By Steve Smith
There is a basic element of unfairness built into most DC plans that is only now coming to the attention of participants, sponsors and advisors. It has to do with how fund fees typically are used to pay plan costs. It also relates to how fund revenue is paid to the plan and/or credited to individual accounts. It’s an inequity that’s worthy of your attention and your client’s for three reasons:
• the inherent value of a retirement plan to a participant is dependent on its basic fairness;
• failure to provide fairness to participants may result in fiduciary liability for a plan sponsor; and
• you can employ a relatively easy solution to this problem, so why expose yourself or your client to unnecessary risk?
Let’s take a closer look at what’s going on here.
Paying Plan Costs with Fund Revenues
As we know, funds offered on a plan’s investment platform will charge different fees, largely depending on whether they are actively or passively managed and on what asset classes they offer. That seems fair enough, but those same funds will also pay a different percentage of the revenue they generate to the plan’s record keeper in order to help offset plan costs. For instance, an actively managed fund which charges higher fees could provide more revenue to the plan than a passively managed fund. And that means plan participants invested in an actively managed fund will shoulder a heavier burden of plan costs than participants invested in a passively managed fund.
The result? Two employees of the same firm, participating in the same plan, each subsidize a different percentage of the plan’s costs. Yet both participants have access to the same basic plan services.
That’s clearly unfair. But it’s not the whole story.
No Clear Guidance from the DOL
When providing guidance on plan expenses in the past, the Department of Labor has made it clear that the allocation of expenses among participant accounts is a fiduciary act. With respect to revenue payments, however, there is no clear guidance. So what happens when there is a surplus in plan revenue that needs to be reallocated among plan participants? Isn’t it reasonable to assume that plan fiduciaries will be expected to apply an understanding of ERISA combined with a prudent process?
Of course, if a plan sponsor isn’t aware of the issue, it’s highly unlikely that it has instituted a process to solve for it. For the sake of argument, let’s say that plan sponsors do want to take a proactive approach to this issue. How can they implement a prudent process?
The answer is that advisors and plan sponsors concerned about this issue can apply “fund revenue equalization” (FRE) technology to solve for it. This new recordkeeping technology:
• facilitates a fairer distribution of revenue;
• ensures that all participants pay a similar percentage for the plan’s administrative services;
• avoids penalizing participants who invest in actively managed funds that pay more revenue; and
• enables sponsors to avoid annual reconciliations, revenue shortfalls, ad-hoc plan fees or deductions from the plan’s expense budget account.
And it makes it possible for the plan advisor to select or change funds without consideration of how much revenue they generate. All in all, a simple, fair resolution that works in the best interests of all concerned parties.
Steve Smith is a vice president at Transamerica Retirement Solutions.
Transamerica Retirement Solutions does not provide tax, legal, insurance, or investment advice and nothing presented herein should be construed as a recommendation to purchase or sell a particular investment or follow any investment technique or strategy.
FA -11833 (3/13) ©2013 Transamerica Retirement Solutions Corporation. Used by permission.
