Breaking Down Revenue Sharing and Fee Levelization

By: Matt Voecks  RPA, AIF®

Originally posted: 05/16/2019

As a plan sponsor, you may or may not have heard the term "revenue sharing." As retirement plan advisors we hear it all the time, and more and more fiduciaries are becoming aware of the issues that come with it. The industry jargon is confusing, and we're here to break it down for you.

What exactly is Revenue Sharing?

Revenue sharing is the allocation of additional fees to the expense ratio of a mutual fund to offset the cost of non-investment management services. In the Retirement Plan industry, revenue sharing is often used to cover the recordkeeping and administration costs of the retirement plan providers and advisors, not the fund company managing the fund.

Why should I care?

The challenge with revenue sharing is that funds within the same retirement plan can have varying revenue sharing rates that widely vary from one investment option to the next. Conservative advisors may believe that whenever investments in the plan generate unequal revenue, potential liability exists because participants inevitably contribute unequally to covering the cost of the plan.

Example

Participant A picks an investment with low revenue sharing and Participant B picks an investment with high revenue sharing, it means that Participant B is paying more toward plan administration and recordkeeping expenses of the plan than Participant A.

Some go so far as to say that Participant B is subsidizing the cost of the retirement plan for Participant A. This is the problem.

So, what can we do to fix this? Queue: Fee Levelization.

Today many Plan Providers will allow revenue sharing to be directly credited back to the specific participant using the investment option rather than used to pay plan fees. Many recordkeepers call this process "Fee Levelization." This approach allows for plan fees to be assessed uniformly to all participants across all assets through a flat asset charge, or via pro-rata hard dollar expense. Applying uniform plan expenses and fees to all participants reduces fiduciary risk associated with a single participant claiming an unfair assessment of plan expenses.

With this strategy, a Plan Sponsor obtains an added opportunity to provide expense savings to participants by selecting the lowest net cost available investment share class knowing that the revenue sharing is credited back to the participant (if permitted by the plan provider).

Let's look at a sample mutual fund that reflects the experience of many mutual funds available to retirement plans:

The Sample fund company has five different share class option for the same Equity Income fund. Each share class carries a different expense ratio and different revenue share, indicating the investment manager captures different amounts of revenue depending on the share class chosen. This situation does not seem logical as each share class is managed the same way, however, in today's marketplace, this is an example of how many investment companies structure their expenses. If revenue sharing is reallocated to the participants in that fund, the Plan Sponsor can choose the share class that produces the least amount of investment manager revenue so that participants can access each investment at their lowest possible cost.

What can I do as a plan sponsor about revenue sharing?

1. Review your Plan Sponsor 408(b)2 Fee Disclosure document from your recordkeeper to gain an understanding of your current fee structure.
2. Check if your revenue sharing is the same or different for each investment in your plan.
3. Discuss with your recordkeeper if fee levelization is a service they offer.
   • if Fee Levelization is available from your recordkeeper, discuss how the fee structure would change if this service were to be implemented.
   • if Fee Levelization is not available from your recordkeeper and you'd like to stay with your recordkeeper, the next best option is to consider only using investment share classes that have zero revenue sharing (like the Equity Income Fund Class R6 in the chart above). While this may not create the lowest investment management fee, it does remove the fiduciary issue of fees being applied unevenly amongst participants.
4. Utilize the services of a Retirement Plan Advisor who understands the benefits of Fee Levelization and how it can reduce fees and reduce fiduciary liability.

Questions? Please reach out to your Pensionmark advisor or (888)201-5488 or info@pensionmark.com.