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Fee Allocation: Some Things to Consider

Fee litigation trends and disclosure requirements have compelled plan sponsors to focus on how recordkeeping fees are allocated to participants, but beyond ERISA’s general fiduciary requirements, there is limited legal guidance, explains a new white paper.

Under the Department of Labor’s fee disclosure regulations, much attention has been paid to the information that plan sponsors and participants receive about fees paid for plan services, which, in turn, has drawn attention to questions regarding fee allocation.

In “Slicing and dicing retirement plan fees: Allocation consideration for plan sponsors,” Vanguard reviews the legal background related to fee allocation, discusses considerations for plan sponsors and considers common fee allocation approaches.

For plans that pay for recordkeeping services through investment expenses, the rules – coupled with litigation focused on plan fees and allocation arrangements – have caused some sponsors to evaluate increased fees resulting from account growth, according to the paper. Meanwhile, other plan sponsors have become more aware of the fee fluctuations that may be attributable to market volatility or they have questioned providers about revenue-sharing practices.

Overall, this increased awareness has contributed to “plan sponsor due diligence and procedural prudence” since they evaluate not only the reasonableness of fees, but also the appropriateness of cost structures under their plans’ unique circumstances, the authors note. In fact, a recent survey by Callan finds that continued scrutiny of fees will most likely be a primary area of focus in 2019 for DC plan sponsors.

Reasonable Method

One of the most important aspects for plan sponsors is properly documenting the fee allocation process. “Ultimately, ERISA is a procedural statute, and a prudent process is crucial in establishing that plan fiduciaries have allocated fees in a reasonable manner,” Vanguard notes.

In further explaining that sponsors have considerable discretion, Vanguard advises that, as with many other issues under ERISA, plan sponsors should start their analysis with the plan document and whether it sets forth a particular method for allocating plan expenses.

For topics not addressed in the plan document, plan sponsors must determine a reasonable method for apportioning costs, but that determination of whether a particular method is reasonable must be based on a plan’s specific facts and circumstances, the paper advises. “The DOL guidance underscores that a reasonable method for allocating fees should include a prudent process that considers the various allocation methods and the implications of these methods on different classes of participants,” it states.

In Vanguard’s experience, according to the paper, many plan sponsors have historically applied the pro rata method of allocating recordkeeping fees or a combination of pro rata and per capita methodologies. “Over the past several years, Vanguard has seen plan sponsors shift their fee allocation methodology to a per capita fee, particularly in the large 401(k) plan segment,” the paper observes.

It further notes, however, that the trend toward implementing a per capita fee in plans with less than $500 million has developed at a slower pace. In many cases, the minimum investment requirements for lower-expense share classes cannot be met or the per capita charges may be high. In the smaller end of the market, a hybrid approach is more prevalent, typically because the asset-based fees for these plans cannot fully cover the recordkeeping expenses, Vanguard explains.

Plan sponsors may also face other questions related to fee allocation, the paper notes. These include whether to differentiate between active and terminated employees, compliance with ERISA’s “exclusive benefit” rule and whether to disclose revenue-sharing fees and/or attribution credits.

Fee Policy Statement

Meanwhile, some plan sponsors have found it helpful to adopt a fee policy statement designed to provide structure for their fee discussions, according to the paper. It cautions, however, that as is the case with investment policy statements, “sponsors should make certain that the fee policy remains up-to-date and is revised to reflect changes in investment policy, employee demographics, appropriate and necessary plan services and other factors that may impact fee decisions.”

Whatever course is taken, Vanguard advises that strong documentation is critical. “To the extent the fiduciaries are questioned later, they will be best served if they are able to point to detailed documentation reflecting the information considered, the decision-making process and rationale support any of the decisions that fiduciaries make,” the paper advises.