The most daunting certainty of the Department of Labor's new 401(k) fee disclosure regulations may not be the rules themselves, but the aftermath of employee confusion and/or outrage.
Plan sponsors and service providers can take diligent steps to become compliant, but it's going to take efficient communication efforts to prepare participants for what's coming down the pike.
[See also: 5 fee disclosure steps for plan sponsors]
Before plan sponsors can dive into what particpants may have heard and know about the regulation, or what they're expecting, they should first assess what these participants already do and don't know about 401(k) fees and expenses. According to AARP:
- 71 percent of plan participants report that they don't pay any fees
- 62 percent are unaware of how much they they are paying in fees to their plans
- 32 percent don't feel knowledgeable about the impact fees could have on their retirement savings
Here are seven steps benefits managers can take to mitigate misunderstanding and communicate effectively with their employees >>
Know the effective dates
Sure, you know that in February, the DOL clarified disclosure rules and pushed back the compliance date. But are you aware of the new dates?
July 1: Deadline for plan sponsors to receive fee disclosure data from 401(k) plan investment providers.
August 30: All 401(k) plan sponsors must disclose plan facts and investment fees.
November 14: All 401(k) plan sponsors issue their first quarterly fee disclosure showing the fees deducted from individual participant accounts for the third quarter.
Next: Pick a 'point person'
Pick a 'point person'
Most employees don't understand that there may be an Investment Oversight Committee (or at least it's recommended) for 401(k) plans, says Trisha Brambley, partner, Retirement Playbook.
Brambley served on the DOL’s ERISA Advisory Council, and has prepared DOL recommendations on target-date fund analysis, stable value issues and participant financial education.
Brambley says a committee should be responsible for the best interests of the plan participants, and have the capability to facilitate vendor relations, and do fund and fee analysis. Committee members have a fiduciary responsibility, but they're not committed to finding the cheapest costs, only the most appropriate ones, she emphasizes. In the wake of the final rules, Brambley predicts "[Fee disclosures] will cause plan committess to reconsider the fund lineup and may incorporate more lower cost funds, such as index funds if they dont already have them."
But while employers will review their options, Brambley says fund firms may not necessarily bring down slash costs like a fire sale. "They will still need to make enough money to handle all the administrative aspects of running a plan. We might see some innovation, such as offering more proprietary index funds or lower cost options and combine that with the offer to manage the individuals account for an additional fee."
According to the Society for Human Resource Management, plan sponsors are also required to produce and update regularly a website that is capable of acting as a second source of all specific information required to be released to participants and beneficiaries on the plan and each designated investment.
To ensure uniform communication, SHRM notes it's also helpful to have a glossary of terms readily available.
The DOL provides a sample plan fee disclosure form to help plan sponsors make cost-benefit decisions.
Know what must be disclosed
It sounds like an no-brainer. But if plan sponsors are confident they know what must be disclosed, they can reiterate in plain language what participants can expect to see in their plan statements.
According to Drinker Biddle, a benefits and executive compensation law practice, there are three basic disclosure requirements: services, status, and compensation.
The first requirement is that the service provider provide a description of its services to the plan. The regulation requires that the disclosures be made to the “responsible plan fiduciary,” who is the person with the power to hire and fire the service provider on behalf of the plan. For small plans, that is typically the plan sponsor, often represented by the president of the company (or other key officers, or an owner or partner). For mid-sized and large plans, it is usually a plan committee. The description should have enough detail that you can determine if the provider is delivering the services you expect and need for your plan. If you need more information, ask for it. In the preamble to the regulation, the DOL makes a point of saying that fiduciaries are responsible for asking for additional information if they need it to properly evaluate the services and the compensation.
The second disclosure requirement is whether your service provider is serving as an ERISA fiduciary and/or as a registered investment advisor. If the service provider “reasonably expects” to be a fiduciary to your plan, it must affirmatively say that it is. For example, if an advisor is making recommendations regarding the selection and monitoring of the plan’s investments, it is most likely serving as a fiduciary to the plan and, under the 408(b)(2) regulation, must tell you in writing that he is.
On the other hand, if a service provider is not acting as a fiduciary, it is not required to state that. Thus, if a provider is silent on the issue, you can assume that it is not acting as a fiduciary. This raises an issue: if you believe that the advisor is a fiduciary, or if you expect the provider to serve the plan in that capacity, you should request written confirmation of fiduciary status. Similarly, if a provider is acting as an RIA (i.e., a registered investment adviser), the provider must affirmatively state that fact in writing.
The third disclosure is compensation. Compensation is defined very broadly. It is anything of monetary value, such as gifts, awards, trips, etc. (However, non-monetary compensation totaling $250 or less does not need to be reported to you.) It also includes certain payments to affiliates or subcontractors of your provider (that is, if the payments are transactional, like commissions, or if they are charged directly against the investments). In the preamble to the regulation, the DOL makes a point that, in addition to determining the reasonableness of compensation, those payments may indicate conflicts of interest that the fiduciaries must evaluate. Compensation is divided into four categories: direct, indirect, related parties and termination.
Understand and communicate the fees and expenses associated with a typical retirement plan
According to the Department of Labor, plan fees and expenses generally fall into three categories:
- Plan administration fees
- Investment fees
- Individual Service fees
Click here to understand the differences in these 401(k) fees.
Provide an understanding of services provided through the fees
Aside from the management of the fund, the fees can include employee communication and/or education, say experts at Financial Finesse. If it does include financial education, such as workshops, webcasts, a financial helpline, financial planning sessions, and/or online financial guidance, this can be an opportunity to let employees know they are available and what they’re paying for so they use and appreciate the benefit in order to obtain their financial goals.
Use the fee disclosure as an opportunity for retirement education
Experts at Financial Finesse say they repeatedly find that less than 20 percent (17 percent last year) of employees are confident they’re on track to retire. This is a huge issue as you probably know for employers and they can use the fee disclosure to turn something of a hassle into a positive-- similar to how the credit card act raised awareness, fee disclosure can do the same thing with retirement preparedness. Benefits of the plan to communicate to employees:
- Save in taxes - the tax savings from the 401(k) outweigh fees the employees may be paying. For the pre-tax 401k, employees reduce their current taxes from 10 percent to 35 percent depending on their federal tax bracket and there may be state income tax savings on top of that. They can defer taxes on all of their investment earnings until withdrawn, which can add up to thousands of dollars per year. If they invest in a Roth 401(k), the earnings are the highlight and can be withdrawn completely tax free at retirement.
- Get free money toward retirement – This is obviously unheard of in any other savings vehicle! Companies that have a dollar for dollar match are essentially providing a 100 percent return to the investment and for a fifty cent match a guaranteed 50 percent return so this help(s employees significantly.
- Can retire earlier by using a company 401(k) - the IRS allows employees retiring from their company to withdraw funds from their 401(k) at age 55. Investors in Individual Retirement Accounts (IRAs), both traditional and Roth, have to wait until 59 ½ years old (or have special circumstances) to avoid an early withdrawal penalty of 10 percent for federal taxes.
- Can contribute more than they could in an IRA- With an IRA, the employee can only contribute $5,000 per year ($6,000 if they are over 50). With a 401(k) plan they can contribute more.
- Can save before they even see their paycheck – by using this, employees’ savings is "out of sight - out of mind" so they can build their savings without the temptation to tap it.
Show employees how your plan fees compare to the industry average
Employees in small and mid-size company plans are often subjected to paying 2 to 4 percent in fees annually on their 401(k) account balances, but there’s no really need for costs to exceed one percent for everything, says Forbes contributing author Stuart Robinson. "By staying below the one percent threshold, employees can accumulate tens if not hundreds of thousand dollars more savings over a thirty year career."
In its examination on plan fees, AARP concluded an employee who has been working 35 years and contributes about $5,000 each year to a 401(k) plan, with an annual return of 7 percent and no fees would earn about $469,000 over the 35-year period.
While plan sponsors should be aiming for the most prudent, not cheapest, fees it's also important to give employees an apples-to-apples comparison on their particular plan, so participants won't assume that their fees are exorbitantly high.
"The average equity mutual fund charges expenses of 1.3 percent to 1.5 percent, while many 401(k) plans have much lower fees due to scale in the size of the plan and the use of low cost index funds in the plan. When disclosing account fees, offer the industry average as a side-by-side comparison to provide some context for employees so they can see the advantages of investing in their company plan," say planners at Financial Finesse.