401(k) disclosure doesn’t go far enough

This year, 72 million Americans will open their quarterly 401(k) statements and for the first time get a glimpse of the cost of their plans as spelled out in new fee disclosures.

Likewise, 483,000 plan sponsors will receive similar fee disclosures from their various service providers.

These long-awaited Labor Department rules, known as ERISA 404(a)(5) and 408(b)(2), are designed to improve fee transparency in retirement plans by uncovering historically hidden costs.

But while they represent a step in the right direction, the new Employee Retirement Income Security Act rules fall far short of providing plan sponsors and employees who participate in the retirement plan with a real understanding of the true cost of their 401(k) plans.

WINDOW INTO COSTS

At best, the rules give participants and plan sponsors a tiny window into costs. At worst, they provide just enough information to thoroughly confuse participants and employers.

What’s needed is for the industry to shine a bright light on the labyrinth of fees, investments and revenue sharing that make up the hidden world of the 401(k) industry.

The need for clear fee disclosure stems from a general lack of awareness among consumers about 401(k) fees.

An April 2011 AARP survey found that 71% of plan participants thought that they paid no 401(k) fees. Of those who knew that they paid fees, just 39% were aware of how much they paid.

What exactly are the new rules?

The first, ERISA 404(a)(5), breaks out participant record-keeping and administration expenses, and lists loans, distributions and other individual fees. It also requires the disclosure of fund performance compared with a benchmark, and the amount per $1,000 that it would cost to invest in a fund.

The second, ERISA 408(b)(2), requires service providers receiving annual compensation greater than $1,000, whether direct or indirect, to disclose this compensation to the plan sponsor. It also requires the reporting of investment expenses of all available funds, though it allows providers to provide a “good-faith estimate” for revenue sharing.

The rules require disclosure of just a fraction of 401(k) fees.

Most notably, the disclosure of investment costs actually incurred by participants — which make up as much as 84% of a typical plan’s fees, according to a 2011 study by Deloitte and the Investment Company Institute — isn’t mandated by the Labor Department regulations. The rule requires the disclosure only of the expense ratios and the amount per $1,000 that it would cost participants to be invested in the fund, forcing individuals to calculate their exact costs.

So how could the Labor Department improve these regulations?

The most significant step would be to require disclosure of an “all in” cost — or what might be called a “personalized expense ratio” — that gives plans or participants a hard-dollar amount and a percentage of assets for everything that they pay.

As it stands, participants will receive expense ratios and benchmarks for all fund options within a plan. They will then need to determine the funds in which they are invested and their balance in each fund, and then multiply the balance by the expense ratio to arrive at their annual investment expense in a dollar amount.

This convoluted calculation could be replaced by presenting investment expenses as a dollar figure using a formula based on a participant’s average daily balance in each fund. The resulting number would be more precise than simply using quarterly balances that don’t consider any activity within that quarter.

Moreover, the personalized expense ratio would then add investment expenses to any explicit fees charged against plan assets to arrive at a true “all in” cost presented as both a dollar figure and as a percentage of one’s account balance. And it would include industry benchmarks for comparative purposes.

Rules require individual funds to contain a performance benchmark, but there is no requirement to list a fee benchmark for the funds. Because this likely will be the first time that participants have seen these fees, they will have no idea whether their fees are reasonable.

Put simply, 401(k) investors need to know their personalized expense ratio in order to fund retirement successfully.

Expenses, contributions and performance all contribute to long-term returns. And all else being equal, low fees get you to retirement quicker.

Tom Gonnella is a senior vice president of Lincoln Trust Co. and a board member of the Council of Independent 401(k) Recordkeepers.

Related Topics: Retirement Income Summit, Retirement Watch