Can expenses associated with a pooled account option be taken pro-rata

[John A]

If a plan sponsor maintains a pooled account as one of their investment options, can the expenses associated with the pooled account option be taken from the participant’s account balances pro-rata (provided the plan document allows it), or must the expenses be paid by the employer?

[Jon Chambers]

Assuming expenses are reasonable, plan document permits it, and there are no other constraints (e.g., party-in-interest transactions), expenses can be charged to participants on a pro rata basis.

[John A]

Jon, thanks for the response.

Do the following additional details change the answer?

There will be specific fees charged by the trustee and TPA specifically due to the plan sponsor providing this pooled account investment option. If only 1 participant chooses this option, then that participant would essentially be paying the entire cost of the plan having this option. If 2 participants choose this option, those 2 (through the assets they invest in the option) would each be paying 50% of the TPA and trustee fees to the plan for having this option.

With this additional information, is it okay for the trustee and TPA fees for this pooled investment option to come strictly out of the assets invested in that option, or must the employer pay the TPA and trustee fees?

If a self-directed brokerage window were an option, could TPA and trustee fees be taken out of the assets of each participant who selected a self-directed brokerage option?

[Jon Chambers]

I'm getting a better sense of your question. Let's consider two issues:

1) What is permissible?

2) What is practical?

First, charging reasonable fees for plan administration against plan assets is clearly permissible. However, you also face the issue of what is practical. Let's say, for example, the trustee and TPA fees for the pooled option are $5,000/year. If one participant selects the option, it costs that participant $5,000. If 1000 participants select the option, it costs them (on average) $5. Thus, you face a difficult communications and investment education issue.

With clients that want to pass fees through to the Plan, I typically address this by determining, at the Plan level, what investment structure (i.e., type and range of investment options) make sense for the plan as a whole. Then, all fees for supporting the investment structure are charged against all plan assets. Thus, in your pooled option example, all participants cover the cost of the pooled option, since they all have access to it, even if they don't select it. This helps the client focus on:

whether the pooled option is a worthwhile addition to the plan's overall investment structure; and

whether cost of adding the pooled option is justified for the plan as a whole.

A similar approach can be taken with respect to brokerage accounts. However, as a practical matter, I typically see a slightly different result. Let's assume that the vendor charges an additional $3,000/year to offer brokerage accounts, plus $100/year per brokerage account. Clients I work with typically pay the $3,000/year from corporate assets and pass through the $100/year per brokerage account to participants selecting the option. Brokerage account availability is perceived to be a benefit enhancement that should be paid by the employer, while direct brokerage account charges are costs to be borne by individual participants. And it seems unfair to charge participants that don't want a brokerage account extra, even though this conclusion may apparently contradict the general rule, above.

Finally, it's important to clearly establish the employers policy for expense charge throughs. I find the investment policy statement (IPS) is often a good place to do this. Further, all expenses should be clearly communicated to participants.

Does any of this make sense.

[John A]

Jon, yes it all makes sense and is helpful. However, leaving aside the question of what is practical and using your numbers, would it be permissible to charge the 1 particpant choosing the pooled option the $5,000? Would it be permissible if the fee were a smaller amount, or if there were 1,000 participants charged $5 each (still leaving aside the question of what is practical)?

[Jon Chambers]

And now we can go to issue three. What is reasonable:

This will be a function of account size. Let's assume that the pooled option is an institutionally managed fund charging 50 basis points (0.50%). All other options are mutual funds charging 1% or more. Participant has a $1 million balance. Currently, participant pays (at least) $10,000/year to own mutual funds. Even if participant were only person to elect to use pooled option, they would still pay $10,000/year ($5,000 base fee + 0.50% x $1 million). If other participants elect to use the fund, our trailblazing participant will pay less than $10,000/year, as the base fee is amortized across more participants.

Generally, I'm uncomfortable with total fee/expense charges in excess of 2% of account balances. If the participant only had $10,00 in his account, the $5,000 base fee would represent 50% of his account. Permissible? Perhaps. Reasonable? Certainly not. In this event, I believe the plan sponsor has a fiduciary responsibility to prevent the participant from incurring unreasonable expenses. Thus, the sponsor should either:

1) Pick up base fee charges, if they believe the pooled option is an important benefit enhancement, or

2) Not offer the pooled option

Does this help?

[RCK]

I like JON'S answers. As a plan sponsor, if I were in that situation I would consider the following:

1. Pass the costs through to the participants.

2. But cap the charges as a % of assets at say 2%, and have the sponsor pick up the balance. I think that your 2% rule of thumb is reasonable, and that anything higher will deter participation, and anything lower might create an artificial demand.

3. Communicate. Communicate. Communicate. That is, tell the participants exactly what you're going to do, and why.

RCK