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Impact Investing

IPE special report May 2018

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More you saved - the more you pay

Revenue sharing is the “big secret” of the retirement industry. It can affect badly planned participants’ and sponsors’ results. People must unveil this secret and learn how to get better services for the money they pay. This is according to a research study just released by McHenry Consulting Group, a firm based in Berkely,
California, which provides business strategy services to financial institutions.
Revenue sharing is defined as “the practice of transferring ‘soft’ dollars between mutual funds and administration service providers who support 401(k) and other types of defined contribution (DC) plans”. It’s an area of hidden costs, to be found most frequently in ‘bundled services’ for smaller and less sophisticated employers. The researchers estimate that 70-80% of all American plans are a source for revenue sharing, totalling as much as $1.5bn (E1.7bn) each year – a significant amount of money flowing from mutual funds to administration service providers that support 401(k) plans.
The problem is that very often sponsors and participants are not aware of these costs so that employees pay too much out of their retirement savings and employers do not meet their obligations under US Department of Labor regulations.
Current rules say retirement plans’ expenses must be “reasonable”. But they do not specify any standard against which a trust fiduciary can determine “reasonable” versus “excessive” costs. Service providers who maintain all the information necessary to administer a DC plan – including daily valuation of assets, record-keeping, communication with members – usually solicit mutual funds for plan-level revenue rebates. “Simply stated”, explains McHenry Consulting, “money is taken from mutual fund account values by the mutual fund and then used to pay” administration service providers something between 0.10 to 1% of assets.
The average rebate is around 0.30% of plan assets. “As an example, a participant with a $300,000 401(k) balance invested in funds that pay revenue sharing may effectively have $900 per year diverted from his assets to pay plan expenses,” say the consultants. Are these costs fair? No, according to this research that claims $100-150, per participant, per year, is a reasonable price for all administration, communication, education and related services to 401(k) plans’ members. In other words, asset-based pricing is unfair when applied to administrative costs and indeed a few operators apply a flat-fee cost.
McHenry Consulting mentions Persumma Financial, a full-service 401(k) provider and member of the MassMutual Financial Group. “With asset-based pricing, the more you save, the more you pay,” says Persumma’s CEO, Spencer Williams. “I believe a fully-disclosed flat-fee pricing method is better for everyone involved. The sponsor can be assured that servicing costs remain capped and competitive both at the time as they make their buying decision and in the future. And the participant knows that as his account balance goes up, his administrative fees remain the same. With flat-fee pricing, the more you save the more you keep”.
Industry leader, the Vanguard Group, which not only manages mutual funds, but also offers retirement plan administration solutions, is at the forefront of providing candid fee disclosure to its clients, aided by its ‘All-In Fee Report’. This report, say McHenry Consulting, “clearly documents client plans’ operating expenses in three categories: 1) asset-based fees, reflected in fund operating expenses ratios, typically the largest portion of plan’s costs; 2) service fees, cost of primary administrative and record-keeping functions provided by Vanguard, assessed as a flat per-participant fee or per-plan fee; 3) fees for additional services that may include customised communications or outsourcing services and billed to the plan separately as these services are used”.
McHenry Consulting recommends six steps that plan sponsors can take to become more knowledgeable and informed about 401(k) pricing and revenue sharing: 1) create, implement and maintain an investment policy statement (IPS) that addresses fund expenses factors and revenue sharing; 2) identify the true cost of plan services; 3) secure improved financial disclosure from plan service providers; 4) understand and document actual, hard dollar costs; 5) benchmark plan costs against fellow employers; 6) keep track of recent news on these issues and find out what others are saying.

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