If you’re a retirement plan sponsor, you probably had July 1 circled on your calendar.
Sunday was the deadline for fee disclosure, a long talked-about regulation from the Department of Labor that requires certain service providers of ERISA-covered plans to provide sponsors with clear disclosure of the compensation they, their affiliates and their subcontractors get from plan assets.
If they haven’t complied by now, plan fiduciaries must take action, which may mean notifying DOL of the service provider’s noncompliance. Service providers need to inform sponsors of the direct and indirect fees they’re paying for services, administration and investment management.
[See also: Fee disclosure communication guide]
Many media outlets and researchers have already pegged this as a day of reckoning for plan sponsors – and their participants - who were blindsided by high-cost fees that drain plan assets. (One Forbes contributor called 401(k)s, “one of the biggest skim games in financial services.”)
The latest study of note was a white paper from research firm Demos, which found “an ‘ordinary’ American household will pay, on average, nearly $155,000 over the course of their lifetime in effective total fees.”
To help participants, senior advocate group AARP launched a consumer tool with BrightScope that helps account holders (71 percent of which don’t know they pay 401(k) fees) figure out their fees and compare them to the average for a low-cost 401(k) investor.
The process of disclosure may lead to protest from 401(k) users, but a few experts are telling plan sponsors to put away their pitchforks. While many sponsors may not have previously known what they were paying for, the improved transparent system will empower them as consumers to better examine the value they’re buying. And cheaper is not necessarily better.
Kevin Crain, head of institutional retirement and benefit services at Bank of America Merrill Lynch, says disclosure preparations were a long time coming, but mostly among midsize to larger 401(k) plans. Now, that level of understanding will spread across plans of all sizes, and that’s a good thing.
“I don't see [fee disclosure] as bad, if what is articulated along side of it is value for cost,” Crain said during a recent interview during the Society for Human Resource Management’s conference in Atlanta. “Just because fees are disclosed in a different way than they were before, this doesn't mean they're bad. What [plan sponsors] will have to get help with is the translation about the value that has been given to them. Do they clearly understand how their plans are performing? Financial wellness, participant utilization, participant satisfaction — those will all be important concepts to equate a value to what they're getting.”
Not all 401(k)s are created the same
When a Moody’s analyst predicted in February that fee disclosure would be “credit negative” for higher-cost asset managers, he noted providers that service smaller markets would most likely feel the greatest pressure under new regulations.
That’s because small plans tend to include “higher-fee share classes of mutual funds to generate revenue for sharing with plan service providers, compared with large plans, whose corporate sponsors have the wherewithal to subsidize plan costs.”
“Typically if you work for a small employer with a small retirement plan, you pay more. And if you work for a big company with lots of assets from the retirement plan, you pay less. That’s how the math works in terms of making those plans sustainable given the assets under management,” said Laura Lutton, editorial director for Morningstar's Fund Research group.
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Lutton says certain fund companies target smaller companies and have higher fees. Then, there are those firms that are huge recordkeepers and tend to have bigger plans and cheaper funds. The type of plan someone is in -- and how it's paid for -- usually depends on their employer. A plan sponsor may decide to split the cost of the plan with participants, or let participants bear the whole cost.
“I think historically it’s been difficult as a participant in a retirement plan to know if you’re getting a good deal or not because the pricing is so inconsistent from their retirement plan versus their neighbor’s retirement plan. It depends on who you work for, what kind of yield the retirement plan has negotiated and whether the firm pays some of those expenses on behalf of employees."
Ultimately when an employee opens his quarterly statement this fall, there’s a reasonable expectation that participant will advocate for lower fees, Lutton says. “But it’s a lot easier for the plan sponsor to negotiate at the outset and make a better informed decision about what’s a reasonable cost to pay given the circumstances of the plan.”
Before participants go running to benchmark what they’re paying in fees, it would be wise for a plan sponsor to give participants an idea of where their 401(k) ranks against others like it.
"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, a retirement education company that works with plan sponsors.
What about those so-called ‘rip-off’ plans?
“Historically before the fee disclosure rules, the set of providers [that] the client least understood around fees — but thought they really didn’t need to — were fully bundled where they were not only giving administrative services for someone, but most of the investments were also with that company,” Crain said.
Crain explains even when BofA Merrill Lynch used to be just Merrill Lynch, it was a recordkeeping service that had investment management, but over the last few years, they’ve gotten out of investments. “Our feeling was [it’s safer] for a plan sponsor in its fiduciary position to say to them, you have completely open investment architecture.”
The ones who are well positioned in the wake of fee disclosure are the firms that say, "I do administrative service, my fees are totally clear and transparent to a client and it has open investment architecture; you can choose your menu and design your menu in any which way you pay for it," Crain says.
“The ones that are still needing to do some work are the still very traditionally bundled providers that had investments as part of their equation. Even with those, they’re finding they have to open up their architecture to more outside-type funds just to be competitive in the market, and I think it’s pushing them to a new generation of their business.”