PRESENT LAW AND BACKGROUND RELATING TO 

QUALIFIED RETIREMENT PLAN FEES 

Scheduled for a Public Hearing 

Before the 

HOUSE COMMITTEE ON WAYS AND MEANS 

on October 30, 2007 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

 

October 30, 2007 

JCX-103-07
i 

CONTENTS 

 Page

I. OVERVIEW .......................................................................................................................... 1 

II. BACKGROUND ................................................................................................................... 3 

A. Favorable Tax Treatment of Qualified Retirement Plans................................................ 3 

B. Fees Charged in Connection with Qualified Retirement Plans ....................................... 8 

C. Impact of Fees on Retirement Savings .......................................................................... 10 

III. MAGNITUDE OF FEES AND SOURCES OF VARIANCE ............................................ 12 

IV. PRESENT LAW .................................................................................................................. 14 

A. Rules Relating to Retirement Plan Fees......................................................................... 14 

B. Prohibited Transaction Rules......................................................................................... 16 

1. In general ................................................................................................................. 16 

2. Exemptions .............................................................................................................. 17 

V. ISSUES AND ANALYSIS.................................................................................................. 19 
1 

I. OVERVIEW 

The Committee on Ways and Means has scheduled a public hearing for October 30, 

2007, on the appropriateness of fees that are charged to certain types of employer-sponsored 

qualified retirement plans. Specifically, the hearing addresses the fees charged to qualified 

retirement plans that are defined contribution plans. This document,1

 prepared by the staff of the 

Joint Committee on Taxation, provides background and economic data relating to fees charged in 

connection with qualified defined contribution plans,2

 a description of present law rules in the 

Internal Revenue Code (the “Code”)3 that relate to the amount and disclosure of such fees, and a 

discussion of issues and analysis relating to such fees. 

The Code provides for the favorable tax treatment of a variety of retirement savings plans 

sponsored by employers, provided that such plans meet certain qualification requirements. Such 

plans are commonly referred to as “qualified retirement plans.” A defined contribution plan is a 

plan under which each participant’s retirement benefit is equal to the participant’s allocable share 

of the trust that funds the plan. Under a defined contribution plan, each participant’s retirement 

benefit in such a plan is increased by contributions to the trust and earnings on those 

contributions, and is decreased by losses on plan assets and fees paid from plan assets. As of 

December 31, 2006, $9.6 trillion in assets was held in qualified retirement plans. Of this 

amount, $3.2 trillion was held in defined contribution plans maintained by private employers. 

The fees that may be incurred in connection with qualified retirement plans may be 

divided into three broad categories: (1) fees related to plan administration; (2) fees related to 

specific services requested by plan participants; and (3) fees related to the investment of plan 

assets. When these fees are paid from plan assets, the amount available under the plan to pay 

retirement benefits is reduced by the amount of such fees paid. By reducing the net return on 

investments, fees can substantially reduce the accumulated plan assets available at retirement 

under a defined contribution plan. In a recent survey of section 401(k) plans, the average 

reduction in the rate of return due to plan fees was calculated to be 0.75 percent.4

 

 1

 This document may be cited as follows: Joint Committee on Taxation, Present Law and 

Background Relating to Qualified Retirement Plan Fees (JCX-103-07), October 30, 2007. This 

publication is also available on the web at www.house.gov/jct. 

2

 This pamphlet does not discuss the rules and issues relating to fees charged in connection with 

individual retirement accounts or annuities (“IRAs”), regardless of whether the IRA is part of an 

employer-sponsored retirement program. This pamphlet also does not discuss fees charged in connection 

with qualified retirement plans that are defined benefit plans. 

3

 Except as otherwise noted, references to sections and to the Code in this document are 

references to the Internal Revenue Code of 1986, as amended. 

4

 Deloitte Consulting, LLP, International Foundation of Employee Benefit Plans, and 

International Society of Certified Employee Benefit Specialists, Annual 401(k) Benchmarking Survey: 

2005/2006 Edition, Deloitte Development, LLC, 2006. Available at 

http://www.iscebs.org/PDF/srvy401kresults_06.pdf.
2 

The following example demonstrates the effect of this recent study’s findings on 

retirement plan assets available at the time of retirement. Assuming an average before-fee rate of 

return of 8 percent and annual contributions to a section 401(k) plan of $5,000, if there were no 

fees incurred with respect to the annual contributions, the account would grow to $247,115 in 20 

years. For the average reduction in rate of return of 0.75 percent per year that was found in the 

recent study, the account value at the end of 20 years is reduced by $21,181, or 9.37 percent. By 

contrast, if the reduction is 0.25 percent per year, the final amount is reduced by $7,294 (a 

reduction of 3.04 percent). In the case of a fee that reduces the rate of return by 2.0 percent per 

year, the final amount is reduced by $52,151 (a reduction of 26.75 percent). 

Plan fees can vary dramatically across different plans. For example, larger companies 

and larger plans tend to have smaller expense ratios because the fixed costs with respect to plan 

expenses can be spread over more participant account balances and greater amounts of aggregate 

plan assets. The mix of assets impacts overall costs to the plan as some asset classes are more 

costly to manage than others. In addition, some plans may have higher fees because they offer 

additional services, such as financial planning or, in the case of a plan that permits a participant 

to direct the investment of the participant’s account under the plan, the plan may have higher 

expenses associated with offering a variety of platforms to allow for the participant direction 

(e.g., the plan might allow for both telephone call centers and web-based applications). Some 

plans may have higher fees for investment related expenses because such fees also cover 

administrative and recordkeeping functions (sometimes referred to as a bundled fee arrangement 

or bundled services agreement). 

The Code generally does not include specific rules that restrict the amount of fees or 

require specific disclosure of fees incurred by qualified retirement plans. An exception is the 

prohibited transaction rules set forth in the Code. These rules generally permit a plan to pay a 

service provider a reasonable fee. Other non-tax rules may apply to limit the amount of fees that 

may be charged to qualified retirement plans or that may require disclosure of such fees to plan 

sponsors and participants. For example, Federal and State law banking rules, State law insurance 

rules, Federal and State securities laws, and licensing laws applicable to professionals (such as 

attorneys and investment brokers) may apply to a specific service provider or to a particular 

investment alternative offered under a retirement plan. 

The Employee Retirement Income Security Act of 1974 (“ERISA”) contains rules that 

govern fees that can be charged to retirement plans with respect to plan assets. Under ERISA, 

fiduciaries of a retirement plan are required to discharge their duties solely in the interest of the 

participants and beneficiaries and for the exclusive purpose of providing benefits to participants. 

This duty includes defraying plan expenses and ensuring that the expenses are reasonable. Thus, 

ERISA expressly permits the payment of fees in connection with plan administration, but such 

fees must be reasonable. ERISA also contains rules that require the disclosure of plan fees to 

plan participants. 
3 

II. BACKGROUND 

A. Favorable Tax Treatment of Qualified Retirement Plans 

The Code provides for the favorable tax treatment of a variety of retirement savings plans 

that are sponsored by employers, provided that such plans meet certain qualification 

requirements. Such plans are commonly referred to as “qualified retirement plans.” Qualified 

retirement plans include the following types of plans: (1) plans qualified under section 401(a), 

which are commonly referred to as “tax-qualified plans” and which may include qualified cash 

or deferral arrangements (so-called “section 401(k) plans”); (2) plans described in section 403(a), 

which are commonly referred to as “section 403(a) annuities” and which are employee 

retirement annuities that meet certain requirements applicable to tax-qualified plans; (3) section 

403(b) tax-deferred annuities, which may only be sponsored by certain types of tax-exempt 

employers;5

 and (4) section 457(b) plans sponsored by State and local governments, which are 

sometimes offered by a governmental employer in lieu of a section 401(k) plan.6

In general, a qualified retirement plan may be designed as either a defined contribution 

plan or a defined benefit plan. Under a defined contribution plan, the employer or the employee 

(or sometimes both) make contributions to the plan. These contributions, plus earnings on the 

contributions, are credited to an individual account on behalf of each employee who participates 

in the plan. For each employee, the account balance of the employee under the plan at the time 

of retirement represents the employee’s retirement benefit. Therefore, under this type of plan, 

the employee is at risk for the investment performance of the plan because the investment 

performance directly affects the amount of benefits available upon retirement. In addition, any 

reduction in the employee’s account balance, such as fees deducted from the account, directly 

affects the employee’s retirement benefits. A section 401(k) plan is the most common defined 

contribution plan that is sponsored by employers.7 

In contrast, under a defined benefit plan, the employee earns a benefit pursuant to a 

formula in the plan that is typically based on length of service and final pay or average pay. For 

example, a typical formula under a defined benefit plan might provide a benefit at normal 

retirement age in the form of an annual annuity payment that is equal to one percent of the 

 5

 Section 403(b) tax-deferred annuities may be purchased by: (1) an organization that is exempt 

under section 501(a) and is described in section 501(c)(3); (2) certain types of educational organizations 

or an employer which is a State or political subdivision of a State; and (3) by certain ministers and 

churches.

6

 The term qualified retirement plan is also typically used to describe two types of plans that are 

funded by individual retirement accounts established by the participating employee: (1) simplified 

employee pensions described in section 408(k); and (2) simple retirement account plans described in 

section 408(p). 

7

 Investment Company Institute, “401(k) Plan Asset Allocation, Account Balances, and Loan 

Activity in 2005,” Research Perspective, August 2006 (Volume 12, No. 1). Available on the web at 

www.ici.org/pdf per 12.01.pdf. 
4 

employee’s final average pay multiplied by years of service with the employer. Under this type 

of plan, the employer is responsible for ensuring that the plan has sufficient assets to pay an 

employee’s promised benefit. Thus, under a defined benefit plan, the employer is at risk for the 

investment performance of the plan. Fees charged to the assets of such a plan affect the amount 

of the employer required contributions. 

Under the Code, qualified retirement plans are eligible for significant tax subsidies if they 

satisfy certain minimum qualification requirements. One such requirement is that the plan 

generally must be funded. In general, this is satisfied by establishing a trust for the exclusive 

purpose of providing benefits for the participants under the plan.8

 These plans are also subject to 

qualification requirements that limit the amount of the tax subsidy associated with such plans. 

The tax subsidies are designed so that the tax benefits are broadly distributed among a fair cross 

section of the employer’s employees (and not just the most highly compensated employees). 

The Code provides three favorable tax rules with respect to qualified retirement plans. 

First, a participant generally is not currently taxed on compensation that is contributed to the 

plan. Instead, the participant must include any distributions received from the plan in gross 

income. Thus, contributions to a plan are generally made on a pre-tax basis.9

 Absent this special 

treatment, under general tax law principles, contributions to a trust are includible in the 

beneficiary’s income at the time the beneficiary’s interest in the trust becomes nonforfeitable, 

which is typically earlier than the actual distribution of benefits from the trust.10 Second, a 

taxable employer is generally permitted to immediately deduct contributions made to the plan on 

behalf of participant employees.11 The treatment is different in the case of nonqualified 

retirement plans. In such cases, a matching rule applies that delays the employer’s deduction for 

contributions until such contributions are includible in the participant’s gross income.12 Third, 

the trust that funds a qualified retirement plan is treated as a tax-exempt entity, with the result 

that earnings compound in the trust on a tax-deferred basis.13 This produces the benefit of tax-

 8

 Sec. 401(a) (relating to tax-qualified retirement plans) and sec. 457(g)(1) (relating to section 

457(b) plans maintained by State and local governments). Section 403(a) annuities and section 403(b) 

tax-deferred annuities are funded through the purchase of an annuity contract. In the case of section 

403(b) tax-deferred annuities, sections 403(b)(7) and 401(f) permit the funding of the benefit through a 

custodial account provided that the person holding the assets agrees to hold the assets in a manner 

consistent with the requirements of section 401(a) (relating to tax-qualified plans). 

9

 Secs. 402(a), 403(a)(1), 403(b)(1), and 457(a)(1)(A). 

10 Under the economic benefit doctrine, the receipt of property such as stock options or an 

interest in a trust is treated as gross income for the recipient. Commissioner v. Smith, 324 U.S. 177 

(1945); E.T. Sproul v. Commissioner, 16 T.C. 244 (1951), aff’d per curiam, 194 F.2d 541 (1952). 

11 Sec. 404(a)(1), (2), and (3). 

12 Sec. 404(a)(5). 

13 Secs. 403(b)(7)(B), 457(g), and 501(a). 
5 

deferred build-up for the period of deferral, which in some cases may be 20 or 30 years or 

longer. 

The amount of the tax expenditure associated with these favorable tax rules is substantial. 

For the 2007 Federal fiscal year, the Joint Committee on Taxation estimates the total tax 

expenditure for the net exclusion of pension contributions and earnings for employer plans and 

plans covering partners and sole proprietors to be $117.4 billion. The aggregate tax expenditure 

for Federal fiscal years 2007 through 2011 is estimated to be $661.8 billion.14 These figures 

include the tax expenditure relating to both defined benefit plans and defined contribution plans. 

As mentioned above, among the qualification rules that a tax qualified retirement plan 

must satisfy are rules that limit the amount of the tax benefits with respect to each plan 

participant and the plan in general. These rules include limits on the contributions an employer 

can deduct for any one taxable year.15 Section 401(a) limits the amount of annual additions that 

can be made to a participant’s account balance under a defined contribution plan to the lesser of 

100 percent of the participant’s compensation or $45,000 (for 2007).16 Elective salary reduction 

deferrals by a participant in a section 401(k) plan, section 403(b) tax-deferred annuity, or section 

457(b) plan maintained by a State or local government are subject to a separate annual limitation. 

The limitation on the amount of annual elective deferrals is generally $15,500 (for 2007), 

although participants who have attained age 50 may be eligible to make an additional $5,000 (for 

2007) in elective deferrals.17 

Most qualified plans are subject to rules that require a minimum number of an employer’s 

active employees to participate in the plan, and that the plan provide for nondiscriminatory 

benefits (when the benefits of highly compensated employees are compared with the benefits 

provided to nonhighly compensated employees).18 These rules are designed to ensure that the 

tax benefits are broadly distributed among all of an employer’s employees, and are not unduly 

concentrated among the most highly paid employees of an employer. Special additional rules 

also apply to certain types of plans. For example, in addition to the minimum participation and 

nondiscrimination rules described above, many tax-qualified retirement plans are subject to the 

top-heavy rules of section 416, which require that the plan provide certain minimum benefits if 

 14 Joint Committee on Taxation, Estimate of Federal Tax Expenditures for Fiscal Years 2007-

2011, (JCS-3-07), September 24, 2007. This publication is also available on the web at 

www.house.gov/jct. 

15 Sec. 404(a). 

16 Sec. 415(c)(1). Annual additions include employer and employee contributions and the 

employee’s allocable share of any amounts forfeited by other participants. 

17 Secs. 402(g)(1), 414(v), and 457(e)(15). 

18 See, for example, secs. 401(a)(4) (nondiscrimination of contribution and benefits in taxqualified plans), 401(a)(26) (minimum participation rules for tax-qualified defined benefit plans), and 

410(b) (minimum coverage rules applicable to tax-qualified plans). 
6 

the benefits provided under the plan are too heavily concentrated among key employees of the 

employer. 

As of December 31, 2006, $9.6 trillion was held by trusts and other funding vehicles for 

qualified retirement plans. This amount has grown at an annualized rate of 6.1 percent since 

1996, when $5.3 trillion was held for qualified retirement plans. The chart below shows the 

growth in total pension assets over this time period. The table below shows the asset balances of 

various types of pension plans since 1996. While assets in all categories have increased, defined 

contribution plans have grown faster than defined benefit plans. As of December 31, 2006, 

$3.2 trillion was held in defined contribution plans maintained by private employers, compared 

with $2.2 trillion held by defined benefit plans maintained by private employers. 

As of March, 2007, it is estimated that 51 percent of private sector employees in the 

United States participated in an employer sponsored retirement plan. It is estimated that 

43 percent participated in defined contribution plans, while only 20 percent participated in 

defined benefit plans.19 Approximately 76 percent of public sector workers participated in some 

type of employment-based retirement plan in 2004.20 

 19 National Compensation Survey: Employee Benefits in Private Industry in the United States, 

March 2007, U.S. Department of Labor, Bureau of Labor Statistics, Summary 07-05, August 2007. 

Available on the web at www.bls.gov/ncs/ebs/sp/ebsm0006.pdf. 

20 Employee Benefit Research Institute, Facts from EBRI, June 2007 available at 

http://www.ebri.org/pdf/publications/facts/0607fact.pdf. EBRI estimates are from the 2005 March 

Current Population Survey for public sector wage and salary workers aged 21-64. 
7 

Year 1996 1997 1998 1999 2000 2001 2002 2003 200

Private Defined Benefit Plans 1,590.2 1,763.5 1,907.7 2,074.6 1,979.0 1,810.2 1,639.3 1,994.5 2,13Private Defined Contribution Plans (1) 1,634.2 1,949.3 2,236.2 2,519.2 2,488.6 2,238.0 2,037.9 2,525.6 2,78State and Local Government Retirement Funds 1,509.2 1,794.5 2,030.6 2,325.8 2,293.1 2,206.6 1,930.5 2,344.0 2,57Federal Government Retirement Funds (2) 605.8 659.1 716.0 774.0 796.7 859.7 893.8 958.5 1,02 assets in TSP (3) 46.4 60.7 77.3 94.6 97.7 100.6 102.3 128.9 14 Federal net of TSP 559.4 598.4 638.7 679.4 699.0 759.1 791.5 829.6 87Total Pension Assets 5,339.4 6,166.4 6,890.5 7,693.6 7,557.4 7,114.5 6,501.5 7,822.6 8,51source: Board of Governors, Federal Reserve System, Flow of Funds, release September 17, 2007.

(1) Includes 401(k) plans; excludes IRAs and Keoghs(3) Data from audited financial statements of the TSP

Pension Asset Balances

(billions of dollars; amounts outstanding end of period)

(2) Includes Thrift Savings Plan (TSP), National Railroad Retirement Investment Trust, and nonmarketable government securities helretirement funds

Market Value of Assets Held In Pension Plans,

1996-2006

0

1,0002,0003,0004,0005,0006,0007,0008,0009,000

10,000

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 

Year

billions of dollars
8 

B. Fees Charged in Connection with Qualified Retirement Plans 

The fees that may be incurred in connection with qualified retirement plans may be 

divided into three broad categories for fees related to: (1) plan administration; (2) specific 

services requested by plan participants; and (3) the investment of plan assets. When these fees 

are paid from plan assets, the amount available under the plan for retirement benefits is reduced. 

For example, in the case of a section 401(k) plan where fees are paid by plan assets, each 

participant’s account balance in the plan is reduced by the participant’s allocable portion of the 

fees paid by the plan. 

Fees related to plan administration include fees charged by attorneys and consultants for 

plan design (e.g., the expenses associated with the initial establishment of the plan or plan 

amendments required to be adopted by a plan on account of changes in qualification 

requirements of the Code or other laws), compliance with periodic reporting requirements, and 

participant communications (e.g., periodic benefits statements, summary plan descriptions, 

websites, and telephone service assistance). In general, these types of fees may be paid by the 

sponsoring employer or may be paid from plan assets. 

Fees related to specific services requested by plan participants include fees charged in 

connection with loans to participants against the participants’ interests in the plan, or the review 

of a court order to divide a participant’s interest in the plan pursuant to a divorce decree. For a 

defined contribution plan, such fees are often charged against the participant’s account balance. 

Fees related to plan investments are typically paid from plan assets. Such fees include 

any of the expenses associated with buying and selling investment assets, such as broker 

commissions, appraisal fees, attorneys’ fees, and investment management fees. The following is 

a description of the fees typically charged in connection with common investment alternatives 

offered under participant-directed plans,21 such as section 401(k) plans: 

• Mutual funds: The manager of the mutual fund typically charges a management fee 

with respect to the assets of the fund and which are paid out of the assets of the fund. 

In addition, some mutual funds provide for a sales charge which respect to each 

investment in the fund and is either paid upon initial investment (a “front-end load”) 

or upon sale of the investment (a “back-end load”, “deferred sales charge”, or 

“redemption fee”). Some funds charge “rule 12b-1” fees, 22 which are fees paid from 

 21 See A Look at 401(k) Plan Fees, U.S. Department of Labor, Employee Benefits Security 

Administration. Available on the web at www.dol.gov/ebsa/publications/401k_employee.html. 

22 Rule 12b-1 fees take their name from the Securities and Exchange Commission rule that 

permits a fund (such as a mutual fund) to pay such fees. Generally, the rule permits a fund to pay 

distribution fees out of a fund’s assets only if the fund has adopted a plan permitting the payment of such 

fees. Distribution fees include fees paid for marketing and selling fund shares, such as compensating 

brokers and others who sell fund shares, and paying for advertising, and the printing and mailing of sales 

literature. See “Answers with respect to Mutual Fund Fees and Expenses,” Securities and Exchange 

Commission, available on the web at www.sec.gov/answers/mffees.htm. 
9 

the assets of a particular fund to cover broker commissions or promotional expenses. 

If a participant’s account balance is invested in a fund that pays rule 12b-1 fees, then 

such fees effectively reduce the participant’s account balance. In some cases, the rule 

12b-1 fees are used to pay for administrative costs associated with the plan. 

• Variable annuities: An insurance company and an employer sponsoring a qualified 

retirement plan may enter into a group variable annuity contract, under which the 

insurance company offers investment options that may be chosen by plan participants, 

such as mutual funds. The group variable annuity contract is often described as 

“wrapping” around the investment options available under the contract. Some of the 

options may contain an insurance component which might include special fees. In 

addition, the variable annuity contract is subject to surrender and transfer charges if 

the employer terminates the group contract. Sometimes the amount of the surrender 

charge decreases over a specified time period, such that there is no charge (or a 

reduced amount) after the expiration of the time period. 

• Collective investment funds and pooled guaranteed investment contract (GIC) funds: 

Collective investment funds are comprised of the pooled assets of various investors 

(e.g., two or more qualified plans participate in the fund) and are managed by a bank 

or trust company. A pooled GIC fund is issued by an insurance company or bank. A 

GIC is an insurance product that offers a specified rate of return over the life of the 

contract. A pooled GIC fund is a common method of providing a fixed income 

investment alternative to plan participants. Collective investment funds and pooled 

GIC funds involve management and administrative fee charges. 

In general, the fees described above are negotiated by the employer that sponsors the 

plan. However, in some cases, the fees may not be subject to negotiation (e.g., front-end and 

back-end loads charged in connection with mutual funds). In addition, the total amount of fees 

paid and the distinction between the type of fees being paid may not be readily apparent to either 

the plan sponsor or participants. For example, as described above, it is possible that investment 

fees charged to plan assets and classified as investment fees may be used to pay for plan 

administration services, such that there is no separately stated fee (or a reduced fee). This 

particular practice is the subject of recent litigation. The issue in most cases is whether the 

practice complies with the fiduciary requirements that apply to retirement plans.23 

 

 23 See James P. Baker, “How Much Is Too Much? A Primer on the 401(k) ‘Feegate’ Litigation,” 

Benefits Law Journal, Summer 2007. 
10 

C. Impact of Fees on Retirement Savings 

The amount of fees charged against plan assets has a significant impact on the amount of 

plan assets that are available for retirement benefits. The following table illustrates the impact of 

fees on a hypothetical participant in a section 401(k) plan who elects to contribute $5,000 

annually to the plan for each of 20 years, beginning on January 1, 2007. The table illustrates the 

growth of the contributions over 20 years under a variety of earnings and fees assumptions. The 

fee assumptions generally represent the range of fees currently charged with respect to qualified 

retirement plans (this economic data is discussed in the following section). The first panel of the 

table assumes an average before-fee rate of return of 6 percent; the second panel assumes an 

average before-fee rate of return of 8 percent; and the third panel assumes an average before-fee 

rate of return of 10 percent. 

In panel one, which assumes an average before-fee rate of return of 6 percent, if there 

were no fees incurred with respect to the annual $5,000 contributions or the earnings thereon, the 

account would grow to $194,964 in 20 years. In the case of a fee that reduces the rate of return 

by 0.25 percent per year, the account value after 20 years is reduced by $5,607 (a 2.96 percent 

reduction). If the reduction in the rate of return is 2.0 percent per year, the account value is 

reduced by $40,118 (a 25.91 percent reduction). For the average reduction in the rate of return in 

a recent survey of plans (0.75 percent),24 the final account value is reduced by $16,285, or 

slightly over 9 percent. 

In panel two, which assumes an average before-fee rate of return of 8 percent, if there 

were no fees incurred with respect to the annual contributions or the earnings thereon, the 

account would grow to $247,115 in 20 years. In the case of a fee that reduces the rate of return 

by 0.25 percent per year, the account value after 20 years is reduced by $7,294 (a 3.04 percent 

reduction). If the reduction in the rate of return is 2.0 percent per year, the account value is 

reduced by $52,151 (a 26.75 percent reduction). For the average reduction in rate of return of 

0.75 percent per year, the account value is reduced by $21,181, or 9.37 percent. 

Panel three assumes an average before-fee return of 10 percent. If there were no fees 

incurred with respect to the annual contributions or the earnings thereon, the account would grow 

to $315,012 in 20 years. In the case of a fee that reduces the rate of return by 0.25 percent per 

year, this amount is reduced by $9,501 (a 3.11 percent reduction). If the reduction in the rate of 

return is 2.0 percent per year, the amount is reduced by $67,898 (a 27.48 percent reduction). For 

the average reduction in rate of return of 0.75 percent per year, the account value is reduced by 

$27,586, or 9.60 percent. 

As set forth above, a fee structure is more costly to participant account balances as rates 

of return increase. The same percentage point reduction in the rate of return leads to a greater 

loss in account value, both in absolute dollars and in percentages, as the gross rate of return 

increases. This is attributable to the amount used to pay the fees and the loss of earnings at the 

higher rate of return on such amounts.

 24 Deloitte Consulting, LLP, supra.
11 

Fees as a reduction in the annual rate of return 0.00% 0.25% 0.50% 0.75% 1.00% Annual net-of-fee rate of return 6.00% 5.75% 5.50% 5.25% 5.00% Annual contribution $5,000 $5,000 $5,000 $5,000 $5,000 Number of years of contributions until retirement 20 20 20 20 20 Final account value at retirement $194,964 $189,357 $183,930 $178,679 $173,596 Reduction in final account value due to fees $0 $5,607 $11,033 $16,285 $21,367 Percentage reduction in final account value due to fees 0.00% 2.96% 6.00% 9.11% 12.31% Fees as a reduction in the annual rate of return 0.00% 0.25% 0.50% 0.75% 1.00% Annual net-of-fee rate of return 8.00% 7.75% 7.50% 7.25% 7.00% Annual contribution $5,000 $5,000 $5,000 $5,000 $5,000 Number of years of contributions until retirement 20 20 20 20 20 Final account value at retirement $247,115 $239,820 $232,763 $225,934 $219,326 Reduction in final account value due to fees $0 $7,294 $14,352 $21,181 $27,789 Percentage reduction in final account value due to fees 0.00% 3.04% 6.17% 9.37% 12.67% Fees as a reduction in the annual rate of return 0.00% 0.25% 0.50% 0.75% 1.00% Annual net-of-fee rate of return 10.00% 9.75% 9.50% 9.25% 9.00% Annual contribution $5,000 $5,000 $5,000 $5,000 $5,000 Number of years of contributions until retirement 20 20 20 20 20 Final account value at retirement $315,012 $305,511 $296,319 $287,426 $278,823 Reduction in final account value due to fees $0 $9,501 $18,693 $27,586 $36,190 Percentage reduction in final account value due to fees 0.00% 3.11% 6.31% 9.60% 12.98% 

Impact of Fees on Retirement Savings

Annual gross rate of return: 6 percentAnnual gross rate of return: 8 percent

Annual gross rate of return: 10 percent
12 

III. MAGNITUDE OF FEES AND SOURCES OF VARIANCE 

As previously discussed, various components of fees contribute to the overall costs of 

retirement plans. Several studies have been conducted on the amount of retirement plan fees 

paid by retirement plans. A recent benchmarking survey of 830 section 401(k) plan sponsors 

revealed an average expense ratio of 75 basis points (bps) (or 0.75 percent) for fund assets.25 

The expense ratio represents total expenses as a fraction of total plan assets. Thus, 75 bps is 

equivalent to 0.75 percent of plan assets (or $7.50 for every $1,000 of assets invested). Plan fees 

can vary dramatically across certain plans. Larger companies and larger plans tend to have 

smaller expense ratios in part because certain fixed charges can be spread over more participants 

and more plan assets. Expense ratios may also vary because some employers may choose to 

subsidize certain fees that plan participants would otherwise pay.26 Some plans may have higher 

fees because they offer additional services, such as financial planning, which may be bundled 

with the typical investment management and recordkeeping functions. Individual participant 

accounts with high investment turnover may also have higher expenses (e.g., the participant 

frequently redirects the investment composition of the participant’s account balance), leading 

some plans to charge additional fees on frequent traders in an effort to reduce costs on other 

participants. 

According to another survey of defined contribution plans in 2005,27 total expense ratios 

ranged from 6 bps (or 0.06 percent) to 154 bps (or 1.54 percent). Key factors that contribute to 

this variation in plan costs include overall plan size, individual account size, and asset 

composition. Under this survey, large plans benefited from economies of scale, and plans with 

more than $10 billion in assets had costs less than half that of those plans with less than 

$500 million in assets (28 bps (or 0.28 percent) versus 71 bps (or 0.71 percent)). For a given 

overall plan size, a plan with fewer, but larger individual accounts may have lower expenses than 

a plan with many, but smaller accounts, in part due to lower administrative and recordkeeping 

costs since there are less participants in the plan and the spread of such costs over larger account 

balance and aggregate plan asset amounts. For accounts with an average balance below $55,000, 

costs are 4 bps (or 0.04 percent) higher than for accounts over $55,000 (19 bps (or 0.19 percent) 

versus 15 bps (or 0.15 percent) that the latter incurs). 

The mix of investment assets impacts overall plan costs as some investment options or 

classes of assets are more costly to manage than others. Guaranteed investment contracts 

(GICs), insurance products that offer a specified rate of return over the life of the contract, are 

 25 Deloitte Consulting, LLP, supra. 

26 Investment Company Institute, The Economics of Providing 401(k) Plans: Services, Fees, and 

Expenses, 2006, Research Fundamentals, 16:4, September 2007. Available at 

http://www.ici.org/home/fm-v16n4.pdf. 

27 Hubert Lum, Why Do Plan Costs Vary? CEM Benchmarking, Inc., Defined Contribution 

Insights, March/April 2007. Available at 

http://www.cembenchmarking.com/research/Articles/WhyDoPlanCostsVary.pdf. 
13 

among the least expensive of assets to manage at 26 bps (or 0.26 percent) average total cost. 

Increasing in costs are broad-based bond portfolios (46 bps or 0.46 percent), domestic large 

capitalization stocks (57 bps or 0.57 percent) and domestic small capitalization stocks (74 bps or 

0.74 percent). The most expensive asset class to manage is the class of alternative investments 

(106 bps or 1.06 percent), which includes real estate, private equity, and hedge funds. Within 

each class, costs can vary based on the vehicle which provides the participant access to that 

investment. For example, a retail large capitalization stock mutual fund may have a higher cost 

than institutional class shares of the same large capitalization stock mutual fund. On average, the 

cost difference between retail and institutional class shares of mutual funds is 11 bps (or 0.11 

percent). Also, within asset classes, the level of active versus passive management can influence 

costs. A manager who actively trades stock in an effort to beat a market index may incur greater 

costs than a passive manager trying to replicate the return of that same market index. Based on 

2005 data, this cost differential is 34 bps (0.34 percent) for a plan with all of its assets actively 

managed versus a similar plan with all of its assets passively managed. 
14 

IV. PRESENT LAW 

A. Rules Relating to Retirement Plan Fees 

The Code generally does not include rules that restrict the amount of fees that can be paid 

by a retirement plan or require the disclosure of fees incurred by these plans. The exception to 

this rule is the prohibited transaction rules, which restrict transactions involving the assets of 

certain retirement plans and related parties (referred to as “disqualified persons”), such as service 

providers to a plan. 

Other non-tax rules may apply to limit the amount of fees that may be charged to these 

plans or require disclosure of such fees to plan sponsors and participants. For example, Federal 

and State laws that govern banking rules, State law insurance rules, Federal and State securities 

rules, and licensing rules applicable to professionals (such as attorneys and investment brokers or 

agents) may apply to certain plan service providers, depending on the services or investment 

alternatives offered. The Employee Retirement Income Security Act of 1974 (“ERISA”) 

contains rules that govern the fees that can be charged with respect to retirement plans.28 

For example, under ERISA, fiduciaries of a retirement plan are required to discharge 

their duties solely in the interest of the plan’s participants and beneficiaries and for the exclusive 

purpose of providing benefits to participants and defraying the “reasonable expenses of 

administering the plan.”29 Thus, ERISA expressly permits the payment of reasonable fees in 

connection with plan administration, but requires that the fees be reasonable. 

ERISA also contains rules that require the disclosure of plan fees to plan participants. 

For example, ERISA requires the administrator of a defined contribution plan to provide 

participants with an annual summary of certain information relating to the plan (referred to as the 

“summary annual report”).30 Under regulations issued by the Department of Labor, the summary 

annual report must include the disclosure of the aggregate amount of administrative expenses 

paid by a plan for the year.31 The administrators of both defined contribution and defined benefit 

retirement plans must periodically provide summary plan descriptions to plan participants 

 28 Not all qualified retirement plans are subject to the fiduciary and disclosure rules of ERISA. 

For example, governmental retirement plans are exempt. ERISA sec. 4(b)(1). 

29 ERISA sec. 404(a)(1)(A). Certain qualification rules under the Code provide for a somewhat 

similar rule as the ERISA rule in that the trust holding the plan’s assets must be established for the 

exclusive purpose of providing plan benefits. See, for example, sec. 401(a). The Code-based rules do not 

expressly describe the payment of fees, although the payment of reasonable expenses and fees paid with 

plan assets for the administration of the plan is not a violation of the Code-based rules. It is possible, in 

certain circumstances, that the payment of an unreasonable fee might violate the exclusive benefit rule. 

30 ERISA sec. 104(b)(3). 

31 29 CFR sec. 2520.104b-10(d)(3). 
15 

(referred to as “SPDs”). SPDs are required to provide a description of any fees the payment of 

which is a condition for the receipt of plan benefits.32 

In addition, participants in certain defined contribution plans may receive information 

regarding fees charged in connection with the investment of plan assets. This results because 

ERISA provides relief from certain fiduciary requirements in the case of a plan that provides for 

participant-directed investment of plan assets, provided certain requirements specified by the 

Secretary of Labor are satisfied.33 Among these requirements are the following disclosures with 

respect to investment fees: (1) disclosure of any transaction fees and expenses which affect the 

participant’s account balance in connection with purchases or sales of interests in the investment 

alternatives available under the plan, and (2) a description of the annual operating expenses of 

each designated investment alternative (e.g., investment management fees, administrative fees, 

transaction costs) which reduce the rate of return to plan participants and the aggregate amount 

of such expenses expressed as a percentage of average net assets of the designated investment 

alternative.34

ERISA is generally administered by the Department of Labor (“DOL”). The DOL is 

currently considering the issuance of additional guidance with respect to retirement plan fees. 

For example, the DOL has proposed changes to the annual report required to be filed by 

retirement plans (on Form 5500) with respect to fee reporting.35 In addition, the DOL has 

announced that it is reviewing the rules under ERISA applicable to the disclosure of plan 

administration and investment fees to participants in participant-directed defined contribution 

retirement plans. The DOL has requested comments from interested parties.36 The purpose of 

the review is to determine to what extent rules should be adopted or modified (or what other 

actions should be taken) to ensure that participants have the information necessary to make 

informed decisions with respect to investment of their retirement savings. The comment period 

closed July 24, 2007. 

 32 29 CFR sec. 2520.102-3(l). 

33 ERISA sec. 404(c).

34 29 CFR sec. 2550.404c-1(b)(2)(i)(B)(1)(v) and -1(b)(2)(i)(B)(2)(i). 

35 71 Fed. Reg. 41,392 (July 21, 2006). 

36 72 Fed. Reg. 20,457 (April 25, 2007). 
16 

B. Prohibited Transaction Rules 

1. In general 

The Code’s prohibited transaction rules preclude a “disqualified person” from entering 

into a “prohibited transaction” with respect to a plan that is subject to the Code’s prohibited 

transaction rules.37 A disqualified person includes a service provider for a plan, a fiduciary of a 

plan, and certain persons and entities that are related to service providers and fiduciaries.38 A 

fiduciary of a plan is a person who (1) exercises any discretionary authority or control with 

respect to the management of the plan or the management or disposition of plan assets, 

(2) renders investment advice for a fee, direct or indirect, with respect to property of the plan or 

has authority or responsibility to do so, or (3) has any discretionary authority or responsibility in 

the administration of the plan.39 Tax-qualified plans (i.e., plans that meet the requirements of 

section 401(a)) and section 403(a) employee retirement annuities are subject to the Code’s 

prohibited transaction rules.40 

The following types of transactions, whether direct or indirect, constitute prohibited 

transactions for purposes of the Code: 

• Any sale, exchange, or leasing of any property between a plan and a disqualified 

person; 

• Lending of money or extending credit by a plan to a disqualified person; 

• Furnishing goods, services, or facilities by a plan to a disqualified person or by a 

disqualified person to a plan; and 

 37 Sec. 4975. Plans sponsored by certain types of employers, such as a governmental plan, are 

not subject to the Code’s prohibited transaction rules. See sec. 4975(g). ERISA contains prohibited 

transaction rules that are generally parallel to the rules provided in the Code. See ERISA secs. 406 and 

408. 

38 Sec. 4975(e)(2). 

39 Sec. 4975(e)(3). 

40 Sec. 4975(e)(1). A tax-qualified retirement plan and a section 403(a) employee retirement 

annuity may also be subject to ERISA’s prohibited transaction rules. In addition, the ERISA rules may 

apply to plans that are not subject to the Code’s prohibited transaction rules. For example, a 

section 403(b) tax-deferred annuity plan is not subject to the Code’s prohibited transaction rules, but may 

be subject to ERISA’s prohibited transaction rules. If a plan is subject to both the Code and ERISA 

prohibited transaction rules, the civil penalty specified in ERISA in the case of a violation of the rules is 

reduced by the amount of the excise taxes prescribed by the Code for such violation. ERISA 

sec. 502(l)(4). 
17 

• Any transfer to, or use by or for the benefit of, a disqualified person, of any assets of 

a plan.41

In addition to the foregoing prohibited transactions, the Code’s prohibited transaction 

rules also limit the following transactions involving a plan fiduciary: 

• Any act whereby the fiduciary deals with the income or assets of a plan in the 

fiduciary’s own interest or for the fiduciary’s own account; and 

• Receipt of any consideration by the fiduciary for the fiduciary’s own personal account 

from any party dealing with the plan in connection with a transaction involving the 

income or assets of the plan.42

A two-tier tax is imposed under the Code on the disqualified person if a prohibited 

transaction occurs.43 The initial tax applies during the correction period and is equal to 

15 percent of the amount involved with respect to the prohibited transaction for each year or 

partial year in the “taxable period.” The taxable period begins on the date that the prohibited 

transaction occurs and generally ends on the earlier of (1) the date the transaction is corrected or 

(2) the date notice of a deficiency with respect to the initial tax is mailed (or, if earlier, the date 

of assessment of such tax). If the prohibited transaction is not corrected within the taxable 

period, a second tax applies equal to 100 percent of the amount involved. Both taxes are paid by 

the disqualified person. 

2. Exemptions 

The Code provides for statutory exceptions from the prohibited transaction rules.44 In 

addition, the Secretary of the Treasury and the Secretary of Labor are delegated authority to 

establish an exemption procedure for disqualified persons, or an exemption for transactions, if 

the exemption is (1) administratively feasible, (2) in the interests of the plan, its participants and 

beneficiaries, and (3) protective of the rights of participants and beneficiaries of the plan.45 

These administrative exceptions take two forms: class exemptions, which are applicable to a 

class of disqualified persons or a class of transactions that meet the requirements specified in the 

terms of the class exemption; and individual exemptions, which are applicable solely to the 

transaction or disqualified person for which the exemption is issued. Administrative exemptions 

are subject to notice and comment (by publication of a proposed exemption in the Federal 

Register) prior to being granted. 

 41 Sec. 4975(c)(1)(A) through (D). 

42 Sec. 4975(c)(1)(E) and (F). 

43 Sec. 4975(a) and (b). 

44 Sec. 4975(d). 

45 Sec. 4975(c)(2). 
18 

Several exceptions to the prohibited transaction rules involve the provision of 

administrative or investment services by a disqualified person and are conditioned on the amount 

of fee that is charged by the service provider. For example: 

• A plan is permitted to contract or make reasonable arrangements with a disqualified 

person for office space, or legal, accounting, or other services necessary for the 

establishment or operation of the plan, if no more than reasonable compensation is 

paid.46 Treasury regulations also provide that this exception applies to any service 

that is appropriate and helpful to the plan in carrying out the purposes for which the 

plan is established or maintained.47 This exception does not apply to the prohibitions 

against fiduciary conflicts of interest (i.e., a fiduciary that deals with plan assets in his 

own interest or who receives consideration for his own personal account in 

connection with a plan transaction);48

• A bank (or other similar institution that is supervised by the United States or a State) 

may provide ancillary services to a plan subject to certain conditions, which include 

guidelines that prevent the bank from providing the services in an excessive or 

unreasonable manner and in a way inconsistent with the best interests of the plan’s 

participants and beneficiaries. In addition, the plan must pay no more than reasonable 

compensation for the ancillary services;49 and 

• A plan fiduciary who is also an investment adviser to an open-end investment 

company is permitted to purchase or sell shares in the investment company on behalf 

of the plan if the plan does not pay a commission or an investment management fee 

with respect to the plan assets invested.50 

 46 Sec. 4975(d)(2). 

47 Treas. Reg. sec. 54.4975-6(a)(2). 

48 Treas. Reg. sec. 54.4975-6(a)(1). The prohibited transaction rules of ERISA specify that a 

plan fiduciary may receive reasonable compensation for services rendered, or for the reimbursement of 

expenses properly and actually incurred, in the performance of his or her services for the plan. ERISA 

sec. 408(c)(2). 

49 Sec. 4975(d)(6). 

50 PTE 77-4, 42 Fed. Reg. 18732 (April 8, 1977). 
19 

V. ISSUES AND ANALYSIS 

The amount of fees that are charged against qualified retirement plan assets has a 

significant impact on the amount of retirement benefits that can be provided by remaining plan 

assets. In the case of a defined contribution plan, the amount of fees charged directly reduces the 

amount that is available to a participant at retirement. The impact of fees on retirement savings 

and the degree to which plan sponsors and plan participants understand the fees being charged 

are topics of recent interest.51 

Some question whether the regulation of fees charged with respect to retirement plans is 

an appropriate issue for regulation under the Code. Such commentators note that, in general, 

fiduciary and disclosure issues with respect to retirement plans are addressed by the non-tax 

provisions of ERISA. Others respond that Code-based regulation is appropriate given the 

significant tax expenditure associated with qualified retirement plans. Such individuals observe 

that the amount of the subsidy for qualified retirement plans is limited and thus Code-based 

regulation is appropriate because maximization of the subsidy is at issue. Some note that the 

existing prohibited transaction rules are largely duplicated in the tax and non-tax provisions of 

ERISA, and thus a form of Code-based fee regulation already exists. 

A second issue that arises is over the type of fees that should be regulated and the scope 

of the regulation. Some assert that there is less need for regulation of administrative type fees 

and more need for regulation of fees relating to investment services. Such proponents argue that 

administrative fees are often more easily understood by plan sponsors and are more clearly 

disclosed by plan service providers. Others assert that all types of plan fees should be subject to 

more stringent regulation because it may be difficult to determine the amount of fees that relate 

to administrative services and those that relate to investment services. For example, in the case 

of a bundled services or fee arrangement, certain investment fees may be used to pay for plan 

administration expenses. Such individuals point to recently filed lawsuits that assert that such 

bundled arrangements violate ERISA’s fiduciary rules.52 

A third set of issues arises as to whether additional regulation should be limited to special 

disclosure rules with respect to fees, or whether there should be additional regulation as to the 

amount of fees that are charged. With respect to disclosure, some advocate for uniform fee 

disclosure rules that allow plan sponsors and participants to easily compare information 

regarding various types of fees on the basis of uniform disclosure rules applicable to plan service 

providers or plan investment alternatives. Others are concerned that such rules will result in 

significant increases in plan administration costs or may overwhelm participants with too much 

information focused on one of the many factors relevant in selecting an investment alternative. 

With respect to limits on the amount of fees, some argue that plans should be required to offer 

participants one or more low-fee investment alternatives. 

 51 See, for example, Murray Coleman, “Battle Lines Drawn on 401(k) Fee Reports, “ Wall Street 

Journal, October 4, 2007. 

52 Baker, supra. 
20 

A fourth set of issues arises as to who should be the beneficiary of fee regulation and 

what types of plans should be subject to regulation. Some believe that only defined contribution 

plans should be subject to additional rules, while others believe that additional regulation should 

only apply to defined contribution plans in which the investments are directed by plan 

participants. Others assert that protections with respect to plan fees are necessary at the plan 

sponsor level,53 and that protections should be extended to defined benefit plans. Such persons 

observe that plan sponsors do not necessarily have the expertise that enables them to understand 

the fee structure involved. Such persons also note that, in the case of participant-directed defined 

contribution plans, the plan sponsor typically chooses a limited menu of investment options that 

are available to participants and thus should benefit from the same protections available to plan 

participants. Some assert that sponsor-level protection is only appropriate in the case of small 

employers. Others counter that a sponsor’s size is not necessarily indicative of expertise with 

respect to plan administration and investment matters. 

Concern has also been expressed on the amount of emphasis that should be placed on 

qualified retirement plan fees. Such persons observe that the extent and quality of services 

provided are often proportional to the amount of fees charged. Such persons caution that the 

amount of fees charged are just one component in evaluating the quality and level of services 

that are provided. 

 53 See, for example, Gregory W. Kasten, “High Transaction Costs from Portfolio Turnover 

Negatively Affect 401(k) Participants and Increase Plan Sponsor Fiduciary Liability,” Journal of Pension 

Benefits, Spring, 2007.