A white paper recently published by Vanguard exploring how defined contribution plans can pay for recordkeeping and other plan services noted an “increased scrutiny” in how fees are allocated.

Clearly, more than a decade's worth of lawsuits brought against large retirement plans is motivating sponsors' reconsideration, though Vanguard says regulatory requirements are also pushing the trend.

Central to the claims in those lawsuits is that a pro rata structure of assessing recordkeeping fees, where participants pay a basis point percentage of assets in an account, is a per se fiduciary breach under the Employee Retirement Income Security Act.

Recordkeeping services are the same for a $1,000 account and a $10,000 account, the plaintiffs' bar argues. Charging more for recordkeeping as accounts grow, while the services remain the same, amounts to a misuse of plan assets, plaintiffs have commonly claimed in suits against their employers.

As Vanguard notes in its paper, “there is limited legal guidance directly addressing how to allocate fees.”

The pro rata approach, which uses revenue-sharing arrangements with some mutual funds offered in plans to offset recordkeeping costs, has been a common practice in plans of all sizes.

Recently, however, more sponsors are shifting to a per capita fee structure, where fees are spread equally among all plan participants, Vanguard says.

The rub in that option? Small accounts could end up paying more for recordkeeping under a per capita structure than they would under a pro rata structure, an argument plan sponsors have used to counter plaintiffs claims.

PSCA data shows real change among large plans

Irrespective of who is to credit–or blame–in forcing sponsors to reconsider how to pay for recordkeeping, data compiled in the Plan Sponsor Council of America's Annual Survey of Profit Sharing and 401(k) Plans shows employers are acting, particularly at the large plan level.

The comprehensive annual reports—an industry standard bearer in understanding how employers of all sizes are administering plans and how employees are saving—first began to break out how recordkeeping is paid for in PSCA's 58th Annual Report, which represents data from 2014.

Among the largest plans—those with 5,000 or more participants—the use of a pro rata fee structure increased, then dropped:

In 2014, 31.8 percent used a pro rata fee structure.
By 2016, PSCA's 60th Survey showed the method had increased to 34 percent.
But in the recently released 61st Annual Survey, use of the pro rata structure among large plans dropped precipitously, to 24 percent, according to PSCA.

The use of a fixed-dollar assessment of recordkeeping fees has commensurately increased:

In 2014, 49 percent of large plans relied on the structure.
In 2016 the rate increased to 52.4 percent.
But by 2017 the fixed dollar structure jumped to nearly 64 percent, or a 30 percent increase in just three years.

PSCA also breaks out which plans use a combined approach. That option, too, is on the wane, from 19.3 percent of plans in 2014 to 12.1 percent in 2017.

Use of mutual funds with revenue sharing plummets in big plans

The use of retail shares of mutual funds, which commonly allow for revenue-sharing agreements that can be used to pay for recordkeeping, has also motivated lawsuits against retirement plans.

The large plans that are mostly targeted in lawsuits are clearly shifting out of investment options with revenue-sharing agreements as they move away from a pro rata structure of assessing fees:

In 2014, 13.3 percent of large plans offered investments with revenue-sharing agreements, according to PSCA data.
By 2016, the rate had jumped to 21.2 percent.
But a mere year later, that rate was halved, to 10.9 percent in large plans.

Meanwhile, the use of institutionally priced mutual funds, which do not come with fees that can be used to pay for recordkeeping, increased substantially, from 46.2 percent in 2016 to nearly 60 percent in 2017, or a 30 percent increase in just one year.

The trend is also seen in the use of a combined approach. In 2014, 35.6 percent of large plans combined mutual funds with revenue sharing and institutionally priced funds in investment lineups. By 2017, the rate dropped to 29.3 percent.

More employers managing liability by paying for recordkeeping out of pocket

As large sponsors are moving away from fee-based revenue structures and retail share classes, more are picking up the tab for recordkeeping as a way to mitigate fiduciary liability.

In 2017, 19.1 percent of large plans' recordkeeping costs were paid for by the sponsoring company, up from 16.5 percent in 2014.

But at the same time, more employers are paying for fees out of plan assets: 67.4 percent in 2017, compared to 62.1 percent in 2014.

The increase is explained by a considerable drop in plans that once used a combined approach to pay for recordkeeping:

In 2014, 21.4 percent of plans used a combination of company and plan assets to pay for recordkeeping.
By 2017, only 13.5 percent did, according to PSCA.

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Big 401(k)s shedding pro rata recordkeeping structure

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