare the cost with the value your plan and participants are receiving and to benchmark it against comparable costs in the marketplace. Remember that your job is to evaluate the needs of the participants and to provide the services and investments appropriate for those needs. So, the issue is not whether the costs are the lowest, but whether they are reasonable relative to the value, or effectiveness, of those services. At least, that’s the legal issue. As a best practice, fiduciaries should look for lower costs without sacrificing needed services.
I want to emphasize the report’s recommendation that fiduciaries should refuse to work with providers and advisers who won’t furnish the information. Being a fiduciary is a burden, even with the help of good providers and advisers. It is a difficult, and perhaps impossible, task if those providers and advisers don’t cooperate fully. It doesn’t make sense to work with people whose interests aren’t aligned with your fiduciary duties and with your participants’ best interests.
Unfortunately, the benefits community has, by and large, substituted “average” for “reasonable” when evaluating plan expenses, services, and investments. Conventional thinking seems to be that, if the expenses are average, they are, by definition, reasonable. I have my doubts about that kind of thinking, but that is an issue for another day.