What Does Your Plan Really Cost, And How Can You Lower It?

By Stephen J. Lansing CIMC, CEBS, President and Founder of Sentinel Fiduciary Services, Inc. of Orlando, Florida. If you would like to discuss this issue further, you may contact Steve at stevel@sfs.cc or call him at 407.246.7221.

Not everything that can be counted counts, and not everything that counts can be counted. --- Albert Einstein

It is important to know that the Government has added another compelling reason to do the calculus.

"You should be aware that your employer also has a specific obligation to consider the fees and expenses paid by your plan…Among other things, this means that employers must: Ensure that fees paid to service providers and other expenses of the plan are reasonable in light of the level and quality of service." --- The Department of Labor's booklet: A Look at 401k Plan Fees

While plan fees and expenses appear simplistic, there is much more to the subject than meet the eyes. The most convoluted aspect of determining implicit plan expenses is the practice of revenue sharing. Without understanding the basics of this arcane subject it is impossible for fiduciaries to prudently discharge their responsibility.

Background

Hard dollar fees charged by providers are disclosed in the service agreements. But this is the tip of the iceberg. With few exceptions, mutual fund families pay marketing agents and administrators money (revenue sharing) for using their funds as investment options. To complicate things even further, some mutual funds have numerous share classes, all with different revenue sharing properties. The payments can generally be categorized in two ways.

• Finders (commissions) and 12b-1 fees Finder fees are paid by some mutual funds on new money contributed to the plan. Theses payments can be as large as 100 basis points and are paid on all deposits made to the plan. As you can imagine, this reimbursement can be significant in the first year of a "rollover" plan. These amounts are not disclosed in the prospectus.

  The 12b-1 fees (so called distribution payments) are paid by the majority of funds and are usually asset based. These reimbursements can be as large as 100 basis points and are customarily .25% of assets. You can determine this part of the expense ratio by reading the prospectus.

• Sub-transfer agent fees: These payments are made to the provider doing the plan administration. The reimbursements are earmarked to pay the vendor for participant servicing work it does on behalf of the fund. These stipends are expressed either as a percent of assets or as a per participant fee. Basis point payments can be up to .65% of assets and the per-head payment can sometime reach $18 per person per fund per year!

So, what's the point? Sometimes we hear sponsors ask who cares what the vendor collects; all the more power to them. If only life was that simple for fiduciaries.

Connecting All The Dots

Sponsors should understand some postulates when it comes to computing the direct and indirect costs of running their plans. First, all revenue sharing belongs to the participants, not service providers. Second, a select group of administrators will directly and totally offset hard dollar charges with the revenue sharing they collect. Therefore, there is an opportunity cost in not accounting for and managing this revenue. Third, as we described at the beginning of the article, the Department of Labor expects fiduciaries to account for and control plan costs so the charges are "reasonable" in view of services provided. Fourth, providers view their costs and profits as a function of a per participant charge. Finally, providers must make a profit form servicing your plan. However, they should not be given a blank check. Someone coined the phrase "There is no such thing as a free lunch but at least you should know the price of the meal before you order."

A Solution Path

Here is how the sponsor should solve the problem.

• Take the cream off the top, so to speak, by deliberately using low cost funds. Strange as it may seem, it is not unusual find less expensive alternatives that pay greater revenue sharing! Of course, don't ignore funds that have no revenue sharing. Empirical studies indicate that investment costs are negatively correlated to returns. Every dollar saved has a multiplier effect.
• Ask your provider for a complete disclosure of all the revenue sharing your provider receives from your plan. If they do not provide the information, find the publicly disclosed amounts and use these in the spreadsheet. Then, as soon as practical, begin a search for a new provider that will tell you what they are collecting from the funds
• Build a spreadsheet that includes all the fund balances as of the last custodial statement. Input the revenue sharing figures and compute the total money paid to the provider by the funds.
• Add any hard dollar costs and total the direct and indirect expenses.
• Divide the number of participants with account balances into the total remuneration the provider receives. This will give you a per participant cost you can use to benchmark your costs against competitive alternatives.

As a point of information, if you have been with your provider for over five years and if your plan relatively straight forward to service, the annual participant cost should be no more than $65 to $85 for each person with an account balance.

With this information in hand, it is time to either negotiate for a concession or to take the vendor out to dinner and thank them for giving you a deal!

Some Parting Thoughts

The plan should pay for all hard dollar expenses. This will eliminate most of the conflicts of interests that exist when you conduct this process. If you feel that employees are materially harmed by this policy increase the contribution. You will get more mileage from giving a larger contribution than from telling people you have paid a bill for them.

If you use an outside person for assistance in the project, make sure you know how they are getting paid. Commissioned brokers and agents have an inherent conflict of interest and you should know the details before you begin managing the relationship.

Don't be too elated after you have extracted some concessions. The large providers typically have unique shareholder servicing agreements with the funds that pay them more than the "retail" revenue sharing. There is no law that requires disclosure of any revenue sharing so you may never know the total amount the vendor gets from your plan. But at least you have discharged your fiduciary responsibility by going through the process. The participants will have you to thank for more financial security in retirement.

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