401(k) Fee Modernization
For Your Benefit - August 2021
It seems every other day you hear about a new class action lawsuit challenging an employer’s 401(k) fees. There were nearly 100 new cases filed in 2020 alleging breaches of fiduciary duties in connection with the fees participants incur, compared to about 20 cases in 2019*. As a 401(k) plan fiduciary, it is essential to evaluate fees because ERISA requires fiduciaries to act solely in the interest of participants while ensuring fees charged are necessary and reasonable. While this does not imply that employers should always choose the lowest cost providers and investment options, it does mean that employers are required to follow DOL guidance to periodically review fees and services in the context of industry averages and document that sound due diligence and comparison was conducted.
A part of a plan fiduciary’s role in monitoring fees is to determine the appropriate fee model. The below fee arrangements represent the three models seen in the 401(k) marketplace, but there has been a shift in the industry to modernize fee structures to create more transparency for participants and mitigate exposure to lawsuits.
Types of Fee Arrangements
- Revenue Sharing (12b-1 fees) to Offset Expenses – This fee structure utilizes investment options with theoretically higher cost expense ratios, which allow for a component of that expense to be used to offset the Plan’s administrative expense. The additional marketing fee called a 12b-1 fee, that is passed on from the mutual fund company to the recordkeeper is imbedded into the expense ratio of the mutual fund. Therefore, the participant rarely understands the real cost of the administration of the Plan and in most cases perceives the cost as free. The revenue share (12b-1) fee model had historically been the most popular fee model utilized by employers, but according to PLANSPONSOR’s 2020 Defined Contribution Plan Benchmark Report only 36.4% of banks across the country are offering this fee model today.
- Fee Leveling/Revenue Rebating – Within this fee model the aim is to elect lower share class mutual fund options, but in the case of a mutual fund providing excess revenue share, the funds will be rebated back to the participants accounts through a series of debits (where there does not exist enough revenue share to cover the plan expense) and credits (where too much revenue share is received when reviewing the plan expense). The downside to this model is that it can be confusing to participants to follow within their account.
- Explicit Fees (Zero Revenue) – The goal of the explicit fee model is to select the least expensive mutual fund share class (i.e. R6, I) available and charge administrative expenses outside the investment options in a transparent manner. All plan administrative expenses would be reflected on the participant statement/website and allow participants to better understand all fees charged. This model is perceived to promote transparency and financial wellness for 401k Plan participants.
Currently, there is no enforcement action by the DOL regarding the single best fee policy or model, but as employers look to offer competitive 401(k) plans and create more transparency with participants there has been a move to the explicit fee model. Additionally, the explicit fee model provides an opportunity for employers to offer institutional share class mutual funds and collective investment trusts which historically have provided for the lowest expense ratios.
VBA Benefits Corporation Approach to Fees
In 2020 the VBA Benefits Corporation conducted a market analysis on behalf of our participating members that included evaluating our existing fee structure. While our members have always benefited from lower fees due to economies of scale with over $400+ million in plan assets we manage, we had previously used a revenue share fee model to cover administrative expenses. Through our market analysis we learned that we could generate additional savings for members and create more transparency with fees by taking advantage of a more modern approach to fees through the explicit fee model. This fee model would allow us to select lower share class mutual funds options (including institutional share class funds) while also still producing strong investment performance for our participants. As you evaluate your own 401(k) Plan’s fees, it is best to remember to have a prudent process in place and document your thorough due diligence process.
If you have any questions about this article, please contact John Snead.