Plan sponsors have important obligations as ERISA fiduciaries to a retirement plan. They must follow ERISA’s high standards of conduct as they administer the plan and safeguard participants’ assets. The key to managing ERISA fiduciary responsibilities is developing and following prudent plan governance practices like fee disclosures. Plan sponsors who adopt policies and procedures to make certain they are handling plan assets properly and making prudent decisions will be able to demonstrate that they have met their fiduciary responsibilities.
This is the first in a series of posts about plan governance best practices for plan sponsor fiduciaries. You can find the following posts about Internal Controls, Plan Check-ups, and Fiduciary Calendars at their respective links.
Five Fiduciary Responsibilities
- Act solely in the best interests of the plan participants
- Carry out duties prudently
- Diversify investments
- Follow the terms of the plan document
- Pay only reasonable plan expenses
Understand Plan Fees
Especially important for a plan sponsor is selecting and monitoring service providers and investments for the plan. As a plan fiduciary, they must ensure that quality services are provided to the plan and that fees are reasonable and necessary if paid from plan assets. In order to make prudent, informed decisions about plan fees, plan sponsors must have a solid understanding of the types of expenses that their plan can incur. Three categories of expenses typically arise in a retirement plan, such as a 401(k) plan:
Certain services are viewed as primarily benefiting the plan sponsor rather than the plan participants and cannot be paid from plan assets. These “settlor functions” include services related to plan establishment, plan design and plan termination.
Plan Administration Fees
Service providers assess fees for recordkeeping and third party administration costs for the day-to-day operations of the plan. This can include processing transactions, performing compliance testing, and generating plan reporting. They can assess additional fees if the plan uses an outside trustee or custodian. These fees may be paid by the plan sponsor, from plan assets, or through revenue sharing arrangements. Fees for services performed for an individual participant (e.g., loan processing) are typically debited from the affected participant’s plan account balance.
Investment providers charge fees to cover the costs of investment management, administration, and account maintenance, along with distribution and sales charges. They deduct these fees from the participant’s investment account. Investment fees and revenue sharing arrangements between service providers and investment managers can be complex. Most plan sponsors tap into the expertise of an investment advisor to better understand their plan’s investment fees.
Make Sure Fees Are Reasonable
In recent years, there have been an increasing number of lawsuits brought by retirement plan participants alleging that plan sponsors breached their fiduciary duties by paying excessive fees for services or investments. Plan sponsors are not required to choose the least expensive service providers and investments. However, they should make sure the fees are “reasonable.” According to the Department of Labor, cost is just one of multiple factors that plan sponsors should consider in making this determination. Even more, plan sponsors should have a methodical approach for weighing the value of the services received and the benefit to the plan against the cost for those services. They should document their decision-making process and the basis for determining a plan fee is reasonable.
To ensure plan sponsors have the information they need to evaluate whether fees are reasonable, the ERISA Section 408(b)(2) disclosure regulations require service providers to provide fee disclosures to plan sponsors. Plan sponsors must collect and review this fee information prior to contracting with providers. Furthermore, a financial advisor can provide benchmarking support and help plan sponsors identify and evaluate competitive service arrangements and investment options.
A Prudent Process
In addition to reviewing fee disclosures before engaging with a service provider or including an investment option on the plan menu, plan sponsors should develop and document a prudent process for monitoring fees on an ongoing basis. This will ensure that the fees paid by the plan continue to be reasonable. If the services, the marketplace, or the plan’s needs change, plan sponsors must determine whether to modify or terminate the arrangements based on their new circumstances. Plan sponsors should conduct fee reviews on a regular schedule. Benchmarking fees against other service providers who deliver comparable services or similar investments is critical to determining whether fees continue to be reasonable. So, as with other fiduciary functions, plan sponsors should maintain records of the steps they took to satisfy their responsibilities and the reasons for their decisions.
Finally, a plan sponsor has a fiduciary obligation under ERISA to make prudent choices regarding plan-related fees and expenses. This will ensure that only reasonable fees are paid from plan assets. Advisors can provide valuable assistance in helping plan sponsors understand the fees associated with their plan. They can also design a due diligence process to help satisfy their fiduciary requirements. Fiduciary best practices include working with a financial advisor to
- Establish a due diligence process for evaluating both service provider and investment fees
- Benchmark fees to determine reasonableness
- Document the review processes
- Review plan fees on a regular schedule (e.g., annually)