Creative practices by providers in how they bid retirement plans are great. But, how much additional liability do they create for plan sponsors?
Let’s say you want to add a spare bedroom and bathroom to your home. In the process, the builder tells you to engage three vendors: a plumber, an electrician, and a carpenter. You contact a few local vendors, provide plans for the project and ask each for a proposal. Your goal is to compare the proposals, talk to each contractor, and check references before making final vendor selections.
Now let’s imagine that two of the vendors come back with a fee quote involving not only their own services, but a strange mix of other services you didn’t request. The plumber wants to do a little bit of electrical work, some carpentry, and some painting. The carpenter’s fee includes wiring and plumbing too – but trust me, he knows what he’s doing – and he’s putting some strange kind of pressure on you to provide those services as well. Would you simply accept the proposals and say, “Fine, do whatever you want and just send me the bills?” Not likely. You’d ask each vendor to provide a clean quote for just the services you requested. Then, you’d make an open-eyed decision and proceed with the contractors best suited to the job. You’d now have clarity, transparency, and accountability.
Taking this approach would seem only natural in a home renovation project. But for some reason, in today’s world, we’ve allowed a much larger purchasing need – the selection of retirement plan service providers – to slip into “mashed potato pricing” without much challenge. Allow me to explain.
As plan sponsors oversee their retirement plan, there are three specific functions (ingredients) they need to manage the:
- Investment menu (mutual funds, collective funds, annuities, brokerage window, etc.)
- The recordkeeping/administrative solution
- The relationship with an Investment Advisor or Corporate Trustee (and the fiduciary and education services they will provide)
Just like the plumber, electrician, and carpenter, each service is essential to the big picture. Working together, these services help educate and engage plan participants, support the long-term accumulation of wealth, and manage the administrative complexity of the plan to reduce risk for the employer.
Fee benchmarking: What’s the obligation?
In establishing a qualified plan, each plan sponsor takes on important fiduciary obligations. One of these obligations is to periodically review and benchmark fees and services for reasonableness. This step applies not only in the aggregate sense—“The total cost of our plan is 121 basis points per year, while the benchmark group is running at 125 basis points” —but also in a functional way to each service area. Investments, administration, and advisory services each need to go under the microscope. The goal of a fiduciary process is not to “offer the cheapest fees,” but rather determine what services the plan needs, then find the best quality of services at reasonable and competitive fees—driving value for the plan.
The goal of a fiduciary process is not to “offer the cheapest fees,” but rather determine what services the plan needs, then find the best quality of services at reasonable and competitive fees—driving value for the plan.
If an Advisor charges 50 basis points per year to a $17 million 401(k) plan merely to perform plan-level fiduciary services with two client meetings a year – with no participant education or daily engagement – chances are this would not be a reasonable fee arrangement, even if the plan was using 100% index funds. Likewise, if a $55 million plan was using a fund lineup with an average management fee of 85 basis points, you’d likely have a similar outcome, regardless of the cost of the other services. In a DOL or IRS audit, or plan-related litigation, the plan sponsor will be in the hot seat to defend these arrangements. Yes, most Registered Investment Advisors or Corporate Trustees will assist in the process. But a non-fiduciary, bundled service provider standing on the sidelines will usually be of little or no value as you try to defend yourself against allegations that fees were unreasonable, fiduciary process was not followed, or worse yet, you didn’t really know what you were paying for the various services; it all just blended together.
Whether it’s driven by legitimately bad facts or mere opportunism, we’ve seen a surge in litigation concerning fees, investments, and fee reasonableness in recent years. It should be a wake-up call for plan sponsors.
We’ve seen a surge in litigation concerning fees, investments, and fee reasonableness in recent years. It should be a wake-up call for plan sponsors.
How mashed potatoes get started
Mashed potato pricing starts with an innocent premise: “Here’s a proposal for your 401(k) plan, along with a few other ways you can reduce certain costs.” In a recent bid of a $35 million 401(k) plan, three separate bidders were serving up their own recipe of mashed potatoes. Two of these quotes looked very similar:
- Scenario 1. Open architecture quote using the funds available on our platform, in any mix you choose. Quote: 12 basis points for recordkeeping and administration.
- Scenario 2. Open architecture quote using the funds available on our platform, but selecting our proprietary stable value fund for all money market or stable value assets. Quote: 10 basis points for recordkeeping and administration.
- Scenario 3. Open architecture quote using funds available on our platform but where we auto-enroll participants into our proprietary target date funds as QDIA options. Quote: 2 basis points for recordkeeping and administration.
Paul Neveu is President of BPAS Plan Administration & Recordkeeping Services.