Fees paid CAP Members to recordkeepers, advisors, and fund managers have a major negative impact on savings over time. Fees are like cancer, silently eating away savings!
Annual fees are usually 1-3%: the total paid over time is shocking! Sponsors and advisors should provide full disclosure of the annual fee deducted from the members' accounts. CAP members should question fees costs and ensure record keepers and advisors are providing sufficient 'added value' and good service.
CAP sponsors have a fiduciary duty to ensure that the CAP fees are reasonable: periodic formal fee reviews should be part of the governance to minimize legal risk.
In a Defined Benefit (DB) plan the employer pays all fees and costs incurred in administering the plan. The CFOs and Controllers are cost-conscious and keen on ensuring the fees are monitored and reasonable. The fees paid by CAP members unfortunately do not get the same level of scrutiny.
Find out more about fees and issues below
#1 Fees paid by Members are not fully disclosed
#2 Fees are the sponsor's responsibility
#3 The Impact of Fees on CAP Members
#4 Avoiding legal risks relating to CAP Fees
#5 How significant is the impact of CAP fees on savings?
#1 Fees paid by Members of a CAP aren't fully disclosed!
Do investors have the right to know how much they pay in fees? Apparently not!
For many years mutual fund investors and Capital Accumulation Plan (CAPs) members have been kept in the dark about the amount they pay in advisor, record keeping and fund manager fees. These costs are automatically deducted from their accounts but the dollar amount is not disclosed.
Account-holders are given the investment management rates (IMFs) but then cheekily told if they want to know what they paid to “figure it out yourself". As a result, there is no effective way to determine how much was actually paid or, if you have been incorrectly charged.
Over the long term the fees have a significant negative impact on savings accumulations. Complaints about the high Canadian investment fee rates and reluctance to disclose the annual costs have been going on for years with only a half-baked response from the industry.
Mutual Fund Industry
In 2016, after two decades of ‘investigation’, the Canadian Securities Administrators (CSA) introduced the Client Relationship Model Phase 2(CRM2). This requires disclosure of certain, but not all costs, paid by the clients. The costs reported include front-end commissions, commissions paid to the dealer and advisor, and trailing commissions. Fee disclosure now only requires disclosure of the amount received by the dealer firm as direct and indirect fees but not the amount paid to the advisor. Itemization of costs is needed but is left to the dealer’s discretion.
Many mutual fund investors assume they now know their annual cash costs. They have been are wrong: disclosure does not include the amount paid to the investment fund manager which are often the largest portion of MER. The Canadian equity fund weighted average fee was 2.4% and it is higher for foreign equity funds. Therefore, a key component of the cost is not being disclosed. The individual cost elements are also not required to be disclosed under CRM2.
While the CSA should require full disclosure of total dollar costs paid by investors the fear is that investors would challenge the high costs of fees given the services provided.
While CRM2 is a step in the right direction it is misleading and simply adds to investor confusion. Legislation should be introduced requiring full disclosure since the industry is reluctant to address the problem.
Capital Accumulation Plans (DC and RRSP Pension Programs)
The financial and legal risks associated with Defined Benefit (DB) plans have led many sponsors to replace DB programs with Defined Contribution (DC) plans or RRSP. DC plans are registered pension programs that fall under provincial or federal pension legislation. An RRSP is a savings vehicle falling under the Income Tax Act. Pension legislation however primarily focuses on DB plans: there is very little in federal or provincial legislation or regulations specific to DC plans.
The federal and several provincial governments have also promoted a DC/CAP type program called a Pooled Registered Pension Plan (PRPPs). PRPPs are intended to encourage small businesses to provide pension programs but are also available to large companies.
Insurance and other companies are often the record keepers for a CAP pension program. A record-keeper provides account information and reporting, education, and other program information. Sponsors also often use an advisor to assist in selecting investment funds and overseeing the CAP pension program. In some cases, advisors will even provide CAP members with investment advice.
Members pay for these services via an investment management fee (IMF) which includes the record keeper, advisor, and fund management fees. As in the case of mutual funds, the IMF is automatically deducted from member CAP accounts each month. IMF rate is usually disclosed but the members are kept in the dark about much money is taken out of their account: members pay for their pension program but do not know how much they are paying.
DB plan members who transfer to a DC program are usually not aware they will bear the bulk of the cost of administering the DC plan fees. They are also not told that the fees will increase once they retire and are transferred to the record keeper LIRA or RRIF program.
With the exception of BC and Alberta provincial and federal legislation does not require fee disclosure. In the case of BC, Section 30 of the PBSA Regulations requires an annual reconciliation of the balance in DC accounts at the end of the year. This includes contributions, any interest credited, and “… any administration expenses deducted and any other payments, transfers or withdrawals made...”. The withdrawals from a member account for record keeper, advisor, and fund manager fees would qualify as ‘administrative expenses’ or, as ‘other payments’. The requirement to disclose these costs as reconciling items however is not being enforced.
Both mutual fund investors and DC plan members are not told what they pay monthly or each year for fees. Since Canadian fees are “some of the highest in the world” it is clever of sponsors, record keepers, advisors, and fund managers not to highlight these costs: if investors knew the cost they may demand lower fees or higher employer contributions.
The mutual fund industry should require full fee disclosure. It is questionable whether RRSP and DC pension program employers, administrators and pension committees are acting in plan members’ best interest with respect to fee disclosure if they are not insisting on full fee disclosure. The lack of fee disclosure is an area of potential conflict of interest legal and fiduciary perspective for pension sponsors and CAP service providers.
Regulators need to step up to the plate by adding fee disclosure requirements or enforcing the existing regulations.
Gerry Wahl, Managing Director, The PensionAdvisor
2) Fees are a sponsor's responsibility
A sponsor’s role in overseeing fees is the area most susceptible to litigation.
Sponsors need to understand their role and responsibilities for fees to minimize litigation risk. Sponsors of US 401(k) and 403(b) plans (defined contribution plans) are seeing a wave of ERISA law suites targeting plan fees. Since 2006 there have been hundreds of lawsuits in the USA related to fees and breaches of fiduciary duty: in 2016 and 2017 about 60 fee-related cases were filed. The cases mostly involve plans with $100 million or more in assets which represent just 1% of US plans but, resulted in settlements of over $300 million. Litigation against smaller US DC plans however is steadily increasing.
There is limited legislation or legal actions regarding CAP fees in Canada but fiduciary issues and concerns are comparable to the USA. More litigation relating to fees is expected as CAP members become older and more aware of the negative impact fees have had on retirement savings and income.
Both CAP sponsors and members need to be aware of fiduciary requirements with respect to fees. This is discussed in more detail in ‘The Impact of Fee on Members’, ‘Converting from DB to DC, and “The Trouble with Fee Disclosure in CAPs”.
Fiduciary Role and Responsibilities – Fees
In Canada, the CAPSA Guideline recommendations provide limited guidance regarding fees (IMFs- Investment Management Fees). The impact of fees or the impact on financial planning models is not highlighted. The Guidelines do not recommend governance processes for fees (even though the recommendations are ‘best practices and likely to be cited in litigation).
Guideline #4 – Principle #9 states that a sponsor (administrator) should have transparent communication in place that outlines the legislated fiduciary responsibilities. Principle #11 simply recommends a regular review of the governance processes in place with no specific mention of fees.
Guideline #3 - Section 4.4 recommends that members should be provided with the description and amount of all fees including record keeping, fund management, and other service provider fees. Members generally are not told the actual amount deducted from their accounts during the month or year.
Section 5.3 states that return performance should be reported net of fees. This is seldom done. Members usually only see Gross Returns before fees. They are kept in the dark about the associated fees paid.
Provincial legislation and regulations and jurisprudence, regarding DC plan limited and may vary by province. For example, the requirement for a Statement of Investment Policies and Procedures (SIP) which often includes a section on fees, is no longer required in BC and Alberta. In addition, while a sponsor is required under the regulations to disclose any administration expenses deducted, and any other payments, transfers or withdrawals made, from member accounts the BC and Alberta Regulators, for some inexplicable reason, do not enforce this regulation. Resistance to requiring fee disclosure by the Regulators is likely related to the mutual fund industry and some CAP record keepers’ reluctance to disclose the actual cost of CAP and mutual fund fees.
Good Governance and Understanding fees
From a governance perspective, a regular review of the Investment Management Fee (IMF) structure is warranted. Competitors will participate in a formal fee review and offer competitive pricing: it is an opportunity to attract a new client.
A comprehensive and fully documented fee review should take place every 3-5 years. It should include the record keeper, fund manager, and, if applicable, the advisor portion of the IMF. There should also be a clear understanding of the costs the members pay vs. the sponsor per the plan document. the following should be considered when undertaking a fee review:
1) The quality of record-keeping and advisory service is a key factor - not just the fees paid.
2) Ensure it is clear to what extent each party is responsible for fees in the plan.
3) IMF’s consist of Recordkeeping, fund manager, and advisor fees – consider all three components.
4) Specific fund manager fees vary significantly amongst record keepers. Consider the competition’s fees on your existing investment options or any new funds you want to add.
5) Large record keepers should have lower fund manager fees. (If you know the fund management fee and the advisor’s cost, you can estimate and compare record-keeping costs).
6) Large record keepers have the advantage of scale re: service, communication, education, and fees.
7) A record keeper always has room to lower the fees on their proprietary funds.
8) Consider the performance vs the fees of a record keepers’ proprietary funds.
9) Be aware of getting into ‘locked in’ situations such as TDFs where it may be difficult to extricate yourself from a record keeper’s proprietary funds in the future.
10) Target-date funds are not all the same. There are often subtle but significant differences that include how fees are set. (If TDFs include many proprietary funds the fees should be lower.)
11) Send an RFQ to at least 3 platform providers and include information you would like included. The record keeper and advisor should be advised a formal fee review is being undertaken.
12) Document the fee review and the resulting decision.
Sponsors should be prepared to insist on lower IMFs as the plan total assets grow. Recordkeepers, fund managers, and advisors automatically get more money as the value of the member's assets increase i.e. without providing any additional service
Active vs Other Members - Fees
Fee reviews usually focus on the IMFs paid by active members. When a member retires or leaves the organization however they are often transferred into a record keeper’s plan i.e. they are no longer members of the organization's CAP program(s). The record keeper does not provide the same level of service, education, and communication and it is more difficult to hold them accountable legally. More importantly, members, are often shocked to find out their fees increase!
In the case of DB to DC conversions, members are seldom told they will no longer continue as part of the employer’s plan upon retiring nor about the fee increase. This could have legal consequences since it negatively impacts retirement planning and retirement income.
If members are moved into a record-keeper's CAP program(s)a sponsor upon retirement or termination, the sponsor should consider the IMFs paid by members as part of the fee review.
The mechanics of undertaking a fee review are not difficult but they require planning and time. A fee review also gives the record keeper and advisor an opportunity to review the fees and levels of service. CAP members should be aware of fees and request information about the reviews and request evidence that the fees are competitive. A fee review should be part of your CAP governance: it satisfies a variety of governance and fiduciary issues and affects all Plan members.
G.Wahl, Managing Director, The PensionAdvisor
#3 The Impact of Fees on CAP Members
Fees are a cancer - they quietly eat away savings without you knowing about them
Fees touch on many aspects of pension governance and can have a substantial negative effect on asset accumulation over time. The lack of transparency (i.e., hidden costs, commissions and undisclosed fees) has lead to a series of legal challenges in US 401k plans including class action lawsuits that claim sponsors did not exercise due diligence in monitoring fees.
In Canada the CAPASA Guidelines recommend that sponsors disclose the nature of any costs paid directly or indirectly by members i.e., fees paid to an investment fund manager, record keeper, investment advisor fees, and operating costs charged directly to a fund. The CAPSA Guidelines also recommend sponsors establish criteria and monitor the performance of all service providers, including record keepers, advisors, fund managers, or other consultants.
Fees have a significant role in a plan sponsor’s evaluation of the services rendered by service providers on behalf of the CAP members. It is noteworthy that one of the key objectives of the recent Pooled Registered Pension Plan (PRPP) proposal is to substantially lower the fees that members pay. Whether this is feasible, given the involvement of financial institutions in the PRPP is questionable. Breaking down and understanding the nature and amount of the fees paid by members is therefore prudent from a fiduciary perspective.
CAP members and sponsors often complain that the fees paid to fund managers are too high. Let’s have a closer look at some of these costs and see if this is true or just a case of not understanding the fee structure.
What fees do members pay?
CAP members generally pay fees to the record keeper, fund manger and often the sponsor's plan advisor. This is usually reported as single amount, e.g. 1% - 1.5% which is applied against the market value of equities, bonds etc. (marked to market) and deducted from the members’ accounts weekly, monthly or quarterly.
In addition, the investment manager uses money directly from the fund to pay administrative costs for things like accounting, audit, reporting, and transaction costs. If these costs weren’t paid out of the fund (in short, paid for by the members) the total assets and the returns would be higher.
The fund manager administration costs are disclosed annually, on a retrospective basis, and generally range from 0.01% to 0.35%. Since these costs can vary from year to year they should be disclosed separately from the record keeper and investment management fees.
In the case of record keeping fees the entire fee may go to the record keeper. In other cases, however, a portion of the fee may be paid to an agent of record, say 0.25% – 0.45%, who provides member services on behalf of the record keeper. However, the record keeper’s fees are usually the largest component of the total fee paid by a CAP member, often representing 40% to 60% of the total.
The record keeper also generally charges plan members a higher fund management fee than the fee the record keeper actually pays the fund manager: the fund management fees members pay don’t all go to the fund manager. The CAP investors will often be charged the higher fund manager’s fee associated with the current (low) level of investment in the fund in their specific plan. At the same time, because the fund manager is managing a larger pool of funds on the record keeper’s platform, they are paid a lower fee (amount) based on the total larger pooled fund investment they are managing.
For example, if the fund manager is managing $300 million on a record keeper’s platform in a specific fund the record keeper will negotiate a lower fee, say 0.35%, to be paid to the manager based on the total $300 million (fees paid to the fund manager decrease as the size of the investment increases) whereas the member will pay the higher fund manager fee, say 0.55% based on say, $20 million invested in that fund in that plan. Fees paid to investment managers therefore are generally not the largest component of the fees paid by plan members.
In the US, the Department of labour (ERISA) now requires detailed provider-to-sponsor disclosure and sponsor-to-participant disclosure. In addition, the dollar amount of fees per $1,000 of investments must be disclosed and must be presented in a way that allows the members to compare fees between investment options. The new ERISA requirements are intended to level the playing filed for record keepers, fund managers and consultants and provide members with a better idea of what they are paying for–and reduce fees through increased competition.
The Advisor Fee controversy
A CAP sponsor almost always hires a CAP advisor to assist in overseeing a CAP. The advisor helps the sponsor monitor CAP investments, fund manager manager searches, and governance, and ensures the CAP administrator and pension committee are aware of changes that may impact the CAP. The advisor seldom has direct involvement with CAP Members except in the case where the sponsor has instructed an advisor to provide investment advise (unusual because of the legal risks it entails).
The cost of the advisor is included as part of the Investment Management Fee (IMF) that is paid, and automatically deducted, from CAP Members accounts each month. In other words, the Employer/Sponsor is the principal user and beneficiary of the advisors services yet, the CAP Members pay the cost. This appears to be both an unreasonable and unfair expense borne by Members.
Questions for CAP Members to consider:
1) What advisor services do the CAP members receive or benefit directly from?
2) Are the members aware that they are paying for the advisor's services?
3) If DB accounts were converted to DC accounts were Members told they are pay for the advisor fee?
4) What does the CAP document say about fees?
The plan document is key in this fee issue. The plan document may state that the Members are responsible for the advisor fees or it may be silent on this issue and simply state that Members pay the fees. If the fees are not mentioned in the document Members should ask why they are paying the costs of the advisor service which primarily benefits the sponsor.
While Members pay the fees they have no control or say about them - this is part of the problem .
Over time, fees have a significant negative impact on Member savings. Fee transparency is obviously an issue in Canada as well and it is unfortunate that more emphasis was not put on better fee disclosure in the recent proposed CAPSA revisions to the CAP Guidelines.
The CAPSA Guidelines recommend that plan sponsors describe and regularly monitor not only the performance of the investments but that of the service providers. From a fiduciary perspective it therefore is important that plan administrators request a breakdown of fees from the record keeper that explains the nature and amount of each component of fees.
The issue of fees is a bit more complex than it appears at first. It is therefore critical that the sponsor, administrator, and the pension committee clearly understand, monitor and disclose fee costs to CAP members.
Other hidden fees and the issues relating to fees for different forms of life cycle funds are discussed in other articles on this site.
G.Wahl, Managing Director, The PensionAdvisor
#4 Avoiding legal risks relating to CAP Fees
Fees issues can lead to legal actions - understand the issues and risks
Issues relating to CAP fees are discussed in the preceding articles. Disclosures and communication about fees are important particularly in the case when DB accounts have been converted to DC accounts.
Law suites relating to CAP fees are not common in Canada while they are a often the subject of legal actions in the US - it's probably a matter of time before this is also the case in Canada.
Perhaps the best and least expense way for a sponsor to avoid legal problems relating to fees is to simply pay the fees on behalf of the Members. Paying the fees could also be considered and promoted as part of employee benefit package.
#5 How significant is the impact of CAP fees on savings?
The annual CAP fees paid significantly erode savings over time
The CAP fees paid by employees have a significant negative impact on DC and RRSP savings programs investment. As part of the governance of company DC and RISP plans, fees must be are monitored and reflected in reviewing fund manager quarterly return performance.
Recordkeepers (banks, insurance companies, etc.) automatically deduct Investment Management Fees (IMFs) from CAP accounts each month. The CAP member is not told how much has been deducted despite this information is readily available. The recordkeeper distributes the fees collected to the fund manager and advisor.
Recordkeepers earn revenue from a CAP from 3 basic sources:
the flat per annum charge per employee paid by the company;
a portion of the management fees levied by the recordkeeper based on the market value of the investments funds in each specific investment option in which the employee id invested; and,
the spread on GIC’s rate offered in the CAP vs. the current market rate for GICs.
Investment Manager Fees (IMF) for investment options can vary from 0.10% to 0.70%. For certain types of investment options e.g. foreign equity, or specialty funds the fees can be 0.75% to 1.50% or more, depending on the fund and manager and the recordkeeper. Relative to retail mutual fund investments, the investment management fees (IMFs) paid by CAP employees may be lower by ~0.3%.
Fees have a significant detrimental impact on employees’ efforts to accumulate pension wealth. The table below shows the impact of fees (0.25% -2.50%) at ~$210,000 of net savings over the long- term (30 years).
IF Fee (IMF) Net Savings Reduction in savings
1.00% $180,000 $30,000
2.00% $158,000 $52,000
2.50% $140,000 $70,000
The difference in savings with fees of 0.25% vs. 2.50% is $70,000 over the 30 year period. If the investments total more than ~$210,000, say $400,000- $500,000, the reduction in savings will be $100,000 or more.
When adding a new DC, RRSP, TFSA investment the fund managers' return performances, net of fees over 1, 5, 10, and 20 years, vs. appropriate benchmark is usually considered. This ensures recent performance and volatility do not ‘colour’ the long-term net performance: short-term returns are often affected by style bias and not an appropriate indication of performance. Longer-term performance, 10-20-30 years is the key in selecting fund managers. Keep in mind that CAP members are usually reminded they are "in it (saving) for the long term so a consistent approach should be used in selecting CAP investments. An alternative approach is to use index (passive) funds (or ETFs) that have significantly lower fees.
The employer (sponsor) has a fiduciary responsibility to ensure CAP fees are monitored and reasonable. Despite this, in most cases, the employer (sponsor) does not know or ask about the total annual fees paid by Cap Members.
G.Wahl, Managing Director, THE PensionAdvisor