Debunking four common fee levelization misconceptions

Retirement plan sponsors have a lot on their minds, especially in light of recent fee-related lawsuits in the news. As a result, plan sponsors are more aware of their fiduciary role than ever before with over half expressing concern about potential litigation.1

Debunking four common fee levelization misconceptions hero image | Principal

While awareness is good, all of the headlines can often lead to confusion or concern about how best to approach fee allocation. Plan sponsors can take comfort knowing there’s really no one right way. It comes down to knowing and reviewing available options and putting a documented process in place.

As plan sponsors review the options, we want to make sure they have the real insights on fee levelization. For instance, some may think it’s only for large companies and others fear participants will react negatively. Although reasonable assumptions, these aren’t quite accurate. By debunking four common misconceptions we offer fresh perspective on where we see fee levelization working and how it’s being received.

The headlines in the news can often lead to confusion or concern about how best to approach fee allocation.

Misconception 1:

Lots of buzz, lots of adoption

There’s a lot of buzz about retirement plan fees. And for good reason. But some believe all of the talk has led to widespread adoption of fee levelization among plan sponsors. Turns out the uptake may not be happening as quickly as suspected.

Misconception 1: Lots of buzz, lots of adoption image.

Advisors expect use of fee levelization to increase

To help get a better sense for what’s currently taking place in the market, we asked advisors about it. The majority of those surveyed report a fairly low percentage of clients currently use a method to levelize or equalize plan administrative fees. Although they do expect that number to grow in the near future.

Visual depiction of 40%
More than a third (40.7%) of advisors report less than a quarter of their current clients equalize participant fees.
More than half image
1 in 5 (23.3%) expect more than half of their clients will make a change within the next year.
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Fee Levelization: Advisor Insights Study conducted by Principal®, July 2017.

Other sources have noted a similar trend. According to a recent study, only one-third of plan sponsors recently restructured administrative fees more equally among participants. But another 39 percent say they’re likely to do the same.2 We’ve seen a similar response as the number of advisors and plan sponsors asking questions about fee allocation has grown significantly in the past several months.

It’s certainly catching on, but hasn’t led to what we’d consider wide-spread adoption yet. If plan sponsors have held back due to not seeing immediate action among their peers, they may want to reconsider. As pressure to mitigate risks associated with their fiduciary role increases, the number of those implementing levelization of plan administrative fees will likely keep growing.

Misconception 2:

Only large companies use it

With adoption of retirement plan administrative fee levelization on the rise, some believe implementation is concentrated among large companies. After all, many 401(k) plan trends start with larger plans and gradually work their way down market. But as we look across our current client base, we actually find a wide range of plan sizes implementing fee levelization.

Misconception 2: Only large companies use it image.

Clients levelizing administrative fees vary by assets and the number of participants3:

A look at our clients proves this isn’t just a trend for the largest organizations, but something that can fit at almost any retirement plan size.

Take for instance, Access Intelligence, a mid-sized media company with 250 employees based in Rockville, Maryland. Not unlike other mid-sized businesses, Access Intelligence has a retirement plan goal to offer the most appropriate, cost-effective investment options and remain compliant.

By levelizing plan administrative fees for all active participants, this company believes they have met both goals. Find out how Access Intelligence achieved their goals and view the results in this case study.

Go to the case study
Dollar sign image for fee levelization.
$1 million
100 million
From less than $1 million to more than $100 million in plan assets.
Participants image for fee levelization.
50 participants
1,000 participants
From less than 50 participants to well over 1,000 participants.
Segmentation chart image.
Less than 100 participants
More than 100 participants
60 percent of clients have less than 100 participants compared to 40 percent with more than 100.
Misconception 3:

Zero revenue options are always cheapest

When it comes to levelizing retirement plan administrative fees, a first instinct is often to assume using zero revenue investment options or zero revenue share classes are the least expensive share class. This approach generally appeals to plan sponsors who want to accomplish a clear separation of plan administrative and recordkeeping fees from investment expenses using the simplest method.

But while this method can be the simplest, it’s actually not always cheapest — a common misunderstanding. Sometimes using an investment lineup that includes revenue sharing can be less expensive when the revenue sharing is credited back to participants.

Misconception 3: Zero revenue options are always cheapest chapter image.

Decide what is best for the plan by comparing an investment option's fees

ABC small cap fund
Investment expense
Revenue sharing (credit back to participants using a zero revenue sharing through fee credit – “credit all” approach)
 

Net investment expense
  
   R6 share
1.01%
 
–0.15

0.86%
  
   Zero revenue share
1.00%
  
no revenue sharing

1.00%

Here we compare a zero revenue share class with a 1.00% investment expense to an I share with a slightly higher 1.01% expense. Unlike the zero revenue share class, the I share has 15 basis points of revenue sharing available to offset plan administrative expenses, such as recordkeeping and advisor fees.

If a plan sponsor uses a zero revenue sharing with fee credits approach, the 15 bps of revenue sharing from the I share is credited back to all participants who elected it. By giving back the credit and subtracting it from the investment expense, the overall net expense is actually 14 bps lower than the zero revenue share class.

Of course that’s not always the case. Take a look at this comparison:

ABC global bond fund
Investment expense
Revenue sharing (credit back to participants using a zero revenue sharing through fee credit – “credit all” approach)
 

Net investment expense
  
   R6 share
1.24%
 
–0.60

0.64%
  
   Zero revenue share
0.58%
  
no revenue sharing

0.58%
In this scenario the zero revenue share class is the most revenue efficient or least expensive option, even after crediting back the revenue for the R6 share. This highlights an important point that there’s no one right answer to approaching fee levelization. Instead, it’s an exercise in comparing an investment option’s fees, objectives and philosophy along with the plan’s goals when deciding which will work best for the organization.

Zero revenue shares still new

It’s important to keep in mind that zero revenue investment options are still relatively new. But the numbers are growing. Up from 15 managers in 2011, over 50 managers offer zero revenue share options today.5 Since these newer funds have lower assets under management, some may have higher costs for now. As uptake increases, it’s likely this type of investment may become the most cost-efficient. Until then, a credit all approach can work better in some cases.
But it’s not an issue for all investment managers. Some recognize lower asset levels can impact pricing and have ensured zero revenue share classes don’t have higher expenses. That’s why it’s crucial to understand all available investment options and their total net investment expense. By showing plan sponsors have done their due diligence to choose the most appropriate share class for the plan and participants, they can demonstrate their fiduciary responsibility.
But it’s not an issue for all investment managers. Some recognize lower asset levels can impact pricing and have ensured zero revenue share classes don’t have higher expenses. That’s why it’s crucial to understand all available investment options and their total net investment expense. By showing plan sponsors have done their due diligence to choose the most appropriate share class for the plan and participants, they can demonstrate their fiduciary responsibility.
Misconception 4:

Participants won’t like it

For those considering levelizing their plan administrative fees, but are not quite ready to pull the trigger, we often hear concerns about participants’ reaction to retirement plan fees. According to a recent report that’s valid, 6 in 10 participants don’t know what fees they pay or say their employer pays all of the fees.6 By implementing fee levelization, participants may become more aware of the fees they pay. But that’s not necessarily a bad thing.

Misconception 4: Participants won't like it chapter image.

Impact of fee levelization

To better understand this concern and, more importantly, the impact on savings, we took a look at participants in our retirement plans. By analyzing three major savings factors — participation, deferral and account balance — we determined plan administrative fee levelization did not negatively impact participant actions.

Participation

Half (51%) have participation rates between 75 and 100%.3
Above the industry average of 78.5%.8
51%

Participation rates
between 75%-100%

51%

Participation rates
between 75%-100%

Deferral rate

36% higher average deferral rate.3
9%
6.6%

Fee levelization
average

Industry
average

Account balance

Average account balance 10% higher than the industry average.3,7
$95,490
$87,038

Fee levelization
average

Industry
average

Levelization doesn’t seem to hurt plan outcomes, but what about it raising more questions and concerns from employees? According to one of our clients, that simply wasn’t the case.

“We had a lot of discussion around exactly how this was going to work. How do we communicate to participants? Will they understand? This is where we spent most of our time,” said Michelle Levy, compensation and benefits manager for Access Intelligence. “Our biggest surprise during implementation was that we only had a few questions from our participants.”

Ease the transition

One way to further ease the transition to fee levelization is through effective employee communication. If the plan sponsor makes an effort to equalize administrative fees, participants should be aware of the change and understand it. In addition to providing required notices, here are a few ideas:
  • Remind participants how retirement plans work and the benefits.
  • Explain retirement plan administrative fees. Show how fees are charged similar to those in a mutual fund if they invest on their own outside a sponsored plan.
  • Break down fee types — investment expense, plan administrative fees and participant transaction fees.
  • Describe what’s changing and show how to find fee information.
With a better understanding and more transparency around fees, participants may actually make more well-informed decisions about their savings.

Take action

As with any hot topic, there’s bound to be some confusion. But by debunking some of the most common misconceptions, we hope you have a better understanding of the real story around plan administrative fee levelization.
With this in mind, now’s a good time to take a fresh look at fee allocation. To better understand the options and help mitigate related fiduciary risk, check out our recent white paper covering what fiduciaries need to know. Then consider using these steps:

1. Gather and evaluate relevant facts, including plan participant needs.

Gather & evaluate

Assess

Document

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Learn More

Gather & evaluate

Topic 2

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Topic 3

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Topic 4

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2. Assess available fee payment methods and determine how fees will be collected.

Gather & evaluate

Assess

Document

3. Document, document, document. Use a fee policy statement for help.

Fee policy statement

Gather & evaluate

Assess

Document

1. The Cerulli Report, U.S. Retirement Markets 2016.
2. AON Hewitt Hot Topics in Retirement, January 2016.
3. Principal block analysis as of June 30, 2017, Principal 2017. Based on sample of 981,695 participants in plans using fee levelization.
4. Deloitte Annual Defined Contribution Benchmarking Survey, August 2015.
5. PlanAdviser Magazine, November/December 2016.
6. The Cerulli Report: U.S. Evolution of the Retirement Investor 2016 (page 84).
7. Plansponsor DC Benchmarking survey, February 2017.
8. Plansponsor DC Benchmarking February 2017.

For financial professional or plan sponsor use only.

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Insurance products and plan administrative services provided through Principal Life Insurance Co., a member of the Principal Financial Group®, Des Moines, Iowa 50392.

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The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Insurance products and plan administrative services provided through Principal Life Insurance Co., a member of the Principal Financial Group®, Des Moines, IA 50392.

© 2018 Principal Financial Services, Inc.