What does it mean when fees are assessed “pro-rata”?
The pro-rata method of assessing a fee is when the total fee amount is deducted proportionally from participant accounts. An asset-based fee that is calculated directly from the participant account balance (i.e. quarterly asset-based fee of .10% from each participant account) is not pro-rata.
Examples of fees that may be assessed pro-rata:
- Per participant fees that are added together and then deducted pro-rata
- Base fees that are deducted pro-rata
- Fees that are invoiced from a 3rd party and deducted pro-rata
- Step-rate asset or participant based fees that are computed to a total dollar amount and deducted pro-rata
Sample pro-rata calculation:
A Recordkeeper has a $500 fee to deduct across 10 plan participants (could be an invoiced fee, a base fee or a total of ten $50 per participant fees). Without a pro-rata calculation, each participant would simply be charged $50, regardless of their account balance. In the illustration below, Participant 1 (who has a smaller account balance) will have a significantly higher percentage fee than Participant 2 who has a larger account balance. With a pro-rata deduction, the Recordkeeper assesses each participant’s fee according to their account balance. If a participant with a $26,103.98 balance represented 14.07% of the total balance (taking into account the other 9 participants), her fee would be 14.07% of $500 or $70.37.
|Name||Account Balance||% of Total Balance||Flat Fee||% of Account Balance|
(for $50 Flat Fee Deduction)
Why is the pro-rata method not fully transparent?
Participants don’t know how many others are in the plan or their account balances. As a Recordkeeper, you can’t prove that this one person represented X% of the total and you can’t prove how you came up with the total. On top of that, the participant’s percentage and/or amount changes each billing period as the overall number of participants or participant balances change.
In today’s world, people are looking at their accounts often and want to understand their fees rather than accept an ambiguous explanation of how their fees were calculated. I have never walked into a restaurant that calculated variable prices on a burger depending on the current price of ingredients or a department store that had unpredictable pricing when you get to the register that was dependent on how many customers had made purchases that day.
Why do providers choose the pro-rata method for deductions?
Pro-rata deductions are used to ensure that participants with a lower account balance do not get charged a greater percentage of their balance than another participant with a higher account balance.
In terms of fee fairness, pro-rata fees will ensure that all participant fees are reasonable based on their account balance. In terms of fee clarity, a participant will never be able to verify or calculate their pro-rata fee, since they are only aware of their individual account balance and not the balances of other participants.
Although in theory the pro-rata pricing may be the fairest model for participants overall, there is a strong argument to be made for explicit pricing that can be calculated and verified by each participant.
What are the alternatives to the pro-rata method for deductions?
- Deduct a specific asset-based fee percentage from each participant (usually at the beginning of a month or quarter). There is no issue of fee transparency, as the deduction is strictly a set percentage of the participant’s account balance.
- Deduct a fixed-dollar, per-head fee – this dollar fee structure ensures fee transparency for participants, but does not necessarily ensure fee fairness, as participants with lower balances will pay a higher percentage of their account balance in fees than other participants with higher account balances.
- The employer can choose to pay the participant fees – if an employer is willing to cover the participant fees, there would be no issue of calculating or justifying the determination of per participant fees.
As 401(k) fees are being challenged in excessive fee lawsuits, and participants are, rightfully, checking their accounts and verifying their fees, it is prudent to have fees that are fair and transparent.
About RPG Consultants
RPG Consultants is a leading recordkeeper and third party administrator (TPA) for 401(k) and other types of defined contribution plans, with deep actuarial expertise managing defined benefit and cash balance plans. Our goal is to understand your business and your strategic objectives to provide you with a complete, custom-tailored solution. For more information, please contact us at firstname.lastname@example.org or 212-947-4800 ext 227.