The world of 401(k) and 403(b) retirement plan sponsors has been somewhat nightmarish in recent years, marked by countless lawsuits over fees paid by participants for investment services. Now, those hoping to avoid being the next company in the headlines for the wrong reason are having to undertake a comprehensive audit of every fee charged to participants.
The latest place plan sponsors should audit in detail is fees charged on managed accounts.
First there were the lawsuits against Boeing Co., Lockheed Martin Corp. and others over 401(k) fees. Then there were suits against the 403(b) plans of universities such as Yale University and Massachusetts Institute of Technology. Now, a case against Xerox HR Solutions, now called Conduent Inc.— over an alleged pay-to-play scheme with managed-account provider Financial Engines Inc. — highlights why all plan sponsors should review the thicket of relationships that make up modern retirement plans to ensure every fee is reasonable.
The plaintiffs say Xerox took a “kickback” from Financial Engines to be included on the record-keeper's platform, thereby inflating investment advice fees. Financial Engines has been named in several other suits claiming it paid record keepers Fidelity Investments, AON Hewitt, Voya Financial Inc. and Mercer (whose record-keeping business was bought by Aegon in 2015) a large part of its fees to be the exclusive provider of investment advice on their platforms.
The cases make clear that many plan sponsors don't understand the fees being charged for investment advice and by third-party administrators for other services. The problem is particularly acute for managed accounts, where many sponsors believe that because participants sign individual agreements with the adviser, the sponsor has no fiduciary responsibility to assess fees so long as they are disclosed clearly to participants. However, plan sponsors must review every fee being charged, including those related to managed accounts and legal and audit fees.
The Department of Labor demands plan sponsors determine if the fees of each party are reasonable for the services provided. Increasingly, sponsors are signing up for managed accounts as the plan's default option. Indeed, we see a growing number of providers offering lower administration fees in exchange for offering the managed account as the qualified default investment alternative. This makes it ever more important that those options are appropriately analyzed, selected and monitored to provide the highest level of service to plan participants.
Organizations offering managed accounts face a particular challenge fulfilling their fiduciary duties, because while some employees are actively involved, typically a sizable percentage of employees fail to engage despite picking a self-directed option.
Managed accounts should be tailored to the individual, with allocations based on input provided by the participant about such things as wages, life expectancy, savings, spousal information, other retirement savings and risk tolerance. That information is then typically run through an algorithm to determine the appropriate investment mix. When done right, higher employee engagement can lead to more saving, superior returns and more appropriate allocations for the individual.
In return, the fees associated with these accounts are high, typically ranging from 40 basis points to 100 basis points annually (on top of the underlying investment costs of the overall retirement plan). However, the success of managed accounts is only as good as the level of information provided by account holders and the level of ongoing engagement. Any data omissions or inactivity can undermine returns. As a result, plan sponsors that offer managed account services should develop effective ways to ensure participants remain engaged.
Given the high level of fees, plan sponsors should ask: Are participants getting value from what they pay for? If participants receive more substantial investment advice that yields substantially better results, then the costs can be justified. However, if participants are not engaged (or don't remain engaged), the value should be questioned. After all, paying a fee for 20 years adds up to big money. Participants with managed accounts that are not engaged tend to get invested in funds that primarily rely on a participant's age, in essence a target-date fund.
Because most record keepers have a variety of services that assist participants with managing their retirement account at no cost, it is particularly tough to justify the added layer of fees for managed accounts to participants that are disengaged.
One solution to low participant engagement is requiring participants “opt-in,” perhaps annually, rather than defaulting them into a managed account program. The communications around the “opt-in” option would allow sponsors to underline not only the fees involved in a managed account but point out less expensive options. In addition, quarterly statements should clearly detail fees and stress that managed accounts are charged higher fees.
As the news about Financial Engines and similar lawsuits underscores, plan sponsors should watch for conflicts of interest. Oftentimes record keepers offer reduced administration fees for plans using managed accounts as the default option. Such an arrangement raises the question as to whether the cost of administration is being unfairly borne by those defaulted into managed accounts.
While it's admirable that plan executives are seeking lower fees, selecting a record keeper based solely on its managed account services and fees might not be in the best interests of plan participants. As a result, plan executives should assess all services offered by the record keeper and evaluate them on the overall quality of service to participants rather than focusing solely on the fee reductions available for making managed accounts the default option.
If the complexity of managed accounts means a plan sponsor is not sufficiently expert to conduct the needed due diligence, other popular default options that have lower fees include diversified balance funds and target-date funds.
Mark Dixon and Susan Shoemaker are partners of Plante Moran Financial Advisors. Mr. Dixon leads the institutional investment consulting practice and Ms. Shoemaker, the qualified plans practice. This content represents the views of the authors. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.