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Dec 2013
02
December 02, 2013

Have You Done the Math?


Few of us were math majors in college.  Even fewer of us ever worked as a detective.  Yet the Department of Labor’s 401(k) provider and participant disclosure rules require both skills!

As a quick refresher, the DOL issued regulations in 2012 requiring that most parties being paid out of 401(k) plan assets inform plan sponsors about their direct and indirect compensation.  The regulations also require that plan sponsors give participants an annual notice describing the fees and expenses directly and indirectly impacting participants’ plan accounts.

Some service providers have done a better job than others in communicating that information to plan sponsors, and some plan sponsors have done a better job than others in analyzing that information and, in turn, providing it in a meaningful way to participants.  In fact, in some cases plan sponsors may have passively received the information from their service providers without analysis and provided that information to participants without “doing the math.”

Here’s an example of one facet of the analysis that should be done.  Let’s assume the plan sponsor has had a long and happy relationship with a well-known, reputable national service provider.  That service provider does a great deal for the plan sponsor – everything from plan recordkeeping to investment recommendations to participant education.  The service provider’s local representative is smart, well-trained and dedicated to the plan sponsor and to compliance with the law.  

Let’s also assume that the service provider did a very good job complying with the service provider disclosure rules and provided all of the information the regulation requires.  And, let’s assume that rather than simply glancing at that information and tossing it into a file, motivated by a desire to understand what its participants were paying, the plan sponsor digs deeper into the information.

The service provider determined that it needs (wants?) $300,000 per year to perform those services for the plan sponsor.  Let’s assume that, based on the plan assets, this works out to be 45 basis points, or $165 per participant, per year.

In addition, as is typical, we would expect the disclosure to show that the service provider makes additional money each year from “service fees” (for example, reviewing QDROs), from the “float” on funds, from “sweep fees” and from payments from mutual fund companies to the service provider to participate in its educational conferences (essentially access fees).  And, let’s assume that the 45 basis points is taken from the internal expense load of the mutual funds in the investment lineup, which is approximately 90 basis points, on average.  (In dollars, the total expense load is approximately $600,000, including the amounts discussed earlier.)

Rough benchmarking of the service provider’s fees shows that the fees come in above the 75th percentile for plans matching our assumptions.  That’s not guaranteed to be a problem, but in today’s litigation climate it should definitely give one some pause.  If the service provider would reduce its fees by $50,000 per year, this would bring its fees to about 37.5 basis points.  Still on the high side, but better.

For a summary, please see the chart below:

Summary Table Total Plan
Expense in
Dollar/Basis
Points
Benchmark
(25th to 75th Percentile)
in Dollars/Basis
Points
Total Service
Provider Fees in
Dollars/Basis
Points
Benchmark
(25th to 75th Percentile)
in Dollars/Basis
Points
Current
Arrangement
$600,000
90 bps
$433,000-$550,000
68-82 bps
$300,000
45 bps
$150,000-$290,000
23-43 bps
Proposal $550,000
82 bps
$433,000-$550,000
65-82 bps
$250,000
37.5 bps
$155,000-$290,000
23-43 bps


ERISA requires that plan fiduciaries pay no more than a reasonable fee for the services provided by each service provider.  Plan sponsors may approve fees that are at the higher end of the spectrum if they conclude that the fees are reasonable based on the level of service being provided, as long as that higher level of service benefits participants (and not just the plan sponsor) and the benefit to the participants is worth the higher cost.

Here, the benchmarks placed the assumed fees in the top quartile for plans of comparable size.  A plan sponsor won’t know that, however, unless it does some digging into the fees and gauges them against a reliable benchmark.  After doing so, a plan sponsor faced with this scenario has the ability to negotiate with the service provider to get to the point where the plan sponsor can conclude that the level of service being provided justifies the cost, viewed through the eyes of the plan participants.

A plan sponsor that does this will be significantly better off in the event of a Department of Labor audit.  A plan sponsor should be able to show that it engaged in this exercise, that it understood what participants were paying and that it made a conscious, reasonable decision regarding those fees.  A plan sponsor that does not “do the math” will have a much less pleasant experience in the event of a DOL audit.

For an example of recent litigation on this issue, see the Fee Litigation: International Paper Settlement in our News Briefs.


 

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