by Justin Goldstein, Director, Financial Wellness Services, Bronfman E.L. Rothschild
According to a recent Aon Hewitt survey, half of plan sponsors are very or somewhat concerned about 401(k) plan expenses and three-quarters of employers review their fees and plan costs annually.1 Plan sponsors want their employees to be able to retire with adequate savings. When plan sponsors offer investment options with reasonable fees in their retirement plans, they help ensure successful retirement outcomes for their participants.
Fiduciaries Own Fee Reasonableness
Under the Employee Retirement Income Security Act (ERISA), plan fiduciaries are responsible for the prudent selection and monitoring of plan investments, including understanding and evaluating plan fees and expenses. This responsibility is ongoing. A plan sponsor or fiduciary needs to monitor plan fees and expenses to determine whether they continue to be reasonable.
Some plan sponsors engage a financial services provider who also acts as a fiduciary on the plan. The provider can serve in either a 3(21) or 3(38) fiduciary capacity. A 3(21) fiduciary is anyone who exercises any authority over the management of the plan, its assets, gives investment advice for a fee, or has any administration responsibility for the plan. A Section 3(38) fiduciary has discretionary responsibility to manage the plan’s assets. [To read more about fiduciaries, please see What is a fiduciary?] As a fiduciary, the service provider is also obligated to make sure the plan’s investment management fees are reasonable. It is incumbent upon the provider to carry out its responsibilities in the best interest of the plan’s participants.
How Can a Plan Sponsor Ensure Reasonable Fees?
Investment fund selection for a retirement plan starts with the creation of an Investment Policy Statement (IPS). A plan sponsor should create an Investment Policy Statement specific to their plan’s needs. The IPS is designed to guide the sponsor’s retirement plan committee and financial services provider in decision making on investment options for the plan and on the performance evaluation of those investments over time. An IPS adds a layer of protection for plan sponsors. Another layer of protection we recommend to plan sponsors we work with is the creation of a Fee Policy Statement. The Fee Policy Statement focuses on absolute transparency of all plan fees and how they are paid.
Investment Selection and Ongoing Monitoring
After an Investment Policy is defined, investment selection can begin. During the selection process, it is important to review investments in a systematic way. We use a proprietary system for scoring and rating investment options such as mutual funds. Our system scores investments on several factors including performance relative to peers, market benchmarks, and fees. Where possible, we secure institutional share classes for plan sponsors. Additionally, we engage in a conversation with plan sponsors about using a combination of both actively managed funds, and passively managed or index funds as core positions. Offering index funds provides participants with a lower cost alternative. For example, if the plan offers an actively managed large growth fund, we suggest complimenting the offering with a lower cost S&P 500 index fund.
After an investment lineup is established, we recommend a quarterly review of investments by the plan sponsor and their investment committee. The investment lineup should be reviewed for both performance and fees. Performance should be benchmarked to a group of peer funds and market benchmarks. Fund fees should also be benchmarked against peer funds. If there is a more favorable share class available it should be incorporated in the fund lineup. For example, if the assets in a specific fund reach a certain level a plan may qualify for an institutional class share at a lower fee. Plan participants ultimately benefit when a lower fee share class is offered in the plan.
In addition to ongoing quarterly fund reviews, we recommend an Annual Fiduciary Review. At this time the overall plan costs—including administrative, trustee, and investment fees—should be compared to industry peers.
Look at the Numbers
If a participant invests his or her $100,000 401(k) account balance and pays 1% in investment fees, over 20 years that will cost $40,182.71 in fees and he or she will end up with a balance of $182,075.50 assuming a 4% rate of return. If the investment fee is reduced to .5% the cost is now $21,088.01, and the balance at the end of 20 years is $201,170.20.2 Lower cost investments can result in larger account balances. Here’s how you can help minimize the cost of the investments in your retirement plan.
Securing Reasonable Fees Snapshot
- Establish an Investment Policy Statement (IPS) and a Fee Policy Statement if appropriate.
- Leverage institutional investment options and pricing if possible. Gain access to institutional (i-class) or retirement plan class (k-class) shares.
- Conduct regular reviews of investment fees and expenses. We recommend quarterly and an annual comprehensive review of all plan fees.
- Compare investment costs to peer funds.
- Offer a lower cost indexed option in addition to an actively managed investment option.
If a plan sponsors has not taken a look at their plan fees within the last couple of years, they could be overpaying for investments. Since this cost is ultimately passed on to participants, they are obligated, as a fiduciary, to review their plan’s investments to make sure the plan continues to offer appropriate and effective choices. After all, plan sponsors offer the plan so their employees can one day retire in comfort.
1 Aon Hewitt survey, http://ir.aon.com/about-aon/investor-relations/investor-news/news-release-details/2014/Aon-Hewitt-Encourages-Defined-Contribution-Plan-Sponsors-to-Reevaluate-How-Workers-Pay-Fees/default.aspx
2 Time value of money calculation that assumes interest and fees are computed monthly.