In this article, I will suggest one of many creative strategies to effectively manage the participant disclosure requirements such that three goals are ultimately satisfied. These three goals being:
- Provide a meaningful benefit to employees to encourage participation through a matching contribution,
- Reward long term participation in the plan by not penalizing higher account balances with higher expenses, and
- Accomplish 1 and 2 without increasing corporate cost.
First, however, I must start with the importance of effectively reviewing total plan expenses and compensation from an ERISA fiduciary standpoint requiring that all plan expenses be “reasonable”. As a result of the new regulations under §408(b) (2), all service providers (investment managers, administrators, advisors, brokers, etc.) must fully disclose in writing, all compensation both direct and indirect to the sponsor (Named Fiduciary) of the retirement plan. Although plan fiduciaries have always had a duty to obtain this information and to make a determination of reasonableness, the new disclosure requirements will create an “in your face” reality that can’t be ignored. It is therefore prudent and recommended to engage in a complete review of the existing arrangement by retaining an experienced consultant or by benchmarking expenses and services.
For purposes of illustration, I will assume that there are three basic pricing scenarios:
- The employer pays all option.
- The all in “free” plan where there is no explicit cost to the employee or the company other than the elevated expense ratio of the underlying investments.
- The plan pays all (or some) option where actual charges are passed on to participants, usually with lower fund expense ratios.
In the employer pay all option, the issue of participant disclosure is moot. The regulations require disclosure of expenses incurred by the participant accounts. If the employer pays all costs of administration, the only disclosure item is the investment expense.
The all in “free plan” is similar to the employer pay all for the purposes of disclosure. If the administrative expense is paid from the investments, then a footnote declaring that “”…some of the plan’s administrative expenses for the preceding quarter were paid from the total operating expenses of one or more of the plan’s designated investment alternatives (e.g., through revenue sharing arrangements, Rule 12b-1 fees, sub-transfer agent fees)” (29 CFR Part 2550 §2550.404a-5 (c) (2) (ii) (C)) must be added to the disclosure report. Although this approach eliminates disclosure of specific dollar amounts from the participants account for administration, it still requires the disclosure of the investment operating expense which generally will be a share class that has higher expenses than others that the participant may be able to purchase at a retail level.
When the cost of plan administration is paid by the plan, the new disclosure requirements will undoubtedly cause some plan participants to question the methodology. In Part I of this series, I illustrated two separate arrangements wherein the first utilized an investment with sufficient revenue sharing to pay for expenses while the second utilized a low cost investment with add on expenses itemized to the participant. Although the second approach resulted in lower overall expense, the itemization creates the potential for participants to question the services required. It also clearly discloses the fact that those with higher account balances pay significantly more administrative and advisory fees than those with lower balances. In this example, a participant with a $10,000 account balance pays $50 from their account while a participant with a $200,000 balance pays $1,000.
A retirement plan (including a 401(k)) is established by an employer (plan sponsor) to benefit the plan participants. The employer determines whether or not they wish to contribute to the plan. The employer may also pass the expense of administration on to the plan and thus indirectly to the participants. In passing the expense on to the plan, there needs to be a non-discriminatory policy for the allocation of the plan expense. This policy can be based on an equal amount per participant, a percentage of plan assets, or a combination of the two. Regardless of how fees are calculated by the provider, most fees are allocated to the plan in total and are then charged to the participants as an equal percentage of their total assets in the plan.
Let us assume the following facts in a hypothetical situation:
- The company makes a matching contribution of 3% of compensation
- The plan invests in low cost index and institutional investments without revenue sharing.
- The company has chosen to pass expenses on to the plan participants.
- Expenses average 0.50% (1/2 of 1%) of total assets and include administration, custody and investment advisor expenses.
- The company values employees with longer service even though newer employees are brought on at higher salaries.
The following chart is a sampling of 5 employees in the company and illustrates how the expenses are allocated based on the asset based pro-rata method:
| Annual Salary | 401(k) Account Balance | Matching Contribution 3% | Admin. And Custody Fee 0.25% | Plan Investment Advisor Fee 0.25% | Total addition to account (Match minus fees) |
| $150,000 | $200,000 | $4,500 | ($500) | ($500) | $3,500 |
| $100,000 | $10,000 | $3,000 | ($25) | ($25) | $2,950 |
| $50,000 | $100,000 | $1,500 | ($250) | ($250) | $1,000 |
| $50,000 | $50,000 | $1,500 | ($125) | ($125) | $1,250 |
| $50,000 | $0 | $1,500 | ($0) | ($0) | $1,500 |
Now let us assume that the company chooses to reduce the matching contribution from 3% to 2.545% and uses the difference to pay the fee directly from the corporation so as not to have it charged to the participant and subsequently avoid disclosure.
| Annual Salary | 401(k) Account Balance | Matching Contribution 2.545% | Admin. And Custody Fee 0.25%(Paid by Employer) | Plan Investment Advisor Fee 0.25% (Paid by Employer) | Total addition to account (Match minus fees) | Increase (Decrease) in total addition from previous methodology |
| $150,000 | $200,000 | $3,817 | ($0) | ($0) | $3,817 | $317 |
| $100,000 | $10,000 | $2,545 | ($0) | ($0) | $2,545 | ($405) |
| $50,000 | $100,000 | $1,272 | ($0) | ($0) | $1,272 | $272 |
| $50,000 | $50,000 | $1,272 | ($0) | ($0) | $1,272 | $22 |
| $50,000 | $0 | $1,272 | ($0) | ($0) | $1,272 | ($227) |
The above change in structure accomplishes the following:
- Longer term employees with higher balances do not subsidize administrative expenses for newer employees with lower balances.
- No fees other than investment operating expense need be deducted nor disclosed to the participants thus increasing net return on investments.
The above is only one example of how creative plan design can accomplish positive outcomes consistent with the objectives of the sponsoring employer. A retirement plan is not a product that can be bought and sold like a stapler or copy machine. Establishing and maintaining a retirement plan is a process best handled by experienced, knowledgeable, retirement plan consultants and advisers. As a plan sponsor, the plan should accommodate its needs, wants and desires, and should not be limited to the provider’s “one-size-fits-all” design.
