By Mary Jo Larson
Nearly every 401(k) plan offers its participants some investment options that include revenue-sharing fee payments. For many years, employers were not even aware that their participants’ investments were generating these payments. Today, in the wake of new U.S. Department of Labor disclosure and reporting rules and well-publicized cases attacking employers for inattention to revenue sharing, ignorance is no longer an excuse.
Recently, DOL’s Employee Benefits Security Administration addressed an important question: When do revenue-sharing amounts become plan assets? The answer to this question is important for determining when the ERISA trust requirement applies, who is a fiduciary, whether prohibited transactions have occurred, and what reporting and disclosure rules apply. In the July 3 Advisory Opinion 2013-03A, EBSA generally concluded that whether or not revenue-sharing amounts are plan assets depends on the facts and circumstances — they are not always plan assets. EBSA, however, went further and detailed the responsibility of employers with respect to ERISA accounts and revenue sharing generally. Following the advisory opinion, employers are on notice that they must be able to at least answer the following questions regarding their 401(k) and other defined contribution plans, such as 403(b) plans.
Do any of your investment funds generate revenue sharing?
Odds are, the answer is “yes.” In this context, revenue-sharing payments are amounts paid to a recordkeeper for hosting an investment fund on the recordkeeper’s 401(k) platform. These payments include 12b-1 fees, shareholder service fees, and sub-transfer agency fees. These fees are generally built into the fund’s expense ratio, which is the cost charged to investors for management of the fund.
Because the expense ratio is taken out of the fund’s earnings, many employers believed for years that both the investment and the recordkeeping were “free.” Neither the employers nor the participants understood that the investment management and recordkeeping was anything but free. It was coming right off the top of the earnings being credited to the participants’ accounts. Generally speaking, the higher the revenue sharing being paid to the recordkeeper, the higher the expense ratio (cost) of the fund and the fewer dollars actually allocated to the participants’ accounts. DOL has observed that even a 1-percent difference in fees over 35 years at 7-percent return results in a 28-percent reduction in the participant’s account balance at retirement.
Because of the damage to participants’ retirement income, EBSA last year began to require that these payments be reported to employers for inclusion on the 5500 Schedule C and on the so-called provider or 408(b)(2) disclosures. Every employer now receives these disclosures and must have a record of having reviewed and understood them. If you placed your disclosure in the circular file, it is time to retrieve it. If you did not receive these disclosures, it is your obligation to ask for them.
To read the complete story on Thompson’s HR Compliance Expert, click here.
Mary Jo Larson of law firm Warner Norcross & Judd LLP puts her 30 years of benefits experience to work on her clients’ 401(k)s, pension plans, nonqualified deferred compensation plans and executive compensation. She also advises fiduciaries responsible for the investment of plan assets.