Department of Labor regulations will be a 401 eyeopener
It may be an eye-opener for a lot of those employees, too, and could lead to some employers seeking new service providers for their 401(k) plans.
Drayton, a partner at Plante Moran Financial Advisors in Grand Rapids, said the regulation announced this summer is under the Employee Retirement Income Security Act of 1974, in regard to “fiduciary responsibilities of companies to act in the best interest of their employees.”
Up to now, she said, both the employer and the employees enrolled in 401(k)s have not always received full disclosure on fees charged to their 401(k) accounts, so now the Department of Labor is mandating that.
“A lot of these plan sponsors have not seen what their fees were in the past, so this is a new transparency for a lot of employers,” she said.
Drayton guesses that as many as 80 percent of the mid-size companies she works with do not know what their 401(k) fees are.
The new regulation will probably add some expense to the employer’s 401(k) program and definitely add to the employer’s responsibility under the law.
“The employer is going to need to make sure that their service providers are complying with the regulation,” she said. Service providers include third-party administrators, record keepers, investment advisors — anyone who does something that results in a fee being deducted from that 401(k) account.
Companies that administer 401(k)s include banks, investment firms such as Charles Schwab, and even insurance companies such as John Hancock.
For most employers, the new regulations may require new legal agreements with those service providers stipulating compliance with the law, and she adds that “it’s always a best practice to have legal agreements reviewed by legal counsel. Whenever you have new regulations, there is always a lot of gray area.”
The law will generate more work for accountants, as well as attorneys.
The next step employers must take, after seeing all the fees for the first time, is to try to determine if they are reasonable, said Drayton. That’s essential because of the employer’s mandated fiduciary responsibility to protect the employees’ 401(k)s.
“A lot of companies won’t really have a basis to conclude if (the fees) are reasonable or not. So, again, a best practice would be to have an independent party conduct a benchmarking study” to compare that plan and its fees against other plans.
That benchmarking would lay out all the services and the costs of each one, because the new regulation does not permit lumping all fees together as one cost.
The benchmarking should be thorough enough to reveal those fees that are higher than normal, she said. “That will give you some negotiating power to either negotiate your fees with your current service providers, or if not able to do that, then look at some other providers,” said Drayton.
Some service providers may claim they can’t break down the fees in each case because they share those fees with other companies that provide some of the service. The ostensible service provider may have a contract with a subcontractor that locks in that fee at a set, non-negotiable price. There may also be stipulations in the contract making fee information confidential.
“That’s going to be another eye-opening experience for a lot of plan sponsors: Who gets paid directly and who shares (fees) through commissions and things like that?” she said.
“The way fees are generated in the 401(k) business can be very complex,” she added. “If you are a plan sponsor and you really don’t know what the fees are, related to your plan, how can you negotiate them?”
Often a plan sponsor trying to tighten up the service fees doesn’t ask the right questions. “So having the assistance of an independent party who will negotiate on your behalf oftentimes is very valuable,” said Drayton.
“Sometimes, I will come into a situation where a prospective client doesn’t know the fees they are paying, and we help uncover them. They honestly think that their plan is free because the company doesn’t write a check (for services) and they don’t see the fees. Often, those are the plans that are the most expensive.”
Those invisible fees can mean annual deductions of up to 3 or 4 percent from the accounts, she said.
“If you’re paying 3 percent right off the top in fees — especially when market returns and investment returns are pretty low — that’s a very high hurdle” blocking growth of the accounts, she said.
“All that needs to be disclosed to both participants and to plan sponsors,” she said.
The new regulations will mean added cost in record keeping, because participants will now receive five statements each year, instead of four.
“I think the true intention of the regulation is to help employees be better stewards of their retirement (account),” she said. However, Drayton acknowledges that “a lot of participants aren’t going to understand the information” regarding fees.
Some employees do understand, and when they see the light, they don’t like it. Ameriprise Financial Inc., the largest employer of certified financial planners in the U.S., according to the New York Times, is being sued by six people, including one current employee. They have accused Ameriprise of investing its employees’ 401(k) plan in the firm’s own “untested” mutual funds and charging expensive, uncapped fees, with violation of ERISA requirements being the basis of the suit. Ameriprise is the company once known as I.D.S.
Other companies that have been sued by employees regarding their 401(k) plans include Bechtel, Caterpillar and General Dynamics. All three settled, and all three suits — plus the Ameriprise suit — were brought by the same attorney, Jerome Schlichter.