How should revenue sharing payments in a 401(k) plan be properly allocated to participant accounts?
ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor in Colorado is representative of a question we commonly receive related to 401(k) plans and revenue sharing.
Highlights of Discussion
Generally, revenue sharing is compensation from plan investments (typically, mutual funds) that a plan uses to offset plan expenses. For example, if a plan contracts to pay an annual fee of $20,000 to one or more service providers and receives revenue sharing (or credits) of $2,000 the amount paid by the plan is only $18,000. The next question is how revenue sharing dollars are equitably allocated among plan participants. Specifically, which participants receive a share of the revenue sharing offset and how much is received?
Plan fiduciaries must follow a documented, prudent process in determining how to handle revenue sharing payments if they exist. If the plan document specifies how revenue sharing is to be used, the fiduciaries have a duty to follow the terms of the plan, unless it would clearly be imprudent to do so.
If the document is silent on revenue sharing, plan fiduciaries could decide to use the payments to pay plan expenses and/or allocate the revenue sharing to the accounts of plan participants.
The three ways to allocate revenue sharing payments to plan participants are 1) pro-rata; 2) per capita or 3) equalization. A pro rata allocation would be a percentage of the payment per participant in proportion to their account balances. A per capita allocation would assign the same dollar amount to each participant account. Under revenue equalization, a fund’s revenue sharing would be allocated to those participants investing in the respective fund. For example, participants who invested in a fund that paid more in revenue sharing than the record keeper charged in administrative fees would receive a credit to their plan accounts, while participants invested in funds with no revenue sharing would receive a debit for their share of the recordkeeping fee.
There is no specific guidance from the DOL on the preferred process for allocating revenue sharing—only that the process itself must be a prudent one. However, the industry has turned to Field Assistance Bulletin (FAB) 2003-03  (regarding the allocation of plan expenses) and FAB 2006-01  (regarding the allocation of mutual fund settlement proceeds) as stand in guidance based on similar concepts. The process for determining how revenue sharing is allocated must
- Be deliberative and documented;
- Weigh the competing interests of various classes of participants and the effects of various allocation methods on those interests;
- Be carried out solely in the interest of participants;
- Bare a reasonable relationship to the services being provided to the participants;
- Avoid conflicts of interest; and
- Include a rational basis for the selected method.
While there is no preferred method for allocating revenue sharing payments, plan fiduciaries must follow a documented, prudent process in determining how to handle such payments if they exist, taking into account several key considerations enumerated above.