Understanding defined contribution pension plan fees (Part 1)
March 16, 2020
Defined contribution pension plan fees have long been an area of significant risk for pension fiduciaries. Typically, a DC plan sponsor will negotiate fees for the plan and members will pay the bulk of those fees through asset-based fees charged on the investment funds. If the fees for the DC plan are excessive, the resulting DC accumulations could be significantly impaired.
The first step in evaluating strategies to manage fees, is understanding the breakdown of various components of DC fees. There are two principle DC administration models: bundled and unbundled
In a bundled model, the recordkeeping services and investment funds are purchased in a package. Typically, the sponsor selects a record keeper and chooses investments from a selection of alliance investment funds made available by the record keeper. In a bundled relationship, there is one contract between the record keeper and the sponsor. From a fee perspective, the record keeper negotiates all fees with the sponsor, including asset-based investment management fees for each investment manager.
In an unbundled model, the recordkeeping services and investment funds are purchased separately. The sponsor selects a record keeper and then selects its own investment managers and must negotiate separate contracts and individual investment management fee levels with each selected investment manager. An unbundled arrangement may require the record keeper to build administrative links with new investment managers, which can be expensive on a one-off basis. For this reason, they may be reluctant to offer the unbundled model, with the exception of for the largest DC plans.
In a bundled DC model, the following are the different element of fees generated through the relationship. The fees can be divided between those fees charged through the market-based investments (or asset-based fees) and those fees charged separately (other fees).
Investment management fees – These are the fees charge by the investment manager to invest the assets in the fund. These includes the cost of manager research and commissions on transactions. It generally also includes an expense margin for marketing, client services and administration for the investment manager. In a bundled relationship, the investment management fee is negotiated by the record keeper with the investment manager based on the aggregate assets invested with the record keeper in the fund. In an unbundled relationship, the sponsor negotiates an investment management fee directly with the investment manager based on the size of the sponsor relationship with the investment manager.
Pooled fund operating expenses – These are expenses for custody, legal and audit of the investment managers pooled fund, which are charged to the investment fund and act to reduce the investment performance of the pooled fund.
Segregated fund fees – Under an insurance contract, the insurance company sets up its own segregated fund for each market-based investment fund. The fund holds units of the investment managers pooled fund and cash (for liquidity purposes). The insurance company strikes its own unit value for its segregated fund. There are costs associated with setting up and maintaining the segregated funds, including legal, audit and administration, which are typically charged to the segregated fund and act to reduce the investment performance of the segregated fund.
Asset-based recordkeeping fee – This fee is paid to the record keeper as compensation for its services. The fee includes, setting up and maintaining accounts and processing ongoing contributions and investment changes. In a bundled relationship, this fee also pays for the communication and education costs under the program. Generally, these fees are added to the investment management fees deducted for the manager. The total asset-based fee is then communicated to the member as the aggregate fee for each fund.
Broker fees – Where a broker is employed to help oversee and maintain the plan, through plan marketing, monitoring and sometime direct member education, it will build an asset-based commission into the investment management fee calculated for each investment fund. In certain cases, consultants may also charge their fees in the form of an asset-based commission or trailer on the investment funds. Where there is no broker, there will not be a broker fee.
Per-member recordkeeping fee – This fee is a per member monthly or annual fixed fee that is paid outside of the plan investments to pay a portion of the recordkeeping cost under the program. The balance is paid out of the asset-based recordkeeping fee (charged directly to the investments). Often this portion of the recordkeeping fee is paid directly by the plan sponsor. The amount of this fee can often be negotiated by the plan sponsor, where a higher per member recordkeeping fee will attract a lower asset based recordkeeper fee. However, most record keepers will ensure that a significant portion of the fees remains allocated to the asset-based fee, which will typically grow with asset growth, which will normally outpace inflation. This fee is in addition to the asset-based recordkeeping fee. In some cases, there is no per-member recordkeeping fee paid and all of the recordkeeping fees are recouped in a higher asset-based recordkeeping fee.
Spread on guaranteed investment certificate assets – The quoted guaranteed rates paid to capital accumulation members on GIC or guaranteed interest account investments incorporate a fee spread, which represents the difference between and the rate of return generated by investing the GIC or GIA assets and the quoted rates offered to members (which is lower than the return generated).
Other service provider fees – The record keeper may charge an additional charge for certain optimal services, such as certain customized communication material or completing regulatory filings, such as annual information returns for registered pension plans. These fees are normally pre-defined and paid directly by the plan sponsor.
Consulting fees – These represent fees charged by a consultant to assist the plan sponsor in setting up and maintaining their capital accumulation plan. They may include charges for designing the plan, marketing the plan and ongoing monitoring of investments. Normally these are charged on a fee for service basis and paid directly by the employer. In certain cases, they are built into a commission or trailer on the asset-based fees (as noted above in the definition of broker fees).
In an unbundled arrangement, similar fee elements to what has been outlined above will be incorporate, with two main differences. First, the investment management fee will be negotiated directly by the plan sponsor with the investment managers, based on the size of the relationship between the plan sponsor and the investment manager.
Second, there will be more customization of the recordkeeping support and service offering and, accordingly, likely more flexibility in the structuring of the recordkeeping fees. The fee will often be dependant on the level of servicing and customization required for the plan. This will allow for more negotiation of fee level between the plan sponsor and the record keeper. There will continue be some allocation by the record keeper between asset-based fees and fixed or per member fees. Additionally, if the record keeper is an insurance company, the segregated fund structure will be utilized, resulting in segregated fund fees.
Now that we’ve laid the foundation of DC fees, stay tuned for a follow-up piece on strategies plan sponsors can use to manage fees in DC plans.
*Please note the follow-up column has been posted and you can read it here.