Understanding RetirementPlan Fees and Expenses

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U.S. Department of LaborEmployee Benefits Security Administration

Understanding Retirement Plan Fees and Expenses May 2004

Understanding RetirementPlan Fees and Expenses

As the sponsor of a retirement plan, you are helpingyour employees achieve a secure financial future.Sponsoring a plan, however, also means that you, orsomeone you appoint, will be responsible for makingimportant decisions about the plan’s management. Yourdecisionmaking will include selecting plan investmentsor investment options and plan service providers. Manyof your decisions will require you to understand andevaluate the costs to the plan.

The Federal law governing private-sector retirementplans, the Employee Retirement Income Security Act(ERISA), requires that those responsible for managingretirement plans — referred to as fiduciaries — carry outtheir responsibilities prudently and solely in the interestof the plan’s participants and beneficiaries. Among otherduties, fiduciaries have a responsibility to ensure thatthe services provided to their plan are necessary andthat the cost of those services is reasonable.

This booklet will help you better understand andevaluate your plan’s fees and expenses. While the focusis on fees and expenses involved with 401(k) plans, manyof the principles discussed in the booklet also will haveapplication to all types of retirement plans.

Remember, however, that this booklet provides asimplified explanation of plan and investment fees. It isnot a legal interpretation of ERISA or other laws, nor is itintended to be a substitute for the advice of a retirementplan or investment professional.

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Why consider fees?

Plan fees and expenses are important considerations forall types of retirement plans. As a plan fiduciary, youhave an obligation under ERISA to prudently select andmonitor plan investments, investment options madeavailable to the plan’s participants and beneficiaries, andthe persons providing services to your plan.Understanding and evaluating plan fees and expensesassociated with plan investments, investment options,and services are an important part of a fiduciary’sresponsibility. This responsibility is ongoing. Aftercareful evaluation during the initial selection, you willwant to monitor plan fees and expenses to determinewhether they continue to be reasonable in light of theservices provided.

In recent years, there has been a dramatic increase inthe number of investment options, as well as level andtypes of services, offered to and by plans in whichparticipants have individual accounts. In determining thenumber of investment options and the level and type ofservices for your plan, it is important to understand thefees and expenses for the services you decide to offer.The cumulative effect of fees and expenses onretirement savings can be substantial.

What are the types of plan fees andwho pays for them?

There are a variety of plan fees and expenses that mayaffect your retirement plan. The following is an overviewof some of those fees and expenses and the differentways in which they may be charged.

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Plan fees and expenses generally fall into threecategories:

Plan administration fees. The day-to-day operationof a plan involves expenses for basic administrativeservices — such as plan recordkeeping, accounting,legal and trustee services — that are necessary foradministering the plan as a whole. In addition, aprofit-sharing or 401(k) plan also may offer a host ofadditional services, such as telephone voiceresponse systems, access to a customer servicerepresentative, educational seminars, retirementplanning software, investment advice, electronicaccess to plan information, daily valuation, and on-line transactions.

In some instances, the costs of administrative serviceswill be covered by investment fees that are deducteddirectly from investment returns. In other instances,when the administrative costs are billed separately,they may be borne, in whole or in part, by theemployer or charged directly against the assets of theplan. In the case of a 401(k), profit sharing, or othersimilar plan with individual accounts, administrativefees are either allocated among individual accounts inproportion to each account balance (i.e., participantswith larger account balances pay more of theallocated expenses, (a “pro rata” charge)) or passedthrough as a flat fee against each participant’s account(a “per capita” charge). Generally the more servicesprovided, the higher the fees.

Investment fees. By far the largest component ofplan fees and expenses is associated with managingplan investments. Fees for investment managementand other related services generally are assessed as apercentage of assets invested. Employers should payattention to these fees. They are paid in the form of

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an indirect charge against the participant’s accountor the plan because they are deducted directly frominvestment returns. Net total return is the returnafter these fees have been deducted. For this reason,these fees, which are not specifically identified onstatements of investments, may not be immediatelyapparent to employers. (See pages 5-9 for moreinformation on investment-related fees.)

Individual service fees. In addition to overalladministrative expenses, there may be individualservice fees associated with optional featuresoffered under an individual account plan. Individualservice fees may be charged separately to theaccounts of those who choose to take advantage of aparticular plan feature. For example, fees may becharged to a participant for taking a loan from theplan or for executing participant investmentdirections.

Plan administrative and investment services may beprovided through a variety of arrangements:

Some or all of the various plan services andinvestment alternatives may be offered by oneprovider 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 otherservice providers that it may have contracted toprovide the services.

In other cases, plans may obtain services andinvestments from a variety of providers (sometimesreferred to as an unbundled arrangement). Theexpenses of each provider (e.g., investment manager,trustee, recordkeeper, communications firm) arecharged separately.

Plans also may use an arrangement that combines asingle provider for certain services, such asadministrative services, with a number of differentproviders for investments.

Fees need to be evaluated keeping in mind the costof all covered services.

What fees are associated with theinvestment choices in my retirementplan?

Apart from fees charged for administering the plan itself,there are two basic types of fees that may be charged inconnection with plan investments or investment optionsmade available to participants and beneficiaries. Thesefees, which can be referred to by different terms,include:

� Sales charges (also known as loads or commissions).These are basically transaction costs for buying andselling shares. They may be computed in differentways, depending on the particular investmentproduct.

� Management fees (also known as investmentadvisory fees or account maintenance fees). Theseare ongoing charges for managing the assets of theinvestment fund. They are generally stated as apercentage of the amount of assets invested in thefund. Sometimes management fees may be used tocover administrative expenses. You should know thatthe level of management fees can vary widely,depending on the investment manager and thenature of the investment product. Investmentproducts that require significant management,research, and monitoring services generally will havehigher fees. (See page 9.) Be aware that higher

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investment management fees do not necessarilymean better performance.

In addition, there are some fees that are unique tospecific types of investments. Following are briefdescriptions of some of the more common investmentsavailable to retirement plans and explanations of someof the different terminology or unique fees associatedwith them.

Some common investments and related fees:

Most investments offered by smaller plans pool themoney of a large number of individual investors. Poolingmoney makes it possible for smaller plans andparticipants in individual account plans to diversifyinvestments, to benefit from economies of scale, and tolower their transaction costs. These pooled funds mayinvest in stocks, bonds, real estate, and otherinvestments. Larger plans, by virtue of their size, aremore likely to pool investments on their own — forexample, by using a separate account held with afinancial institution. Smaller plans generally invest incommingled pooled investment vehicles offered byfinancial institutions, such as banks, insurancecompanies, or mutual funds. Generally, investment-related fees, usually charged as a percentage of assetsinvested, are paid by the participant or the plan.

Mutual funds. Mutual funds pool and invest the moneyof many people. Each investor owns shares in the mutualfund that represent a part of the mutual fund’s holdings.The portfolio of securities held by a mutual fund ismanaged by a professional investment adviser followinga specific investment policy. In addition to investmentmanagement and administration fees, you may findthese fees:

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� Some mutual funds assess sales charges (see abovefor a discussion of sales charges). These charges maybe 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. Aback-end load is paid when the shares are sold. Aback-end load is determined by how long you keepyour investment. There are various types of back-endloads, including some that decrease and eventuallydisappear over time.

� Mutual funds also may charge what are known as12b-1 fees, which are ongoing fees paid out of fundassets. 12b-1 fees may be used to pay commissionsto brokers and other salespersons, to pay foradvertising and other costs of promoting the fund toinvestors, and to pay various service providers to aplan pursuant to a bundled services arrangement.

� 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.

Collective investment funds. A collective investmentfund is a trust fund managed by a bank or trust companythat pools investments of retirement plans and othersimilar investors. Each investor has a proportionateinterest in the trust fund assets. For example, if acollective investment fund holds $10 million in assets andyour investment in the fund is $10,000, you have a 0.1percent interest in the fund. Like mutual funds, collectiveinvestment funds may have a variety of investmentobjectives. There are no front- or back-end feesassociated with a collective investment fund, but thereare investment management and administrative fees.

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Variable annuities. Insurance companies frequently offera range of investment alternatives for individual accountplans through a group variable annuity contract betweenan insurance company and an employer on behalf of aplan. Variable annuities include one or more insuranceelements, which are not present in other investmentalternatives. Generally, these elements include anannuity feature, interest and expense guarantees, andany death benefit provided during the term of thecontract. The variable annuity contract “wraps” aroundinvestment alternatives, often a number of mutual funds.Participants select from among the investmentalternatives offered, and the returns to their individualaccounts vary with their choice of investments. Inaddition to investment management fees andadministration fees, you may find these fees:

� Insurance-related charges are associated withinvestment alternatives that include an insurancecomponent. They include items such as salesexpenses, mortality risk charges, and the cost ofissuing and administering contracts.

� Surrender and transfer charges are fees an insurancecompany may charge when an employer terminatesa contract (in other words, withdraws the plan’sinvestment) before the term of the contract expiresor when a participant withdraws an amount from thecontract. These charges may be imposed if theseevents occur before the expiration of a stated periodand commonly decrease and disappear over time.They are similar to an early withdrawal penalty on abank certificate of deposit or a back-end load orredemption fee charged by some mutual funds.

Pooled guaranteed investment contract (GIC) funds. Acommon fixed income investment option, a pooled GICfund generally includes a number of contracts issued by

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an insurance company or bank paying an interest ratethat blends the fixed interest rates of each of the GICsincluded in the pool. There are investment managementand administrative fees associated with the pooled GIC fund.

While the investments described above are common,plans also may offer other investments that are notdescribed here (such as employer securities).

What other factors might have animpact on the fees and expenses ofmy retirement plan?

Funds that are “actively managed” (i.e., funds with aninvestment adviser who actively researches, monitors,and trades the holdings of the fund to seek a higherreturn than the market as a whole) generally have higherfees than funds that are “passively managed” (seebelow). The higher fees are associated with the moreactive management provided and increased salescharges from the higher level of trading activity. Whileactively managed funds seek to provide higher returnsthan the market, neither active management nor higherfees necessarily guarantee higher returns.

Funds that are “passively managed” generally have lowermanagement fees. Passively managed funds seek toobtain the investment results of an established marketindex, such as the Standard and Poor’s 500, byduplicating the holdings included in the index. Thus,passively managed funds require little research and lesstrading activity.

What steps can I take to evaluateplan fees and expenses?

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Fees and expenses are one of several factors to considerwhen you select and monitor plan service providers andinvestments. The level and quality of service andinvestment risk and return will also affect your decisions.

� Begin by establishing an objective process to aid inyour decisionmaking. This process should include anunderstanding of the fees and expenses you will payand a review of those charges as they relate to theservices to be provided and the investments you areconsidering.

� Before negotiating with prospective providers, thinkabout the specific services you would like from aservice provider (e.g., legal, accounting,trustee/custodian, recordkeeping, investmentmanagement, investment education or advice).Include the types and frequency of reports you wishto receive, communications to participants, meetingsfor participants, and the frequency of participantinvestment transfers.

� You will also need to consider the level ofresponsibility you want the prospective serviceprovider to assume, the services that must beincluded in any retirement plan, the possible extrasor customized services you wish to provide, andoptional features, such as loans, Internet trading,and telephone transfers.

� Once you have a clear idea of your requirements,you are ready to begin receiving estimates fromprospective providers. Give all of them completeand identical information about your plan and thefeatures you want so that you can make a meaningfulcomparison. This information should include thenumber of plan participants and the amount of planassets as of a specified date.

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� In addition, ask each prospective provider to bespecific about which services are covered for theestimated fees and which are not. To help ingathering information and making comparisons, youmay want to use the same format for each prospectiveprovider. See www.dol.gov/ebsa/pdf/401kfefm.pdf foran example of a uniform fee disclosure format thatwill help you in selecting and monitoring the servicesto your plan.

� Once you have selected a service provider orinvestments, be prepared to monitor the level andquality of the services and performance ofinvestments to make sure they continue to bereasonable and they suit the needs of youremployees. Make sure that you receive informationon a regular basis so that you can monitorinvestment returns and service providerperformance and, if necessary, make changes.

By continuing to ask questions, you can make betterdecisions for your plan and your employees.

In Conclusion ...

Fees and expenses are an important component inmanaging your retirement plan. For further information,you may want to consult the following resources atwww.dol.gov/ebsa:

� American Bankers Association/American Council ofLife Insurance/Investment Company Institute - 401(k)Plan Fee Disclosure Form(www.dol.gov/ebsa/pdf/401kfefm.pdf)

� What You Should Know about Your Retirement Plan� A Look at 401(k) Plan Fees (for employees)

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U.S. Department of LaborEmployee Benefits Security Administration