Fee disclosure requirements for employer-sponsored 401(k) and other defined contribution retirement plans are a good idea, some financial and plan advisers here say, but they add that the disclosure statements sent to millions of plan participants aren't written in plain English like they're supposed to be.
The U.S. Department of Labor's participant disclosure regulation that went into effect last year requires employers who sponsor 401(k) and other defined contribution plans to disclose previously hidden plan fees to plan participants and eligible employees on an annual basis.
Mark Powers, president of NAS Pension Consulting Inc., of Spokane, says the likelihood of reader confusion is an inadvertent design flaw in the disclosure requirement.
Service providers are required to disclose the information "in a way the Department of Labor says to do it," Powers says. That undermines the department's intent for employers to provide "plain English" fee information to employees, he asserts.
"I'd like to say somebody could have picked a notice that I wrote and that it actually would have meant something," he says. He adds, however, that in a lot of cases, disclosure notices are practically unreadable.
At best, disclosures have six to eight pages of fairly fine print, Powers says, but he adds, "We've got disclosures with 40 to 50 pages. You can't read through that."
As baffling as the disclosure documents might be to 401(k) participants, it's up to the employer to understand and decide whether to act on the information the disclosures provide, he says.
Separately from the disclosure requirement, the Labor Department requires that employers ensure that fees paid for the plans they sponsor are reasonable.
Though the fee percentage—often around 1 percent of plan assets—might look like a small number, the stakes are high, according to the Labor Department.
The department's website shows a comparison of hypothetical identical investments in a pair of 401(k) plans in which a plan with just 1 percentage point higher fees would erode the account balance by 28 percent more over 35 years than the lower-fee plan, assuming an average annual return of 7 percent.
Despite such stakes, a 2011 AARP survey found that 70 percent of 401(k) plan participants thought they didn't pay any fees in their plans.
Chris Codd, a Spokane-based 401(k) adviser with Mercer Health & Benefits LLC, says he's seeing more reaction to the disclosures from employers sponsoring plans than from their employees who participate in the plan.
"Employers are starting to look at fees, understand who's receiving the fees, and evaluate the services provided," Codd says. "The employer needs to know how much the service provider is getting paid to service the plan."
Employers can ask the plan adviser to go to market and do fee checking or do it themselves, he says, adding, "We've seen that pick up."
Revenue for the record keeper and adviser increases as assets climb, Codd says. "Then the employer probably is in a position to negotiate fees down."
The record keeper tracks employee and employer contribution rates, investment selection, balances, and loan activity in the plan. Depending on the plan, record keeping services are usually provided by accountants, payroll service providers, brokerage firms, and mutual fund companies.
When the markets are down and assets drop in value, however, the adviser and record keeper might want to negotiate a fee increase. "We felt that in 2008, when the market crashed," Codd says.
The employer ultimately decides whether and how much employees should share in paying the fees to run the 401(k) plan, Codd says. "It varies by employer and their philosophy."
Some employers only want to sponsor a plan so far, and fees that go beyond a certain level go back to the participants as a wrap fee.
"Prior to disclosure, the wrap fee wasn't very visible, and it was difficult to tell whether a plan was competitive," Codd says. "With disclosure, asset charges will be in the forefront, so participants should notice them on the disclosure."
Powers says the disclosure requirements aim to inform plan participants and sponsors, not just that the expense is there, but who's getting the money.
The Labor Department rule, which is going on two years old, requires disclosure of sales fees, administrative charges, and underlying relationships with brokers, and brokerage houses, he says.
For instance, if a 401(k) plan participant chooses to invest in a mutual fund managed by Merrill Lynch, the world's largest brokerage, the fund might have an expense ratio of 80 basis points (0.8 percent), Powers says.
"A broker might get 15 to 50 percent of that," he says. "A local brokerage house might get another 40 percent, and another portion goes to the main brokerage house."
Plans sponsored by large employers ought to have total annual fees of less than 1 percent for mutual funds, Powers says. But that can be a difficult benchmark for comparatively low-asset plans sponsored by smaller employers.
"Let's say 1 percent investment expense ratio is deemed desirable," he says. "It becomes a matter of what ancillary services going to be included in that 1 percent."
Powers says he encourages small employers to view the 401(k) as an employee benefit, and their first option should be to try to avoid passing expenses, such as for record keeping, on to participants.
"That's easy for me to say, because I'm not writing the check," he adds.
If expenses are too high, the employer might not be in a position to provide a 401(k) plan.
"There is a threshold that a smaller employer can't really have one, and there isn't a good option out there," he says.
Darin Hayes, financial consultant and co-branch manager at the Coeur d'Alene office of Great Falls, Mont.-based D.A. Davidson & Co., says the main intent of the disclosure requirement is to ensure information is provided at the participant level, although he questions how effective it has been going into the second year of disclosures.
"The disclosure requirement is clear about the type of info that must be contained, but it doesn't impose a standardized method of presentation," Hayes says. "I don't know that the majority of participants would do an analysis or understand what the document means to them."
He says though, that the disclosures are reducing the likelihood of expensive plans.
"In the instance where the sponsor is paying too much, that is out in the open," Hayes says. "If someone did have an additional layer of fees, it would become clear to the plan sponsor, who might put it out to bid or work with the provider to reduce the fee."
While record keepers prepare the disclosures, it's up to employers to distribute the information to plan participants and eligible employees, he says.
Hayes also says his company hasn't seen much reaction by employers or employees to the disclosures.
"Our philosophy has been full disclosure and transparency," he says. "Ultimately, disclosure is good. Now that they are getting this information, they don't have to search for it if they want to know what it is."
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