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May 2004
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As the sponsor of a retirement plan, you are helping your
employees achieve a secure financial future. Sponsoring a plan, however,
also means that you, or someone you appoint, will be responsible for making
important decisions about the plan’s management. Your decisionmaking will
include selecting plan investments or investment options and plan service
providers. Many of your decisions will require you to understand and
evaluate the costs to the plan.
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The Federal law governing private-sector retirement
plans, the Employee Retirement Income Security Act (ERISA), requires that
those responsible for managing retirement plans -- referred to as
fiduciaries -- carry out their responsibilities prudently and solely in the
interest of the plan’s participants and beneficiaries. Among other duties,
fiduciaries have a responsibility to ensure that the services provided to
their plan are necessary and that the cost of those services is reasonable.
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This booklet will help you better understand and evaluate
your plan’s fees and expenses. While the focus is on fees and expenses
involved with 401(k) plans, many of the principles discussed in the booklet
also will have application to all types of retirement plans.
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Remember, however, that this booklet provides a
simplified explanation of plan and investment fees. It is not a legal
interpretation of ERISA or other laws, nor is it intended to be a substitute
for the advice of a retirement plan or investment professional.
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Plan fees and expenses are important considerations for
all types of retirement plans. As a plan fiduciary, you have an obligation
under ERISA to prudently select and monitor plan investments, investment
options made available to the plan’s participants and beneficiaries, and
the persons providing services to your plan. Understanding and evaluating
plan fees and expenses associated with plan investments, investment options,
and services are an important part of a fiduciary’s responsibility. This
responsibility is ongoing. After careful evaluation during the initial
selection, you will want to monitor plan fees and expenses to determine
whether they continue to be reasonable in light of the services provided.
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In recent years, there has been a dramatic increase in
the number of investment options, as well as level and types of services,
offered to and by plans in which participants have individual accounts. In
determining the number of investment options and the level and type of
services for your plan, it is important to understand the fees and expenses
for the services you decide to offer. The cumulative effect of fees and
expenses on retirement savings can be substantial.
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There are a variety of plan fees and expenses that may
affect your retirement plan. The following is an overview of some of those
fees and expenses and the different ways in which they may be charged.
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Plan fees and expenses generally fall into three
categories:
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Plan Administration Fees. The day-to-day operation
of a plan involves expenses for basic administrative services -- such as
plan recordkeeping, accounting, legal and trustee services -- that are
necessary for administering the plan as a whole. In addition, a
profit-sharing or 401(k) plan also may offer a host of additional services,
such as telephone voice response systems, access to a customer service
representative, educational seminars, retirement planning software,
investment advice, electronic access to plan information, daily valuation,
and on-line transactions.
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In some instances, the costs of administrative services
will be covered by investment fees that are deducted directly from
investment returns. In other instances, when the administrative costs are
billed separately, they may be borne, in whole or in part, by the employer
or charged directly against the assets of the plan. In the case of a 401(k),
profit sharing, or other similar plan with individual accounts,
administrative fees are either allocated among individual accounts in
proportion to each account balance (i.e., participants with larger account
balances pay more of the allocated expenses, (a “pro rata” charge)) or
passed through as a flat fee against each participant’s account (a “per
capita” charge). Generally the more services provided, the higher the
fees.
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Investment Fees. By far the largest component of
plan fees and expenses is associated with managing plan investments. Fees
for investment management and other related services generally are assessed
as a percentage of assets invested. Employers should pay attention to these
fees. They are paid in the form of an indirect charge against the
participant’s account or the plan because they are deducted directly from
investment returns. Net total return is the return after these fees have
been deducted. For this reason, these fees, which are not specifically
identified on statements of investments, may not be immediately apparent to
employers. (More
information on investment-related fees)
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Individual Service Fees. In addition to overall
administrative expenses, there may be individual service fees associated
with optional features offered under an individual account plan. Individual
service fees may be charged separately to the accounts of those who choose
to take advantage of a particular plan feature. For example, fees may be
charged to a participant for taking a loan from the plan or for executing
participant investment directions.
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Plan administrative and investment services may be
provided through a variety of arrangements:
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Some or all of the various plan services and investment
alternatives may be offered by one provider for a single fee paid to that
provider (sometimes referred to as a bundled arrangement). The provider will
then pay, out of that fee, any other service providers that it may have
contracted to provide the services.
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In other cases, plans may obtain services and investments
from a variety of providers (sometimes referred to as an unbundled
arrangement). The expenses of each provider (e.g., investment manager,
trustee, recordkeeper, communications firm) are charged separately.
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Plans also may use an arrangement that combines a single
provider for certain services, such as administrative services, with a
number of different providers for investments.
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Fees need to be evaluated keeping in mind the cost of all
covered services.
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Apart from fees charged for administering the plan
itself, there are two basic types of fees that may be charged in connection
with plan investments or investment options made available to participants
and beneficiaries. These fees, which can be referred to by different terms,
include:
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Sales charges (also known as loads
or commissions). These are basically transaction costs for buying
and selling shares. They may be computed in different ways, depending on
the particular investment product.
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Management fees (also known as investment
advisory fees or account maintenance fees). These are ongoing
charges for managing the assets of the investment fund. They are
generally stated as a percentage of the amount of assets invested in the
fund. Sometimes management fees may be used to cover administrative
expenses. You should know that the level of management fees can vary
widely, depending on the investment manager and the nature of the
investment product. Investment products that require significant
management, research, and monitoring services generally will have higher
fees. (More
information...) Be aware that higher investment management fees do not necessarily
mean better performance.
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In addition, there are some fees that are unique to
specific types of investments. Following are brief descriptions of some of
the more common investments available to retirement plans and explanations
of some of the different terminology or unique fees associated with them.
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Some common investments and related fees:
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Most investments offered by smaller plans pool the money
of a large number of individual investors. Pooling money makes it possible
for smaller plans and participants in individual account plans to diversify
investments, to benefit from economies of scale, and to lower their
transaction costs. These pooled funds may invest in stocks, bonds, real
estate, and other investments. Larger plans, by virtue of their size, are
more likely to pool investments on their own -- for example, by using a
separate account held with a financial institution. Smaller plans generally
invest in commingled pooled investment vehicles offered by financial
institutions, such as banks, insurance companies, or mutual funds.
Generally, investment-related fees, usually charged as a percentage of
assets invested, are paid by the participant or the plan.
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Mutual Funds. Mutual funds pool and invest the
money of many people. Each investor owns shares in the mutual fund that
represent a part of the mutual fund’s holdings. The portfolio of
securities held by a mutual fund is managed by a professional investment
adviser following a specific investment policy. In addition to investment
management and administration fees, you may find these fees:
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Some mutual funds assess sales charges
(see above for a discussion of sales charges). These charges may be paid
when you invest in a fund (known as a front-end load) or when you sell
shares (known as a back-end load, deferred sales charge, or redemption
fee). A front-end load is deducted up front and, therefore, reduces the
amount of your initial investment. A back-end load is paid when the
shares are sold. A back-end load is determined by how long you keep your
investment. There are various types of back-end loads, including some
that decrease and eventually disappear over time.
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Mutual funds also may charge what are
known as 12b-1 fees, which are ongoing fees paid out of fund assets.
12b-1 fees may be used to pay commissions to brokers and other
salespersons, to pay for advertising and other costs of promoting the
fund to investors, and to pay various service providers to a plan
pursuant to a bundled services arrangement.
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Some mutual funds may be advertised as
“no load” funds. This can mean that there is no front- or back-end
load. However, there may be a 12b-1 fee.
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Collective Investment Funds. A collective
investment fund is a trust fund managed by a bank or trust company that
pools investments of retirement plans and other similar investors. Each
investor has a proportionate interest in the trust fund assets. For example,
if a collective investment fund holds $10 million in assets and your
investment in the fund is $10,000, you have a 0.1 percent interest in the
fund. Like mutual funds, collective investment funds may have a variety of
investment objectives. There are no front- or back-end fees associated with
a collective investment fund, but there are investment management and
administrative fees.
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Variable Annuities. Insurance companies frequently
offer a range of investment alternatives for individual account plans
through a group variable annuity contract between an insurance company and
an employer on behalf of a plan. Variable annuities include one or more
insurance elements, which are not present in other investment alternatives.
Generally, these elements include an annuity feature, interest and expense
guarantees, and any death benefit provided during the term of the contract.
The variable annuity contract “wraps” around investment alternatives,
often a number of mutual funds. Participants select from among the
investment alternatives offered, and the returns to their individual
accounts vary with their choice of investments. In addition to investment
management fees and administration fees, you may find these fees:
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Insurance-related charges are
associated with investment alternatives that include an insurance
component. They include items such as sales expenses, mortality risk
charges, and the cost of issuing and administering contracts.
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Surrender and transfer charges
are fees an insurance company may charge when an employer terminates a
contract (in other words, withdraws the plan’s investment) before the
term of the contract expires or when a participant withdraws an amount
from the contract. These charges may be imposed if these events occur
before the expiration of a stated period and commonly decrease and
disappear over time. They are similar to an early withdrawal penalty on
a bank certificate of deposit or a back-end load or redemption fee
charged by some mutual funds.
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Pooled Guaranteed Investment Contract (GIC) Funds.
A common fixed income investment option, a pooled GIC fund generally
includes a number of contracts issued by an insurance company or bank paying
an interest rate that blends the fixed interest rates of each of the GICs
included in the pool. There are investment management and administrative
fees associated with the pooled GIC fund.
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While the investments described above are common, plans
also may offer other investments that are not described here (such as
employer securities).
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Funds that are “actively managed” (i.e., funds with
an investment adviser who actively researches, monitors, and trades the
holdings of the fund to seek a higher return than the market as a whole)
generally have higher fees than funds that are “passively managed” (see
below). The higher fees are associated with the more active management
provided and increased sales charges from the higher level of trading
activity. While actively managed funds seek to provide higher returns than
the market, neither active management nor higher fees necessarily guarantee
higher returns.
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Funds that are “passively managed” generally have
lower management fees. Passively managed funds seek to obtain the investment
results of an established market index, such as the Standard and Poor’s
500, by duplicating the holdings included in the index. Thus, passively
managed funds require little research and less trading activity.
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Fees and expenses are one of several factors to consider
when you select and monitor plan service providers and investments. The
level and quality of service and investment risk and return will also affect
your decisions.
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Begin by establishing an objective
process to aid in your decision making. This process should include an
understanding of the fees and expenses you will pay and a review of
those charges as they relate to the services to be provided and the
investments you are considering.
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Before negotiating with prospective
providers, think about the specific services you would like from a
service provider (e.g., legal, accounting, trustee/custodian,
recordkeeping, investment management, investment education or advice).
Include the types and frequency of reports you wish to receive,
communications to participants, meetings for participants, and the
frequency of participant investment transfers.
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You will also need to consider the
level of responsibility you want the prospective service provider to
assume, the services that must be included in any retirement plan, the
possible extras or customized services you wish to provide, and optional
features, such as loans, Internet trading, and telephone transfers.
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Once you have a clear idea of your
requirements, you are ready to begin receiving estimates from
prospective providers. Give all of them complete and identical
information about your plan and the features you want so that you can
make a meaningful comparison. This information should include the number
of plan participants and the amount of plan assets as of a specified
date.
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In addition, ask each prospective
provider to be specific about which services are covered for the
estimated fees and which are not. To help in gathering information and
making comparisons, you may want to use the same format for each
prospective provider. See an
example of a uniform fee disclosure format that will help you in
selecting and monitoring the services to your plan.
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Once you have selected a service
provider or investments, be prepared to monitor the level and quality of
the services and performance of investments to make sure they continue
to be reasonable and they suit the needs of your employees. Make sure
that you receive information on a regular basis so that you can monitor
investment returns and service provider performance and, if necessary,
make changes.
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By continuing to ask questions, you can make better
decisions for your plan and your employees.
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Fees and expenses are an important component in
managing your retirement plan. For further information, you may want to
consult the following resources on EBSAs Web site:
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For a complete list of EBSA publications, call
toll-free: 1.866.444.EBSA (3272). This material will be made
available to sensory impaired individuals upon request.
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Voice phone: 202.693.8664
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TTY: 202.501.3911
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This booklet constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.
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