Most of the discussions about fees in defined contribution (DC) plans like 401ks and 403bs have been about reasonableness especially in light of the rash of 401k lawsuits. But another way to look at fees is whether they are fair to participants in the plan as discussed in a white paper by TIAA, the leading 403b service provider. Fee fairness in DC plans may seem subjective, but the TIAA white paper lays-out some objective guidelines to consider.
Fairness and effectiveness go hand in hand and includes:
- Adequacy – are fees adequate to cover all services
- Transparency
- Simplicity – easy to administer
- Fairness
- Horizontally – participants similarly situated pay the same
- Vertically – wealthier participants pay the same percentage as all others
There are three types of fees for DC plans like 401ks and 403bs:
- Administrative & record keeping – benefits all participants
- Investments – chosen by each participant
- Individualized – transactions like loans
The TIAA white paper asks whether flat or per head fees are fair. Though they would pass the horizontal test, flat fees would fail the vertical test as participants with lower account balances would pay a higher percentage of assets than those with larger account balances. For example, a $100 charge per participant would be 1% for a $10,000 account and .1% for a $100,000 account. TIAA proposes that to be really fair and have a progressive fee, like with taxes, a plan might waive fees for the 1st $10,000 which would benefit lower account holders who tend to be younger, lower income workers.
There is an inherent unfairness when a percentage of the investment costs are used to pay administrative and record keeping fees or so called revenue sharing because some investments pay a higher percentage to offset fees. For example, index funds generally pay a lower percentage of their fees towards revenue sharing – some pay nothing. If most or all of the admin and record keeping fees are paid through revenue sharing, a common practice, then participants pay according to which funds they select, not a percentage of assets.
The TIAA recommendation of a waiver for the 1st $10,000 of a participant’s account balance and then an equal pro rata amount above that regardless of the revenue sharing passes all four tests but especially fairness. More and more record keepers can handle this fee arrangement so it’s worth asking. And it’s only fair.
