Upcoming Disclosure Prompts Fee Education

Advisors look to ease ‘sticker-shock’

By Charlie Epstein, CLU, ChFC, AIF

Mr. Epstein, CLU, ChFC, AIF® is the founder of The 401k Coach® Program, which offers expert training for financial professionals to develop the skills, systems and processes necessary to excel in the 401(k) industry and facilitate successful retirement outcomes for plan sponsors and participants. He is the author of the book, Paychecks for Life®, which offers nine Principles for participants to turn their 401(k) plans into a secure retirement income. Charlie has frequently been named to 401kWire’s Top 100 Most Influential People in the 401(k) Industry List and Top 300 Most Influential DC Advisor List. He is a member of the Legg Mason Retirement Advisory Council.

ERISA 408(b)(2) and 404(a)(5) will certainly be game-changers in the industry. Many companies and advisors are already worried that their clients will view their fees as too high. As we march closer to the disclosure deadlines of July 1st and Aug. 30th, it’s time to educate plan sponsors and participants about the various fees and their necessity. If plan sponsors and participants understand the nature of the fees and the services for which advisors are charging, they may be less likely to panic when fee amounts are disclosed and they are faced with “sticker shock.” While it’s important to charge fees commensurate with quality, if advisors are able to explain the value-added services they provide , their clients may be less likely to react negatively to fee disclosure. Advisors who proactively take on the fee disclosure will be more likely to ride out the wave than those who shy away from the disclosures and get caught in the undercurrent.

Hard- vs. Soft-Dollar Expenses

Plan expenses can be divided into hard-dollar and soft-dollar categories. Hard-dollar expenses include the fees charged for the day-to-day operations of the plan, such as plan administration, design and compliance. Employers usually pay these costs, but there are exceptions to this rule. Some employers pay for these expenses out of the assets of the plan, causing the participants to pay indirectly. Other hard-dollar costs include optional individual services, such as loan and distribution provisions, that typically charge one-time fees.
Soft-dollar fees cover many services, including record keeping, website services, automated access to investment information, customer education and advice services. The costs associated with money management, such as investment management fees, 12-b1 fees, sub-transfer fees, asset-based or wrap fees and revenue-sharing fees, are also soft-dollar expenses.

Money Management and Fund Expense Fees

Mutual fund companies that manage participants’ money automatically deduct the money management, or fund expense, fees. Since these fees may have a significant impact on the performance of investments, it is important for participants to understand how they work. Let’s look at the individual fee classes:

Investment Management Fees

This type of fee is charged by mutual fund companies to pay for investment managers. The companies charge these fees as a percentage of assets invested (such as quarter of one percent to two percent) and deduct them from investment returns.

12-b1 Fees

Mutual funds pay these promotion/distribution expenses from fund assets. The 12-b1 fees include broker commissions, marketing expenses and other administrative costs and may range from a quarter of a percent to one and a quarter percent of assets invested.

Sub-Transfer Fees

Mutual fund companies that manage participants’ money automatically deduct the money management, or fund expense, fees. Since these fees may have a significant impact on the performance of investments, it is important for participants to understand how they work.

Record keeping and other services related to participant shares are usually contracted to third parties, called sub-transfer agents. Brokerage firms and mutual funds may pay their cost as a fixed fee on a per participant basis, an asset basis or some combination of the two. This fee is usually 0.05 percent of assets invested in a mutual fund.

Revenue-Sharing Fees

Some mutual funds pay a revenue-sharing fee to operation companies. The expense covers a portion of management fees, record keeping and other services. Revenue-sharing fees are similar to slotting fees, the price that supermarkets charge cereal companies to slot, or place, their products on the shelf. A 401(k) provider’s platform is similar to a supermarket shelf. Mutual funds pay a slotting fee for the best placement in their offerings.

Plan Consulting Fees

These are fees paid to registered investment advisors or consultants or are commissions to brokers for advisory services. Employers may pay this as a hard-dollar expense or participants may pay them indirectly through deductions from investment assets in each fund.

Value-Added Services

Some plan sponsors are trying to save the most money possible, and if these are some of your clients, you may want to consider giving them choices in your fees. This means that you will have to offer tiered services. If a plan sponsor does not want you to act as the participant educator, then charge less. If they do not want you to develop enrollment materials or monitor participant educational goals, then charge less. However, explain to sponsors that the loss of these services will be detrimental to the plans’ participants.
Education is one of the most important steps in helping participants to achieve Paychecks for Life®, a retirement with enough money to live the way you desire or your desirement time. Unfortunately, less than half all American employees have calculated how much they will need to maintain their standard of living into retirement. Furthermore, only one-third of participants are confident in their asset allocations because they do not understand what their allocation strategy means in terms of risk tolerance and targeted retirement age. According to research, when participants do establish retirement goals (and with the proper investment education), nearly half will increase their contribution amount.

Other value-added services may include active managing of plans. This requires that advisors continuously research and monitor the plans’ assets. Active management seeks (but does not guarantee) higher returns than passive management. If you tier your services for clients, make sure that they are aware that they may be sacrificing some of the most necessary components in ensuring financial success for employees.

Your Fees vs. Competitor’s Fees

Disclosure will bring to light not only your fees, but your competitor’s fees as well. A recent study placed the range of total plan costs for a 100 participant plan with an average account balance of $50,000 anywhere from one-third to one and three-fourths percent of assets under management. As advisors disclose fees, it will be important to monitor where you stand in comparison to your competitors. However, you shouldn’t undersell yourself either. Only you know how much your time is worth and how many value-added services you are providing clients.

Although plan sponsors may be attempting to save money, explaining the true value of your services will help them and participants to better understand fees. As we prepare for what could potentially be a huge shake-up in the financial services industry, it is important to exhibit your worth as a financial advisor. By educating plan sponsors and participants on the fees they may be charged, you can explain the true value of your services.