Most employers are familiar by now of the many lawsuits (more than 100) filed against 401(k) and 403(b) plan sponsors and their employee fiduciaries responsible for selecting the plans’ record keepers and investment line-ups, alleging that they breached their fiduciary duty by allowing participants to pay excessive record keeping fees and invest in underperforming and expensive investment funds. See my previous post: “Minimizing the Risk of Costly 401(k) and 403(b) Investment Fee Lawsuits.” In response to these cases and consistent with their fiduciary duties under ERISA, many employers have successfully negotiated reduced record keeping fees, moved to lower expense ratio mutual funds or lower cost investment vehicles such as collective investment trusts, and are more diligent in monitoring fees and costs.
But once an employer is comfortable with how much the plan is paying as plan expenses, the next question it must answer is: who is paying those fees, and how do you know that? There are only two sources of funds available to pay administrative fees: either the employer pays them, or they are paid out of participant accounts. Even money held in a plan’s forfeiture account or a so-called “ERISA account” or “revenue credit account” originated as either employer contributions or from participant accounts, so the employer or participants are in essence still paying.
It has been my experience that many employers and their employee fiduciaries cannot easily answer the question about who pays the various expenses necessary to operate a 401(k) or 403(b) plan and when that decision was made. In many cases the decision on who pays plan fees exists in parts of various service provider contracts, is contained in sporadic board or fiduciary committee meeting minutes, or is lost to history. The participant fee disclosure rules under the 404a-5 regulations require plans to provide a quarterly notice on the actual administrative and individual expenses charged to each participant. Therefore, clearly, someone decided something on this topic at some point in the past.
In Field Assistance Bulletin (“FAB”) 2003-3, the U.S. Department of Labor stated that if the plan documents are silent or ambiguous on the point, plan fiduciaries must prudently select a method or methods for allocating plan expenses. As part of acting prudently, the DOL said in part that:
- Fiduciaries must weigh the competing interests of various classes of the plan’s participants and the effects of various allocation methods on those interests.
- An allocation method does not fail to be solely in the interest of participants merely because the selected method disfavors one class of participants, provided that a rational basis exists for the selected method.
- If an allocation method has no reasonable relationship to the services furnished or available to an individual account, the fiduciary may have breached his or her fiduciary duties in selecting the allocation method.
- A pro rata method of allocating expenses among individual accounts (i.e., based on assets in each account) is in most cases an equitable method of allocating expenses among participants, but it is not the only permissible method.
- A per capita method of allocating expenses among individual accounts (i.e., expenses charged equally to each participant account) may also be a reasonable method of allocating certain fixed plan administrative expenses.
- Where fees or charges to the plan are determined on the basis of account balances, such as investment management fees, a per capita method of allocating such expenses among all participants appears arbitrary.
- Some services might be charged on the basis of a participant’s use of those services (e.g., plan loan fees, distribution fees, QDRO fees).
One effective method for addressing these issues is for an employer to adopt a written plan fee policy. By preparing a written fee policy, the employer can, with deliberation, decide on which expenses will be paid by the employer versus which will be paid by participants, considering each type of expense associated with plan administration (e.g., record keeping, investment adviser, auditor, legal, trustee, etc.). For expenses to be paid out of plan assets, the employer would decide on how to allocate those expenses among participant accounts, taking into account the principles of DOL FAB 2003-3. If a plan has revenue sharing (with or without equalization) or revenue credits, these practices can be included in the fee policy. The fee policy should be reviewed periodically and updated as needed.
Preparing a written fee policy is another prudent step employers and their employee fiduciaries can take as part of best practices plan administration. Employers interested in adopting a fee policy should consult experienced employee benefits counsel who can work with them on making good allocation decisions and drafting a clear and effective policy.