Fee disclosure deadlines loom for 401(k)-type plans

Story by Jean Filut

New fee disclosure rules for 401(k)-type plans take effect early this year. Plan sponsors, providers, and administrators should be aware of the new rules and have a plan for complying.

Most plan providers, especially the larger ones with legal departments and other professionals on staff, have been working diligently to gear up for the increase in information they will need to give plan sponsors, which are generally employers. Employers, however, might be less prepared. They could be caught off guard when they receive new detailed information that they are not accustomed to seeing from vendors. More importantly, they may not fully understand their increased responsibilities or be prepared for the time, analysis, diligence, and accountability required to comply with their new obligations.

Two levels of fee disclosure rules are new: first, fiduciary-level disclosures under ERISA Section 408(b)(2), and second, participant-level disclosures under ERISA Section 404(a)(5). First enacted in 2010, these requirements were originally scheduled to be effective in the middle of 2011 and have been extended twice since then.

In its most recent extension, the U.S. Department of Labor moved the deadline for participant-level disclosures to 60 days after the deadline for fiduciary-level disclosures, which is April 1. As a result, the extended deadline for calendar-year plans is May 31 for participant-level disclosures.

Employers have some work to do

The fiduciary-level guidelines require plan sponsors to verify they received the required disclosures from vendors, examine the disclosures and determine whether they are adequate under the new rules, and determine if the fee information is reasonable and fair for the services provided.

Therefore the burden is on sponsors to monitor and determine the acceptability of vendor behavior.

“Many plan sponsors don’t seem to understand that it is their responsibility to fulfill this new obligation,” according to Michael Scott, financial advisor and principal with Independence Financial LLC, an Oshkosh firm specializing in retirement planning for more than 80 years. “They think it is something required of the plan provider or record-keeper. In many cases, the major retirement plan providers have chosen to gather the necessary information on behalf of the plan sponsor to help them meet their obligations. This will relieve the majority of the legwork involved in the new requirements. Of course it is ultimately up to the plan sponsor to review this information to make sure their plan is in line.”

Plan sponsors might be accustomed to trusting their vendors and presuming that they provide all the required information. However, the vendors might not be acting in the best interests of plan participants. The DOL cautions that vendors may charge excessive fees and use certain reporting tactics to conceal them.

In Mike Scott’s experience, “Some providers have a history of providing excellent fee transparency, while unfortunately others do not. For those that have been fee-transparent for years, there will not be a lot of surprises with the 408(b)(2) disclosure. The others, however, may have many surprises uncovered. While reviewing others’ plans, I certainly run across situations where even as an experienced advisor it is extremely difficult to determine where all the fees are.”

Will failure to comply disqualify your plan?

If you are an employer offering a 401(k) plan and fail to fulfill your fiduciary responsibilities, what are the consequences? We asked John Stiglich, vice president of employee benefit services for Clifton Gunderson Wealth Advisors in Oshkosh, who explained the new rules will not immediately affect the plan’s qualification. They focus instead on fiduciary responsibility and do not provide new penalties for a fiduciary’s failure to comply because adequate penalties are already in place.

For example, suppose your company’s 401(k) plan continues to offer investments with a vendor after receiving fiduciary-level disclosure information. If you cannot show you continued the relationship because you determined the fees are reasonable and fair, the DOL could rule subsequent transactions with this vendor are prohibited and therefore subject to excise taxes.

Stiglich noted that “reasonable and fair” does not necessarily mean the fees must be the lowest available. It means that they are appropriate for the services provided.

With regard to failure to provide the required disclosures – the annual and quarterly disclosures required for participants – Stiglich mentioned a standard already in place for other required notices carries a penalty of $110 per participant, per day in similar situations, without limit.

Benchmarking might help

Stiglich added that cost structure depends a lot on size as it relates to the number of participants and the dollars per participant. Software programs are available to benchmark or compare your fees to other plans of the same size in the same industry, to all plans in that industry, and to other plans of your size across the country.

Right now available information is limited, but these programs will become more useful as data is complied. If you haven’t had an objective review of your retirement plan design and investment options recently, now could be an excellent time to have it done.

Independence Financial is also involved with benchmarking, according to Scott.

“We benchmark to plans of similar size and similar industries,” he said. “Benchmarking plan fees is only one of the many factors we analyze. We also benchmark participation, utilization, fund performance, vesting periods, match level, average account balance, etc. Benchmarking is certainly a helpful tool in understanding the success of a plan.”

What should you expect from participants?

When participants receive their 401(k) statements with all costs stated clearly in real-dollar amounts, they are more likely to become engaged.

“Sadly, the majority of 401(k) participants don’t pay very close attention to their investment allocation and the fees that make up their portfolio,” said Scott. “Because of this, displaying the participants’ actual investment costs front and center on their quarterly statements will likely create questions and potential confusion. It’s good to know what you are paying, but difficult to know if it is fair when you don’t know what to compare it to.”

Although a clear disclosure of fees has long been needed, employers could be faced with a barrage of inquiries. We asked Jason Henderson, owner and principal of Orchard Financial, an Appleton-based investment firm, if he has advice for employers. Henderson has been following this issue closely for nearly two years, and conducts seminars for plan sponsors on the rule changes. He suggested educating participants proactively about this newly disclosed information before they find it on their statements. Human resource directors should be prepared to handle employees’ questions.

Newly designed plans clearly showing all direct and indirect compensation levels the playing field and provides easier comparison. Ask the Heart of the Valley Chamber of Commerce about their “401(k) for Members” program.  Jason, along with his partner, recentlydeveloped the full fee-transparent platform which leverages the combined purchasing power of a traditional association plan without losing the individual customization and legal separation of a single-employer retirement platform – an industry first.

Fees make a difference 

The need for clear and readily available information about fees has long been a concern. You may have seen examples of the effect of what appear to be modest differences in fees over the long haul. One such example from the DOL illustrates how additional fees of 1 percent with 35 years to go before retirement would deplete the value of a 401(k) plan by $64,000, assuming a $25,000 one-time investment, an average 7 percent rate of return, and no deposits or withdrawals over the next 35 years. Instead of $227,000 at the time of retirement, the account balance would grow to only $163,000.

Although fee disclosure will soon be required on 401(k) statements, it is not required on personal IRA statements. Mike Scott explained that extending the fee disclosure requirements to all investment accounts would be an improvement.

“When a participant compares their personal IRA statement to their 401(k) statement, it will appear that their 401(k) has fees that don’t exist in the IRA,” he said. “In reality, the 401(k) is typically less expensive than the IRA investment due to the reduced pricing associated with investing as part of a larger overall plan.”

Focus on the positive

With regard to the outcome of fiduciary-level disclosure, Scott goes on to say, “I don’t see any big drawbacks to it with the exception that it adds yet another layer to the plan sponsor’s responsibilities. The benefits seem worth it though. In the long run, it will help to clear out many service providers who are merely dabbling in this marketplace, which will improve the overall products and services to the plan participants.”

Pressure from both participants and plan sponsors is likely to push fees and expenses down and spur the development of plans with lower fees without compromising quality of service.

Stiglich pointed out the goal of the new fiduciary-level disclosures is to make plan administration more competitive, resulting in lower expense ratios and fees. Participant-level disclosures will make information more readily available, which should result in better investment choices, better value and cost savings. Positive results should help us move in the direction of better retirement savings and a better economy.

Jean Filut writes from Appleton.