The Opportunity Cost and Fiduciary Implications of Retirement Plan Fees

By Jeff Robertson. Jeff Robertson is an attorney with Barran Liebman LLP, representing plan sponsors and retirement plan service providers in all areas of benefit planning. He can be reached at 503.276.2140 or jrobertson AT barran DOT com.

In the aftermath of the Enron and WorldCom litigation and the Mutual Fund trading scandal, stands the often hidden and misunderstood world of retirement plan fees in the 401k marketplace. The 401k Plan is the major retirement savings vehicle for most employees and each year that market expands in size and assets. Fees charged to those accounts, have a direct effect on employees' balances and most employees have no idea as to the size and impact on their retirement quality of life as a result. Perhaps more disturbing, is that the segment charged with prudently administering these plans, the plans' fiduciaries, have never looked into and in large part do not understand the total fees being charged to the plan. This unknown represents perhaps the most significant risk for retirement plan fiduciaries today.

Where Plan Fees Exist

Most Plan Sponsors receive a breakdown of some of the fees paid by the Plan and receive in depth disclosures as to an individual fund's "expense ratio." However, most Plan Sponsors are unaware of the extent and effect of the fees in the Plan. It should be noted that the mere presence of fees is not always indicative of a poor plan, there is certainly a difference between value and price, however, a retirement plan fiduciary should be aware of the extent of all fees to properly judge the value versus the price. A retirement plan generally includes the following fees:

Plan Expenses

There are obviously costs associated with administering the Plan. The Plan may hire accountants, third party administrators, investment advisors, custodians, trustees and lawyers. Additionally, the Plan may offer extra services to employees such as education or investment advice. The Plan may pay for these expenses directly from the Plan or from the general assets of the Plan Sponsor. Usually these expenses account for less than 10% of the total expenses of the Plan.

Investment Expenses

The bulk of the Plan's expenses will exist from investment expenses. These fees are more difficult to understand, as they are often deducted as a percentage of assets from the Plan or directly from the fund, and at times include additional fees that the Plan participant will never see as the investment advisor directly collects these additional fees. Fees in this area vary wildly and we can be as much as 2 or 3 times as expensive depending on the particular platform.

To determine where fees come from, a Plan Sponsor should first work with a comprehensive fee disclosure worksheet. The Revere Coalition, a collection of independent fee-only retirement plan consulting firms, recently published an excellent fee disclosure form. Some categories to be aware of:

Hard Dollar Fees: These expenses are generally easy to determine. Simply look at the Plan and determine how much you are being charged by vendors either on a per participant basis or in the aggregate. These are generally the expenses charged by an investment money managers and investment advisors.
12b-1 Fees: This is a hot area these days. 12b-1 fees are charged based on an SEC rule allowing investors to receive "savings" through certain economies of scale. Many Registered Investment Advisors capture these 12b-1 fees for the plan, offsetting their own costs to the plan.
Revenue Sharing Fees: These fees might include sub-transfer agent fees, commission or finders fees, share class fees, and many other fees paid to the fund or out of the fund to your service providers or to the money management companies. Revenue-sharing fees are a significant source of a fund's expenses and often the most difficult to determine.

The soft-dollar fees are very difficult to discern and determine because they are generally deducted from the investment return of the fund and not expressly listed as a direct expense of the fund for the participant. These expenses are usually disclosed in the prospectus, but some of the revenue-sharing fees are extremely difficult to find and the analysis should be undertaken by an expert professional. Once the total fees are understood, a Plan can consider the lost opportunity cost due to the Plan's expenses.

Opportunity Cost

Excessive retirement plan fees can have a significant effect on an employee's retirement. A savings of less than one percent each year over the course of 30 years may amount to a difference for an employee, with an account balance of $50,000 and who invests at the yearly maximum deferral, of an additional $450,000 with an assumed yearly rate of return at 8%. As little as 1% equals nearly a half million dollars, the opportunity cost is very real and very large, which leads to significant fiduciary implications for Plan Sponsors.

Fiduciary Implications

In the past we have seen primarily two major areas of fiduciary litigation involving 401k plans. First, we have seen litigation based upon a public company employer imprudently using its own stock as an investment option. This is the Enron example. Second, we have seen allegations based upon a sustained market correction. These are the lawsuits we have seen based upon the markets from 1999-2003. The third area of lawsuits, and perhaps the scariest area for the majority of employers, is based upon opportunity cost and plan fees.

These lawsuits are based upon an employer's fiduciary duty. Under the Employee Retirement Income Security Act ("ERISA") a plan's fiduciaries must make a prudent investment decision and act for the exclusive interest of the Plan participants. A lawsuit based upon opportunity cost is a frightening proposition because the shield of ERISA Section 404(c), which is often promulgated as a holy grail defense by attorneys and consultants, is ineffective. ERISA 404(c) only protects a plan's fiduciaries based upon the proper diversification of the Plan, not based upon the prudent investment choices and the plan's fiduciaries making decisions solely in the interests of the plan participants (Duty of Loyalty). With no affirmative defense, plan sponsors are often unwittingly at risk, often times due to the very providers charged with protecting them.

The legal theory of opportunity cost involves a 401k plan account not earning as much as it could have earned, because the plan's fiduciaries offered investment options with excessive fees. For Plans which have expenses 2-3 times the national average and who have never examined or negotiated the Plans' fees, will have difficulty defending such a case.

How To Protect Yourself

Plans can protect themselves against this new wave of ERISA litigation through prudent action. Plans should investigate their Plan fees and determine the true expense cost. The expense of the Plan should be weighed with the services received. There is no right or wrong answer when dealing with plan fees; there is only no answer when the Plan's fiduciaries have failed to investigate.

Other articles by Jeff Robertson: Lower Costs or Hidden Problems: The Legal Concerns for ETFs in 401k Plans, Know When to Hold 'Em, Know When to Fold 'Em: The High Stakes Game of Fiduciary Liability and When To Hire An ERISA/Employee Benefits Attorney.

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