Understanding Your 401K

401(K) Plan Fees … Let There Be Light!

This article was originally published on DentistryIQ.

News Flash…

The temperature across much of the U.S. isn’t the only thing on the rise this summer.

According to guidelines established by ERISA regulations 408(b)(2) and 404(a)(5), new 401(k) plan fee disclosure requirements are upon us as well and heating things up uncomfortably.

Especially plan sponsors who have been hiding – or are simply unaware of – the extent of their plans’ costs may be in for unpleasant discoveries and hot-under-the-collar participants as the disclosures unfold.

In contrast, those who have been careful to understand, minimize, and fully disclose plan fees are well-positioned to continue serving as responsible and appreciated retirement fund stewards.

As a plan sponsor, are you prepared for the new scrutiny your plan will undergo, beginning this summer?

There are two levels of required disclosures taking effect: plan-level and participant-level.

Let’s explore each – what they are and what they mean to you.

Plan Level Disclosures

As of July 1, 2012, as outlined in ERISA Regulation 408(b)(2), your plan providers (investment advisors, financial institutions, custodians, record-keepers, third-party administrators, etc.) should have begun reporting these important pieces of information to you, the plan sponsor:

  1. The services they’re providing
  2. Their specific fiduciary role and obligations to the plan
  3. Their forms of compensation (all of them)

In our estimation, more rigorous plan-level disclosures are long overdue and represent good news for you, your practice, and your employees.

The intent of plan-level disclosures is to enable you to compare plan providers on a more even playing field, where there should be considerably less leeway for providers to hide behind vague language and partial disclosures.

We are cautiously optimistic that plan-level disclosures will help do for the 401(k) industry what improved food labeling has done for consumers, who can now objectively compare ingredients and nutritional information in a more standardized manner.

For example, in assessing the fiduciary role of a financial advisor giving investment advice, is that “advisor” taking on the full fiduciary obligation for appropriate selection and monitoring of your plan’s designated investment alternatives and signing a written agreement to do so?

Or, does the relationship represent a less-protective role under more vague language such as “fiduciary warranty” (which is not the same thing).

It is our hope that the new regulations will make it easier to tell the difference.

The impact of disclosures should be particularly noticeable in compensation and fees.

No longer will a plan provider be able to assure you that your plan is “free.” Like low-fat lard, there’s really no such thing.

There is direct compensation that is sometimes waived, giving the appearance that a plan is free. But there are also a number of sources for indirect compensation.

As of July 1, these will need to be fully disclosed as well, and they’re often where the real fat is hidden.

Indirect compensation might include commissions, 12b-1 fees (essentially another form of commission), finder’s fees, and more.

While you won’t see this type of indirect compensation obviously flowing out of your plan, it is built into the share price of your participants’ holdings.

So, you or they are still paying these fees, if unknowingly – until now.

Other forms of plan-level compensation must also be fully disclosed, including any fees paid to an affiliate or subcontractor, any transaction fees, and any termination fees in place.

But wait, there’s more.

On top of the provider’s forms of compensation, each service provider to your plan must disclose the services provided and costs incurred for each investment option, including:

  • Sales charges
  • Loads
  • Redemption, surrender, and/or exchange fees
  • Expense ratios for annual operating expenses
  • Any other ongoing expenses
  • Any compensation paid

Record-keeping fees also must be reported and they must be reported separately from the above.

In short, after July, you may find your “free” account is costing you and/or your participants a pretty (ugly) penny.

The challenge is to identify when those costs have become unreasonable, to the point where it is your fiduciary obligation to seek better choices.

In other words, the dollar amounts alone are useful, but benchmarking them against industry standards remains an important, protective step. (When selecting a benchmark reporting service, it’s a good idea to ask from where the information is being gathered, to ensure it is robust, reliable data from a credible source.)

If you’ve not yet taken this step, there’s little time to be wasted, because the new regulations aren’t just at the plan level.

Your participants are about to become better informed as well.

Participant-Level Disclosures

As outlined in ERISA regulation Section 404(a)(5), you, the plan sponsor, will be similarly obligated to disclose participant-level fees to your plan’s participants.

And the window of time to plan for it based on the July 1 plan-level disclosure deadline is relatively brief.

These fees must first appear in participants’ statements by August 30, 2012.

Again, we believe that shedding light on a plan’s full costs and characteristics is ultimately in everyone’s best interests.

But you can imagine how your plan participants might feel if the newly revealed costs seem excessive.

Direct or indirect fees they’ve been incurring all along but that may not have been obvious will now be more clearly disclosed, including:

  • Administration expenses – recordkeeping, TPA, legal, accounting, etc.
  • Individual expenses – fees that will be charged for participant-driven fees (loans, distributions, QDROs, etc.)
  • Fees/expenses – asset charge as a percentage and dollar amount for each $1,000 invested

In addition, participants must begin receiving (if they haven’t already been) relatively detailed plan information, investment benchmarks, investment option historical returns, and other pertinent information.

The intent behind the ERISA plan regulatory changes is commendable: to enable both plan sponsors and participants to be better informed on the full spectrum of fees related to their retirement plans.

Properly implemented, the disclosures will help you, your practice, and your employees assess whether you’re paying a fair price for the financial services and fiduciary protections you’re receiving.

If the disclosures reveal pricing that does not compare favorably with similar offerings, they can help you objectively assess when it may be time to consider other opportunities.

At the same time, if you’ve not prepared yourself and your participants for more detailed disclosures, even reasonable fund performance details and fees may cause confusion and fear rather than clarity and purpose.

For some time, for the plans we service in our role as 3(38) fiduciaries, we’ve been fully disclosing the information and fees soon to be universally required by ERISA regulation.

In working alongside plan sponsors to enable informed decision-making for themselves and their employees, we’ve found it can be well worth taking an ounce of time upfront to avoid a pound of misunderstanding once those quarterly reports come out.

Note: If you have questions about these new regulations and how they impact you, feel free to contact me via email at haden@twdadvisors.com. To read previous installments of Wealth Extractions, please click here.

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