Understanding the mechanics of fees will help you
Updated: Feb 23, 2022
Understanding how fees are set is an advantage in a fee review. Knowledge can help you negotiate lower fees.
The focus of this article provide information on the way fund manger fees, advisor record keeping, and advisor fees are determined. Sponsors are responsible for fees and at risk if they fail to negotiate in good faith on behalf of the plan members.
Issues to consider in overseeing the record keeper and advisor are also discussed in “Evaluating Your Record keeper” and “Monitoring you CAP advisor”.
How Fund Manager fees are determined
It is important to understand how the fund manager portion of the Investment Management Fee (IMF) is determined. The IMF is not set by the fund manager: the record keeper establishes the fee for each fund manager based on specific factors related to their platform.
In defined benefit (DB) plans a fund manager’s fee depends on the amount of money managed: the more money invested in a fund the lower the fees. The fund manager only gets a small portion of the total IMF paid by members: the record keeper keeps the rest. This also applies to DC and RRSP fund manager on a record keeper’s platform: the more money in a specific fund the lower the fees paid to the manager by the record keeper. Also keep in mind that the IMFs for each pension plan are not the same – it depends on the amount of the assets in each sponsor’s plan. If possible, check with sponsors with similar sized plans to get an idea what their IMFs are.
The fund manager fee is only one part of the overall investment Management Fee (IMF). The record keeper collects the fund manager fee and remits an amount to the fund manager monthly. You will not be told how much the fund manager gets: it’s a ‘secret’ buried in the IMF.
In a fee review you should therefore should compare record keepers’ IMFs for any specific funds you wish to continue to use or, add as investment options. You can also ask the record keeper to give you the breakdown of the IMF i.e. record keeping, fund manager and advisor fees for each investment option. The difference in IMF’s between record keepers, is often significant.
Record keeper proprietary fund fees are arbitrarily set by the record keeper since the money goes to the record keeper or an associated company. As a result, sponsors have room to negotiate lower fees on proprietary funds than is they can for third party fund manager on the platform.
If a sponsor provides an employee health benefit program via the same record keeper (insurance company) there is an opportunity to negotiate IMF reductions as part of the combined business relationship.
If the plan offers guaranteed investment certificates such as CIAs or GIAs look at the interest rates and the premium paid above normal bank rates as part of the review. A premium should be paid because: a) the record keeper (financial institution) gets a guaranteed steady stream of low cost deposits and, b) the credit rating for the record keeper is usually less than for a bank i.e. it is riskier and warrants a ‘credit risk’ premium. Most record keepers pay a premium of at least 0.25%.
Advisors usually receive a fee (trailing commission) based on the total plan asset values. In most cases the advisor does not interact with the plan members nor provide them with investment advice but simply assists the Administrator (Sponsor) in overseeing the plan and investments. The Plan document will tell you who is responsible for administering the plan. The role of an advisor in a CAP is also quite different and less onerous than their role as an advisor to a client in a mutual fund.
The rate the advisor receives as part of the IMF is not set by the record keeper: it is negotiated between the Plan Administrator and perhaps the CAP Committee and the advisor. The fee a is a single rate applied to all funds. It is communicated to the record keeper who collects the fee and remits monthly payments to the advisor. The advisors automatically get more money as the amount of the members assets increase regardless of whether or not any addition effort or services are provided.
If the advisor is primarily assisting the Sponsor in administering the Plan the sponsor should consider negotiating a flat fee and paying it vs. collecting it from the members. This gives the company more control over the costs. As is the case with its other business contracts, it minimizes potential conflicts of interest and fiduciary risk and, it would provide the members with a significant additional benefit over time.
Record keeper Fees
The record keeping portion of the IMF is set by the record keeper based on a variety of factors: the amount of the Plan assets, the number of Plan members, level of service provided, etc. The number of proprietary funds used in the Plan can also be a factor in how much money the record keeper earns overall from the business and can be a negotiating factor in agree on the record keeper portion of an IMF. Large insurance companies for example also have the advantage of scale with regards to offering lower fees.
Record keepers are reluctant to disclose their portion of the IMF, despite the fact it is a large portion of the IMF; however, it can be estimated if you know the advisor and fund manager portions of the IMF. This allows you to compare it to other record keepers.
DC and RRSP members and sometimes pension committee members often incorrectly assume 100% of the IMF goes to the Fund Managers
Fiduciaries, administrators and pension committee members must act in the members’ best interests: proper oversight of fees is an obvious part of their responsibilities.
Fees are a critical factor in saving both before and after a member retires and need to be considered in both situations. Communicating information about fees and their impact to members is critical.
A comprehensive formal fee review process should be part of a governance process to minimize the risk of litigation. It will satisfy many aspects of good governance ‘killing many birds with one stone’. If fee information is provided it is up to the Plan members responsibility to use it. To protect their legal position, plan members should be aware of the impact of fees and not be shy about questioning the amount they are forced to pay both before and after they retire.
G. Wahl Managing Director, The PensionAdvisor