Different Flavors of Fee Levelization

The concept of fee levelization is garnering attention from defined contribution (DC) plan sponsors and advisers, commencing from such sources as the increased volume of litigation over plan costs and the Department of Labor’s Employee Benefit Security Administration’s (EBSA’s) focus on fee disclosures.

Michael Volo, senior partner at Cammack Retirement, explains, “With fee levelization the recordkeeper applies their recordkeeping fee as a percentage of assets, to each individual investment option. If revenue sharing in the investment option exceeds the recordkeeper’s required revenue, the recordkeeper credits each participant who has assets in the fund with the amount of the excess. If the investment provides less than the required revenue amount, the recordkeeper adds an additional fee, in the amount of the shortfall, to the accounts of each participant using the investment. A participant with several different investments might experience multiple credits and debits based on the revenue sharing in each investment, relative to the required revenue.”

Some plan sponsors and retirement plan providers remain perplexed by fee levelization. A 2017 Plan Sponsor Council of America (PSCA) report on non-profit employers found almost half of survey respondents were unaware of fee levelization, while only one in four plan sponsors could verify if their plan employed revenue-sharing to pay costs. 

Still, 33% of sponsors say they have already taken steps to ensure that fees are assessed to participants in a more equitable manner, according to Aon Hewitt’s “2016 Hot Topics in Retirement and Financial Well-Being.”

Michael Sasso, partner and co-founder of Portfolio Evaluation, stressed that it is a plan sponsor’s duty to consider fee levelization, even more now as firms face an upsurge in lawsuits. As companies are sued left and right over fees, plan sponsors must consider not if, but when, potential litigation can occur should certain plan costs be deemed too high or inconsistent, he says.

“In order to better protect yourself and get ahead of it, it would be wise for companies to really look at this, study it, and do what’s best for them. Have a process in place and make sure it’s well-documented,” he says.

Plan sponsors need to question how revenue sharing payments are applied towards each participant, Sasso says. The practice of revenue-sharing occurs when an investment company or manager pays a portion of funds to the recordkeeper, to decrease administrative service costs instead of paying a brokerage cash expense. Because revenue sharing differs with certain investments, participants invested in certain funds could end up subsidizing costs for participants in other funds, Sasso points out. The unparticipating workers, he says, end up “riding on the coattails of participants in funds generating revenue sharing.”

Volo believes the trend in fee levelization tackles this revenue sharing gap, and improves the situation participants, plan sponsors and recordkeepers are put in when remunerating these costs.

“It addresses that disparity and allows for revenue sharing to go back to participants, allows the plan sponsor to select the funds with the lowest net investment fees, and again, it’s a progressive fee, consistent with how investment fees are charged,” he says.

How participants are charged for these fees, from fee levelization to revenue sharing, can depend on the recordkeeper as well. Recordkeepers levelize fees differently from one another, and since it is a complicated process, not all recordkeepers offer the service.  

Other fees

Other fees can be levelized as well. Plan sponsors and advisers should consider whether participants should be charged at a “pro rata” or “per capita” model, Sasso says. “Pro rata means participants will pay a percent on their account balance, while with ‘per capita’ expenses, participants are charged equal dollar amounts. For example, if a sponsor were to charge each participant an annual per capita fee, say $75, a participant with a $5,000 account balance would be paying 1.5% of their assets, whereas a person with a $500,000 account balance would be paying a mere 0.02%. A ‘pro rata’ 10 basis-point fee for a participant with a $500,000 balance would result in $500 in plan fees, whereas a participant with a $5,000 balance would only pay $5. According to Volo, most advisers would suggest a per capita approach, or apply pro rata fees along with revenue sharing fee leveling.

“When that fee methodology is adopted, it lifts constraints off of selecting funds to provide certain revenue sharing to pay for the recordkeeping expenses, because there’s an explicit fee for recordkeeping,” he says. “So, often it allows plan sponsors and advisers to choose low or no revenue sharing funds, to reduce investment expenses to participants.”

Volo say plan advisers can help plan sponsors with fee decisions by requesting both pro rata and per capita prices from recordkeepers.

Participant reaction to fee levelization

For those DC plan sponsors worrisome over participant reaction—and education—concerning fee levelization, Volo explains how incorporating a questions and answers (Q&A) forum or a frequently asked questions (FAQ) portal could mitigate confusion. Some participants may not give the subject any attention, but most, he says, will address the resource should distresses arise. It’s the plan sponsors making an emphasis on fee levelization, he says, that typically generates the need for educational materials.

“Those who are interested have strong communication material provided during the rollout of fee leveling, including FAQs to address any concerns that participants have,” he says.