The Employee Retirement Income Security Act mandates that plan fiduciaries and administrators ensure reasonable fees are being charged for all services offered under a qualified retirement plan. For 401(k)s, behind-the-scenes fees for investment management and recordkeeping are included, as well as trust and custody, just to name a few. These funds quickly accrue and are passed on to plan participants in one form or another. The big question for any plan sponsor is: How do I make sure these fees are reasonable?
They ask this not only because it is their fiduciary and regulatory duty to ensure fees are cost-conscious for participants, but also because of the looming threat of lawsuits. Plan sponsors that fail to uphold their obligation could pay for it later — often to the tune of millions of dollars — through class-action settlements and regulatory penalties. Just look at recent examples in the news with cases against Northwestern University, Bessemer Trust and Home Depot, among others.
To combat any allegations of excessive fees, plan sponsors often turn to fee benchmarking to ensure they’re being responsible and passing along the lowest possible costs to participants within reason. While many within the industry believe that benchmarking can prevent excessive fee lawsuits, in reality these types of exercises are limited in their ability to effectively safeguard against litigation.
For starters, no two plans are the same.The underlying premise of any benchmarking exercise is that plans in the sample set are substantially similar to the subject plan. But benchmarked plans often share nothing in common with the subject plan — or even with one another — aside from a similar number of participants. And experienced plan sponsors know that all plans with 10,000 participants are not the same. Variations in plan design, the number and nature of vendors involved, and the size of the plan’s assets all help determine what fees are actually “reasonable.”
Notably, differences in service set are almost never considered in benchmarking exercises. Two plans that serve the same number of participants and have practically identical plan designs may ask radically different things of their vendors. For example, a plan sponsor in a high-churn industry may expect its recordkeeper to accommodate a higher volume of enrollments and distributions — and therefore, charge higher recordkeeping fees — than a peer with lower turnover. Or consider the amount of work involved in managing contributions when all participants share the same two-week payroll cycle vs. the level of service required for a company whose 40 locations each have their own payroll cycle.
Benchmarking data, by its very nature, is historic. Consider that many benchmarks rely on plan fees disclosed in annual IRS Form 5500 filings. Since those filings are not due until seven months after the end of a given plan year, the fee information they contain is a minimum of seven to 19 months old at the time of filing — and that’s presuming the disclosed fees were negotiated sometime during the immediate previous plan year.
Realistically, though, most fees reported in 5500s are even staler. Each fee (or set of related fees) is negotiated individually with a different service provider. These negotiations happen on different timetables, and each contract may have a term of one to five years. When a plan is in the fourth or fifth year of one or more service contracts, the fees disclosed on its Form 5500 will be a good five or six years behind current market pricing.
Of course, Form 5500 filings are not the only source of fee benchmarking data. Some data providers base their benchmarks instead on the fees disclosed by plan sponsors in their requests for proposals (RFPs) and the bids furnished by vendors in response. But even when such benchmarks purport to be updated and published annually, they rely on a mix of current and aged data. After all, there are no more than a handful of RFPs issued by plan sponsors in any given year that are truly alike in asset size, number of participants, plan design and service set. No matter how you decide to slice benchmark data, it’s already dated.
Considering the inherent drawbacks of trying to determine reasonable fees using aged data from dissimilar plans, employers that want to bullet-proof themselves against litigation need to go well beyond standard benchmarking exercises.
Here are three pieces of advice for avoiding excess fee lawsuits:
- Don’t be afraid of the RFP process
Rather than benchmark against historical data, it’s better to collect competitive bids by issuing periodic RFPs. While this is much more leg work, remember that if a plan sponsor really wants to ensure its fees are competitive, the only reliably effective way to do so is to put your plan out for bid.
This doesn’t mean plan sponsors must be willing to change providers at the drop of a hat. Rather, if the RFP process reveals the plan is significantly overpaying in a certain fee category, the plan sponsor can use the RFP findings as a jumping-off point for negotiating more competitive pricing.
- Strike the right fee balance
When it comes to selecting a plan recordkeeper or third-party administrator, it would be easy to simply pick the lowest-cost provider in a competitive situation and think nobody could sue you for excessive fees (or if they did, that it would be a cut-and-dry case).
But from a fiduciary perspective, determining whether fees are reasonable is about more than just the price tag. It’s about making sure plan sponsors and participants get what they’re paying for. Therefore, it is important to strike the right balance between cost and quality by taking into account a service provider’s areas of expertise, breadth and depth of experience and track record of success.
- Document Everything
The bigger a plan sponsor is, the bigger the target they are for lawsuits. But no matter the size of the plan, it behooves plan sponsors to thoroughly document that they did their homework. This is particularly true if they chose not to unilaterally pick service providers with rock-bottom lowest fees. All documentation, including emails and call transcripts with consultants and strategic investment advisers, should be retained to demonstrate that the plan sponsor solicited objective, expert input.