Monitoring 401(k) Investment Fund Fees as an ERISA Fiduciary
January 18, 2022
401(k) plan sponsors have numerous fiduciary responsibilities under the Employee Retirement Income Security Act of 1974 (ERISA). Among these duties, plan sponsors must ensure their plan’s investment fund fees are reasonable, so plan participants don’t overpay.
Investment fund fees compensate fund managers for the services they perform, such as security selection and day-to-day fund management operations. Fees can vary widely due to the various styles, objectives and relative complexity of different investments.
Under ERISA, plan fiduciaries are required to prudently select and monitor plan investments. This includes determining whether investment fund fees are reasonable. While ERISA doesn’t explicitly state what qualifies as “reasonable” fees, a widely accepted way to test reasonableness is to compare the fees of similar investment funds. Sometimes, however, fiduciaries must dig deeper to ensure they’re not overpaying for a fund provider’s services. Here are some considerations when evaluating 401(k) net investment fees.
Understanding Revenue Sharing
The same 401(k) investment can come in different varieties, called share classes. Different share classes have different fees, which are included in the expense ratios. This is because some classes engage in revenue sharing, in which they share revenue with the plan sponsor. A plan sponsor can use revenue sharing to pay for various plan services, such as investment advice or recordkeeping. Funds with revenue sharing have higher expense ratios than those without. See Example 1 below, in which two different share class (and expense ratio) versions of the same fund are available for a plan sponsor to select: Class R shares and Class Z shares.
Example 1: Same fund, different share classes (%)
| Fund share | Expense ratio | Revenue sharing | Net fee |
| Class R | 1.00 | 0.50 | 0.50 |
| Class Z | 0.50 | N/A | 0.50 |
This is a hypothetical illustration only; the above is not indicative of any particular investment.
In Example 1, both share classes have the same net fee, which goes to the investment manager. However, Class R has the higher gross fee because it shares revenue. The choice of which fund plan to use depends on how plan sponsors want to pay for plan expenses.
However, unlike in Example 1, net fees aren’t always equal. A plan sponsor may want to consider a fund that shares revenue even if they’re not using revenue sharing to pay for plan expenses; this way, the plan sponsor can refund unused revenue sharing to participants, cutting their net fees. Consider Example 2, in which Class R shares have a lower net fee than Class Z.
Example 2: Same fund, different share classes, and different net fees (%)
| Fund share | Expense ratio | Revenue sharing | Net fee |
| Class R | 1.00 | 0.55 | 0.45 |
| Class Z | 0.50 | N/A | 0.50 |
This is a hypothetical illustration only; the above is not indicative of any particular investment.
As you can see, Class R is now 0.05% cheaper on a net-of-fee basis. Plan sponsors can reduce participant investment costs by choosing Class R and asking their recordkeeper to refund revenue sharing to participants. In this example, participants save 0.05% (the difference in net cost between Class R and Class Z) from refunded revenue sharing. However, this example only deals with investment expenses; plan sponsors must also consider other costs potentially borne by participants, like plan expenses.
Even if you don’t rely on your plan’s investment managers for revenue sharing, consider asking your recordkeeper or financial professional to provide information on revenue sharing funds, which could have lower net expenses. Remember, the fund with the lowest gross expense isn’t necessarily the least expensive for participants.
Drafting an IPS
Many plan sponsors create an investment policy statement (IPS) to provide guidelines and benchmarks for the selection and monitoring of plan investments. An IPS helps plan fiduciaries demonstrate that a prudent process has been followed for selecting and monitoring plan investments. By incorporating share class restrictions or expense ratio considerations, an IPS also proves that participants aren’t paying more than necessary for their plan investments.
Boulay Can Help
To best fulfill your fiduciary duty under ERISA, ask your recordkeeper or financial professional to regularly review your fund, explore alternative share classes and investigate net cost fund options. Proper and formal monitoring of investment fund fees ensures your participants aren’t paying too much for their retirement investments. For those seeking assistance in evaluating, selecting and monitoring plan investments and fees, Boulay is here to help. Contact a Boulay advisor today at 952.893.9320 or learnmore@boulaygroup.com.
Investment Advisory Services offered through Boulay Financial Advisors, LLC a SEC Registered Investment Advisor. Certain Third Party Money Management offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor. Securities offered through Valmark Securities, Inc. Member FINRA, SIPC
Boulay PLLP and Boulay Financial Advisors, LLC are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc. Prime Global is not affiliated with Valmark Securities, Inc. and Valmark Advisers, Inc.
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