Change in Investment Fee Reporting Was Overdue
by Ken Eaton
Any move toward additional transparency will ultimately benefit the investor.
As with any product or service, there is a cost associated with the administration and investment of 401(k) and 403(b) plan assets, and those who provide such services are entitled to a fair profit. Until recently, however, it was nearly impossible for a 401(k) or 403(b) plan sponsor or participant to determine how much he was paying for retirement plan administration.
There was no requirement for disclosure of the complex revenue-sharing deals made between the service provider and the investment managers, or any other compensation arrangements, for that matter. To address that issue, the Department of Labor issued regulations 408(b)(2) and 404(a)(5).
Taken together, the regulations mandate a new level of transparency in retirement plan fees and investment options. Regulation 408(b)(2), which took effect on July 1, requires all plan vendors to disclose all direct and indirect fees that they receive as payment for their services. Regulation 404(a)(5), which takes effect on Aug. 30, requires plan sponsors to give plan participants detailed information about the plan, its investment options, and its fees, before they enroll in the plan and annually thereafter. Additionally, their quarterly statements must contain a breakdown of the fees that were actually charged to their accounts over the past quarter.
In an industry built on opaque compensation structures, any attempt at greater transparency is a step in the right direction. Plan sponsors should now be able to compare and contrast the true costs of their plans, the drain of those costs on the performance of related investments, and the potential conflicts of interest associated with indirect fees that the vendor receives.
Similarly, with more information, plan participants should be able to take greater control of their own accounts and make more sound investment decisions. Additionally, the disclosure of fees to both sponsors and participants is likely to spur competition in the industry, resulting in lower overall costs and higher quality.
Of course, there are costs associated with these benefits, especially for plan sponsors, most of whom are small business owners. Most important, regulation 408(b)(2) specifically requires plan sponsors to assess the reasonableness of their plan’s fees, going so far as to call it a fiduciary duty. Unfortunately, the Department of Labor did not establish requirements, or even guidelines, for plan vendors regarding how to disclose their fees.
Therefore, disclosure statements could be 20 pages long and require a degree in advanced mathematics to decipher, yet still meet the requirements of the regulation. Additionally, to assess reasonableness, one would have to compare the costs of the current plan to those of other plans. Already, some firms are advertising professional assessment services, anticipating that many small employers would prefer to outsource this responsibility.
On the other hand, Labor officials are very specific about the format of the information that plan sponsors must supply to participants. For instance, investment expenses must be expressed as both a percentage and a dollar amount per thousand, statements must include the actual dollar amount of plan-related expenses actually charged to individual accounts, and all investment options must be presented in a chart designed for easy comparison to each other and to index benchmarks.
Plan sponsors are allowed to rely on their plan providers to compile this information, but they are also required to ensure that their plans are compliant with the new rules.
With fees now front and center on a participant’s account statement, plan sponsors should brace themselves for questions. If fees are charged on a per-account basis, someone with a small account balance may want to know why his charge is the same as that for someone with a larger balance. Conversely, if fees are charged on a percentage basis, the person with larger account may want to know why her account is shouldering so much of the administrative fee load. Some people may just be surprised at the true cost of their plans.
As the plan sponsor, it will be your job to help your employees understand that the benefits of saving in a retirement plan, including tax-deferral, employer contributions, and, ultimately, self-sufficiency, still far outweigh the costs.
Ken Eaton is a principal for Stepp & Rothwell, a wealth-management firm based in Overland Park, Kan.
P | 913.236.2000
E | keaton@steppandrothwell.com