401(k) Fees: Participants’ Best Interests May Not Be Served by the “Race to the Bottom”
There’s good news for employers! Many have been on edge as they read about the “excessive fee” lawsuits filed against retirement plan fiduciaries, some of which have made their way to the U.S. Supreme Court. Or they’re shaken as they hear about the detailed fee document requests and questions from Department of Labor auditors to 401(k) and 403(b) plan sponsors and the fines and penalties that can result from DOL investigations.
While lawsuits and investigations have served a purpose in lowering plan fees, a side effect is that many plan sponsors, in their concern to meet compliance standards, have made a search for the lowest fees such a priority that they have unwittingly overlooked the best way to serve plan participants! In fact, when I meet with employers, they often first tell me they need to reduce plan fees to create a “hedge of protection” for themselves.
My first response is to put employers at ease. I explain that what the courts and Department of Labor are most concerned about is that plan fiduciaries have prudently reviewed the services their plan provides, understand the fees paid to each service provider and have undertaken the due diligence necessary to feel confident their fees are “reasonable” based on the services received. These steps, when implemented and documented, form the best “hedge of protection” against an adverse court or regulatory determination.
In other words, while low fees are important, they are not the end-all-be-all. A “race to the bottom” to achieve the lowest possible fees, regardless of what must be trimmed in the process, may not yield the plan that best serves participants. Revealingly consistent with this position, the Department of Labor’s own “Understanding Retirement Plan Fees and Expenses” doesn’t say that plan sponsors need to select the service providers and investments with the lowest fees. Instead, it talks about “understanding” and “evaluating” plan fees to determine if they are “reasonable in light of the services provided.”
And that gets to the crux of the issue: what are the services your plan needs to achieve its objectives? And what are its objectives?
Per ERISA, plan sponsor fiduciaries are obligated to make all plan decisions “with the exclusive purpose of providing benefits to plan participants and their beneficiaries” and “defraying reasonable expenses.” Indeed, the number one retirement plan priority identified in surveys of employers is making sure employees are participating, saving adequately and are properly invested for retirement.
So, if getting employees ready for retirement is the key objective of a 401(k) or 403(b) plan, what’s the best way to achieve it? Certainly, obtaining services at a “reasonable” fee is important. But which services?
Let’s take participation. Good plan design – including automatic enrollment at an optimum level and strategic employer contributions – can help increase the number of employees contributing to their retirement plan and boost the amount of their salary deferrals. Likewise, the review of annual plan participation reports with the consultation of a retirement plan professional can help employers continually improve their plan so it works more efficiently for participants, and with better results.
An employer might want to hire a provider offering such services even if this results in a slightly higher fee because employees will benefit. The role of the plan sponsor fiduciary, then, becomes determining that the provider’s fees are reasonable when compared with others who provide the same service.
Let’s take another priority: making sure employees are invested optimally to grow their retirement nest egg and are making wise financial decisions in other areas. On the investment side, being invested too conservatively or aggressively given their or financial position, or lacking a diversified investment portfolio, can prevent employees from optimizing hard-earned savings. Professional investment management along with individual guidance can help participants achieve higher investment returns. And a broad education program – helping employees manage their finances wisely – can lead to better retirement preparedness. Again, such services may come with a higher price tag but can result in a greater retirement readiness benefit.
Back to that “hedge of protection.” Having the lowest fees doesn’t create it. However, defining a plan objective, identifying important services to achieve it, comparing the fees of service providers providing the same service and – importantly – documenting each step of the objective to fee benchmarking process will result in a defensible position.
While assessing fee reasonableness can be performed via an RFP, an independent benchmark or a simple review of the 401k Averages Book, a truly effective analysis doesn’t just pore over each service and ask, “how much?” It also asks its purpose and whether it contributes toward achieving of a better retirement plan for participants.
Dash off a quick email or give me a call, and we can discuss these things together in more detail!
This blog is written to help make the lives of plan sponsors easier in the process of meeting legal requirements under ERISA for their defined contribution plans. Please understand that reading this blog should not alone take the place of a one-on-one consultation regarding the needs of your specific plan, and hence cannot be a guarantee against fiduciary breaches.