Direct and Indirect Compensation: Understand the Full Cost Structure

For retirement plan sponsors, fee oversight rarely ends with the number on an invoice. Some plan costs are billed directly and plainly. Others are embedded in investment expenses, routed through fund companies, or paid to service providers through revenue-sharing arrangements that can be harder to spot — and even harder to benchmark.

That distinction matters.

Understanding the difference between direct and indirect compensation is essential to assessing whether plan fees are reasonable, whether participants are being charged fairly, and whether provider arrangements create conflicts that need to be addressed. In a marketplace that continues to move toward fee transparency, sponsors that rely only on headline pricing may miss the real economics of the plan.

Start with what you can see …

Direct compensation is the conspicuous side of the ledger. These fees are paid explicitly to a provider and generally disclosed in a straightforward manner.

Common examples include:

• A flat annual recordkeeping fee invoiced to the plan sponsor;
• A per-participant charge deducted from participant accounts;
• An advisory fee paid pursuant to a written agreement; and
• A TPA fee billed for compliance or administration services.

Because direct compensation is visible, it is generally easier for sponsors to evaluate, compare, and monitor. If a recordkeeper charges a stated per-participant fee, for example, fiduciaries can more readily benchmark that amount against competing providers and determine whether the pricing aligns with the services delivered.

… Then uncover what you can’t see

Indirect compensation is different. It refers to payments a service provider receives from a source other than the plan or plan sponsor in connection with services to the plan. In defined contribution plans, the most familiar example is revenue sharing.

In a revenue-sharing arrangement, an investment manager or fund company pays a portion of its fee to the recordkeeper or another provider, often in exchange for access to the plan’s investment platform or for administrative support. These payments may be built into the investment’s expense structure rather than separately billed to the plan.

Typical fee types include:

• 12b-1 fees, which are distribution fees embedded in mutual fund expense ratios;
• Sub-transfer agency fees, paid by fund companies to recordkeepers for maintaining participant-level records; and
• Revenue-sharing agreements, negotiated payments from investment managers to recordkeepers, which are often stated in basis points.

This is where sponsors can get tripped up. A plan’s direct recordkeeping fee may appear modest on paper, while the provider is also receiving substantial compensation through the investment menu. Without fully accounting, the plan’s total cost can be understated.

Why fiduciaries need to look past the headline fee

Indirect compensation is not inherently problematic. But it does create fiduciary challenges that demand closer attention.

What good oversight looks like

For plan committees, the appropriate response may not be simply to reject all indirect compensation. It is to understand it, quantify it, and determine whether the arrangement remains prudent.

A strong fiduciary process typically includes several steps:

1. Review all sources of compensation. Sponsors should obtain and examine 408(b)(2) disclosures from every covered service provider. The goal is not just to collect the disclosures, but to understand them — especially all sources of direct and indirect compensation.
2. Calculate total provider pay. The key number is total compensation, not just the amount separately invoiced. Adding together direct fees and all indirect payments provides a more accurate picture of what the provider relationship actually costs.
3. Consider recapturing excess revenue sharing. Where revenue sharing exceeds the amount needed to pay reasonable plan expenses, some sponsors use an ERISA budget account or similar mechanism to recapture those amounts and allocate them back to participant accounts or apply them to plan costs. That can help improve fee equity and reduce unnecessary expense drag.
4. Evaluate fee-levelization strategies. Some sponsors adopt fee-levelization strategies, so that all participants pay the same recordkeeping fee regardless of which investments they use. This can help reduce the uneven cost allocation that revenue sharing sometimes produces.
5. Consider a more explicit pricing approach. The industry has steadily trended toward transparent, direct fee arrangements — often a flat or per-participant recordkeeping fee with little or no revenue sharing. For many sponsors, that model helps simplify benchmarking, reduce conflicts, and makes participant cost allocation easier to explain.

Disclosure is the baseline not the finish line

The Department of Labor’s 408(b)(2) regulation, in effect since 2012, requires covered service providers to disclose direct and indirect compensation to plan fiduciaries. That was an important transparency step. But disclosure alone does not satisfy a fiduciary’s obligation.

Sponsors must actively review the information, understand what it means, and incorporate it into their oversight process. A disclosure that sits unread in a committee binder does little to protect participants — and fiduciaries.

Final thoughts

For plan sponsors, the real question is not whether compensation is direct or indirect. It is whether the committee understands the arrangement well enough to assess its reasonableness, benchmark it accurately, and explain how plan costs are allocated.

Direct compensation is easier to see. Indirect compensation requires more scrutiny. Revenue sharing, in particular, may lower the apparent price of recordkeeping while increasing complexity around fairness, conflicts, and total cost.

In today’s fee environment, sponsors that look beyond the invoice and insist on understanding the full compensation picture potentially will be in a stronger position to make prudent decisions and run a better-governed plan.

Funds are sold by prospectus. The prospectus contains information about the investment objectives, risks, charges, and expenses plus other information about the investment company, and can be obtained from the fund company.

If you need help, contact the experts at Henssler Financial:

• Experts Request Form
• Email: experts@henssler.com
• Phone: 770-429-9166