There has been a lot of buzz lately around the new fee disclosure rules for retirement plans. The past few months likely have been busy for plan sponsors, plan recordkeepers and investment advisors as they scrambled to meet the August 30 fee disclosure deadline, which required plan sponsors to provide a full written disclosure statement detailing fees and industry benchmarks to plan participants. After receiving these statements many of you might be wondering—what does this mean? Basically, it means that the 401(k) world is changing and here’s how.
Until recently, many people probably didn’t know that they paid fees to participate in their 401(k) plan. More importantly, they probably didn’t realize how much fees could impact their financial security during retirement. According to a recent study by the nonprofit group AARP, 71% of plan participants believed that they didn’t pay any fees for their 401(k) plan.1 This isn’t surprising. Historically plan fees typically weren’t reported on retirement account statements, which usually report post-fee investment returns. The new rules are meant to change all of that; their fundamental purpose is to provide greater transparency around fee structures so as to ensure that investors understand what they’re paying for when they choose to invest in their company’s retirement plan. It is a significant step forward, especially since most employees depend on a 401(k) or other defined contribution plan as their sole source of retirement income.
New Fee Disclosures
Even plan participants who are aware that they pay fees may have a very difficult time understanding exactly how much they pay. Calculating total or “All-in” fees associated with a retirement plan can be complex because several companies may be involved in maintaining a plan, resulting in layers of fees that may be paid by the employer and/or the plan participants. Fees are typically generated by a standard set of services- plan administration (daily operational services), investment management and individual services (e.g. loans). The chart below provides an overview of “All-in” fees:
Source: Investment Company Institute2
The new fee disclosure rules, the first effective July 1, 2012, were instituted by the Department of Labor (“DOL”) after working on the issue of fee disclosures for over two years. The new rules aim to combat the complexity associated with plan fees through a strategic disclosure structure made up of multiple parts. Under the first new rule, plan service providers (recordkeepers, investment advisors, consultants, etc.) are required to clearly disclose the fees they charge, directly or indirectly, related to their services.3 Under the second new rule, plan sponsors are required to make at least two disclosures to participants- an annual disclosure and a quarterly disclosure- that detail the fees associated with the plan, including the amounts individual participants pay.4
The backbone supporting these disclosures is the fiduciary obligation of employers who sponsor 401(k) plans. These plan sponsors’ fiduciary obligations include:
- Establishing a prudent process for selecting investment alternatives and service providers;
- Ensuring that fees paid to service providers and other expenses of the plan are reasonable in light of the amount and quality of services provided;
- Select investment alternatives that are prudent and adequately diversified; and
- Monitor investment alternatives and service providers once selected to see that they continue to be appropriate choices.5
One goal of the new rules is to assist plan sponsors in meeting their fiduciary obligations. As a plan sponsor receives fee disclosures from plan service providers, the plan sponsor will clearly see the costs for services associated with the plan and, as a result, should be encouraged to compare those costs to the costs of similar services available in the market. In turn, such shopping around may make fees more competitive and reduce the overall cost to plan participants.6
In the spring of 2009, the Investment Company Institute (“ICI”) conducted a study assessing the all-in fees of 401(k) plans.7 The resulting report shed light on the mechanics, components, and drivers of a plan’s fee structure. Generally, total plan assets appeared to be the most significant driver of fees.8 The following chart from the study illustrates the all-in fee range of the 10th and 90th percentile of retirement plans based on the plan’s total managed assets:
Although the report was released prior to the DOL’s formal deliberations on the new disclosure rules, a prudent first step for plan sponsors might be to review the disclosures received from their plan service providers under the new rule, calculate their current All-in fees and compare them against this chart. If a plan’s All-in fee doesn’t fall within the average range for its asset size as demonstrated in the chart, it might be a preliminary indicator that the fee structure of the plan requires closer examination, and that shopping for more cost-efficient service providers may be in order.
Disclosures to Employees
Under the second new rule, plan sponsors are required to disclose fee and other plan information to their participants, but instead of simply handing along the disclosures provided by plan service providers, sponsors will be required to disclose information that is more meaningful on a participant level, some of which will require the sponsor to calculate fees on a participant by participant basis.9
Such disclosures include but are not limited to:
- An explanation of any fees for general plan administrative expenses, including the dollar amount of such fees and expenses charged directly to a participant’s account, and the dollar amount of any other fees and expenses that were charged against a participant’s account;
- A list of the plan’s designated investment alternatives and any brokerage windows available under the plan;
- Certain performance data for the plan’s designated investment alternatives, including fee and operating expense data; and
- Additional information as more fully described in the rule.10
Ultimately plan sponsors are responsible for the accuracy and completeness of the fee disclosures they provide, and changes in plan fees must be communicated to participants at least 30 days for the effective date of such change.11 These disclosures generally must be sent to participants as soon as they become eligible to participate in the plan, and then depending on the particular disclosure, either quarterly or annually thereafter.12
Sponsors that have already provided these disclosures may be fielding a barrage of questions from their employees. Yet according to a survey conducted by Sharebuilder 401k, sixty-three percent of companies surveyed said they were not prepared to answer employees’ questions about 401(k) fees.13
As contemplated by the DOL in implementing the new rules, plan participants need to understand the fees associated with their account in order to make informed decisions regarding their retirement investments.14 As such, sponsors will have to work hard to educate participants about the costs and benefits of participating in the plan and investing in its various offerings. Take the following example:
Say a participant’s current 401(k) account balance is $25,000 and the participant has 35 years to invest before retirement. If returns over the next 35 years average 7% and the fee rate is 0.5%, the account balance will grow to $227,000 at retirement, even with no further contributions. However, if the fees and expenses that were charged against the account were 1.5%, the account balance would only grow to $163,000. That is 28% less than the returns associated with lower fee rate. Clearly, knowing both what the fees are and who is paying them (the participant or the sponsor) is important when planning for retirement.
Although fees and expenses are only one of several factors participants should consider in making their investment decisions, companies need to be prepared to assist their participants in understanding their retirement plans, and fee disclosures are certainly a place to start. Further, the receipt of such fee information will likely encourage participants to ask deeper questions about their plan, and companies should be able to address a full range of participant concerns.
It’s pretty clear that the new fee disclosure rules change things for everyone in the retirement plan world, especially sponsors. With an objective partner and the right tools, performing an assessment of a sponsor’s 401(k) can be fairly straightforward. The assessment should include an examination of the plan’s underlying costs, investment options, provider services, participation rates, and a comparison of these elements to similar plans within marketplace. The results should be compiled into a succinct report to give the sponsor the confidence to explain all of the plan’s components, especially concerning how fees affect the plan and its participants.
By undergoing an assessment, a sponsor can proactively present the information to participants as opposed to being caught in a defensive position. In addition to the fee analysis, the results of the assessment may also provide key indicators of a plan’s performance and highlight any possible deficiencies within its design. A sponsor might have the ability to leverage the information to make meaningful plan changes—changes that can benefit both the company and its employees.
For a more in-depth review, we offer all retirement plan clients, as well as all individual clients who are fiduciaries for their company plan, an “All-in” fee analysis of their current plan against the ICI study represented above, as well as an assessment of the individual investment options currently in their plan.