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Are the fees paid by your company's 401(k) plan reasonable? Consider the following:
• In August 2013, a U.S. District Court ordered a 401(k) plan's fiduciaries to restore $321,000 to plan participants after concluding that the fiduciaries breached their fiduciary duties and paid excessive service provider fees to the plan's third-party administrator.
• In July 2013, a U.S. District Court approved a $35 million settlement involving a company and its 401(k) participants alleging, among other things, breaches of fiduciary duty, and payment of excessive service provider fees.
• In March 2013, a U.S. Court of Appeals ruled that a 401(k) plan's fiduciaries breached their fiduciary duties by including more expensive share classes of certain retail mutual without first conducting an investigation into available institutional share classes of the same funds.
In one of these court opinions, the court stated that the plan's fiduciaries had a fiduciary duty to know what the Plan was paying in compensation and fees. In relying exclusively on the third-party administrator's own spreadsheet for that information without obtaining third-party verification, they breached that duty, causing the Plan to pay excess fees. Rather than investing the time and effort to keep tabs on what the Plan was paying, the fiduciaries effectively took the third-party administrator at his word and even went so far as to actively deflect other potential third-party administrators – including Fifth Third Bank – on the now discredited theory that the current third-party administrator offered a better deal for Plan participants.
In order to comply with the Employee Retirement Income Security Act (ERISA) and other Department of Labor regulations regarding 401(k) plans, when the fees for services are paid out of plan assets, fiduciaries need to understand the fees and expenses charged and the services provided. While the law does not specify a permissible level of fees, it does require – under Section 408(b)(2) of ERISA – that fees charged to a plan be "reasonable."
For example, in the third case above, the court observed that "this might have been a different case" had defendants shown that the advisor "engaged in a prudent process" by presenting evidence of the advisor's specific recommendations about the funds, the scope of the advisor's review, whether the advisor considered both retail and institutional share classes, or what questions or steps were used to evaluate those recommendations.
Failure to comply with these regulations can even result in personal liability to the responsible fiduciaries. So what can a plan fiduciary do to determine that fees paid from a 401(k) plan's assets are reasonable? An increasingly common tool is the use of a periodic benchmarking analysis.
A benchmarking analysis typically involves engaging a third-party consultant to evaluate a plan's expenses as compared to those of a "peer group" of similar plans. These reports will evaluate expenses on both an aggregate level and broken down into specific categories (such as recordkeeper, investment advisor, and investment manager fees). Fees are usually also evaluated for each of the plan's individual investments (for example, by comparing each mutual fund's expenses to the average fees paid by peer group plans for mutual funds in the same category). In addition, these reports frequently compare a plan's provisions (such as availability of a Roth option, automatic enrollment, etc.) and participant success measures (such as employee participant rates) to the peer group.
While a benchmarking analysis won't provide a definitive "yes or no" answer as to the reasonableness of a plan's expenses, is can be a crucial tool in demonstrating a fiduciary's due diligence in evaluating these expenses.
Still have more questions? Reach out to your CPA to learn more.
Delap LLP is one of Portland’s largest local tax, audit, and consulting accounting firms, located in Lake Oswego, Oregon.