Allocating Revenue-Sharing Payments

Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security and Medicare. This is where we highlight the most relevant topics affecting your business. A recent call with a financial advisor in Colorado is representative of a common question on 401(k) plan revenue sharing.

“If a 401(k) plan allocates revenue sharing payments to participant accounts, what is the prescribed method they use?”

Highlights of the discussion on allocating revenue sharing payments

Revenue sharing is a common, but declining, indirect fee found in 401(k) plans. It is a way that mutual funds and investment providers compensate third-party service providers of 401(k) plans. Revenue sharing dollars 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.

Plan fiduciaries must follow a documented, prudent process in determining how to manage revenue sharing payments if they exist. If the plan document specifies the treatment of revenue sharing, 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 number of plans that use revenue sharing is steadily declining, likely because of the emphasis on fee transparency. Of the plans that use revenue sharing

• Sixty-two percent credit the amounts back to participants,

• Forty-six percent use it pay recordkeeping and administration fees and

• Fourteen percent use it to pay for other allowable expenses. (1)

And, according to a 2024 Callan Survey, 39 percent of the sponsors surveyed said they were or likely or highly likely to begin rebating revenue sharing to participants.

The three ways to allocate revenue sharing payments to plan participants are 1) pro-rata; 2) per capita or 3) equalization.

There is no specific guidance from the Department of Labor 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

1. Be deliberative and documented;

2. Weigh the competing interests of various classes of participants and the effects of various allocation methods on those interests;

3. Be conducted solely in the interest of participants;

4. Bare a reasonable relationship to the services provided to the participants;

5. Avoid conflicts of interest; and

6. Include a rational basis for the selected method.

Conclusion

While there is no preferred method for allocating revenue sharing payments among participants, plan fiduciaries must follow a documented, prudent process in determining how to manage such payments if they exist, taking into account several key considerations.

(1) PSCA, 65^th Annual Survey, 2022