Did you notice SECURE 2.0 Section 340[i] where Congress directs the Department of Labor (DOL) to provide a report on how to improve defined contribution plan fee disclosures to plan participants?
In part, this may have been prompted by recommendations from a 2021 Government Accountability Organization (GAO) study.[ii] GAO’s recommendations were based, in part, on their assessment of participant understanding of fees, or lack thereof:
Importantly, GAO found that: “… 45% of participants are not able to use the information given in disclosures to determine the cost of their investment fee. Additionally, 41% of participants incorrectly believe that they do not pay any 401(k) plan fees…”
Mandated Fee Disclosures to Participants: Wrong Focus
As a 401(k) plan sponsor, plan administrator, plan investment fiduciary, plan advisor or plan participant, ask yourself, what difference would it make if all 401(k) plan participants:
- Could accurately ‘determine the cost of their investment fees,’ and/or
- Knew that they do ‘pay 401(k) plan fees,’ and/or
- Understood the ‘cumulative impact of fees on accumulations of retirement savings’?
How might participants use that information to improve their outcomes? Consider that most plans don’t offer multiple choices of investments with the same style.
According to the 65th Annual Survey by the Plan Sponsor Council of America, the average number of investments among surveyed plans was 21, and the median was a range of 16-20. Surveyed plans offered an average of 7 fixed income or cash investment choices, and 14 equity choices. Given that there are nine style boxes for domestic equity and another nine style boxes for domestic fixed income investments, most participants don’t have access to a choice of investments for every style of equity or fixed income investment.[iii]
The PSCA survey also showed that one-third of surveyed plans offered a self-directed brokerage window. Use of the brokerage window is minimal—only 2.3% of plan assets were invested using the self-directed brokerage window.[iv] So, most participants don’t take advantage of that opportunity, either.
Importantly, instead of an out-of-context, myopic focus on the size of fees or the impact on retirement savings, shouldn’t participants be evaluating administrative fees against the services provided, and investment performance, net, net of fees?
The myopic focus on mandated fee disclosures can be misleading. For example, where a plan offers a Guaranteed Investment Contract (GIC), there is often no fee disclosure—just the return information. For comparison, where the plan offers an employer stock investment alternative, many/most of those choices come with $0 fees.
Most importantly, mandated fee disclosures are out of context. The regulations omit consideration of the most important factors when it comes to differences in fees—the size and complexity of the plan, the number of participants, the amount of assets, and the various plan features.
Simply, investment management fees vary inversely with the size of the plan.
A recent study showed that: “People who work for smaller employers and participate in small plans pay, on average, around double the cost to invest as participants at larger plans—around 84 basis points (0.84%) in total compared with 40 basis points (0.40%), respectively.”[v]
Back in 2012, coincident with the effective date of the fee disclosure regulations, I delivered many compliance presentations, and I frequently confirmed:
“Over the next ten years, let’s increase the fees paid by individual account plans, like the 401(k), by hundreds of millions of dollars per year to deliver newly mandated fee and investment information that no participant specifically asked for, few will read, even fewer will understand, and still fewer will correctly apply in their investment decision-making. Practical experience and careful evaluation of the proposed regulation cost benefit analysis suggests that at most, 10% of participants will save … However, the other 90% of participants will experience no identifiable savings (as they do not spend any time researching fees today), but will incur … costs … (as most fees are ultimately paid by participants).
“At best, the Participant Disclosure regulations are inconsistent in how they position the required disclosure information. For example, the regulations warn about the impact of fees and use those concerns to require extensive, detailed, specific disclosure of various fee information but fail to suggest, let alone require the plan sponsor to focus any attention whatsoever on the main reason for differences in fees among plans—by failing to require disclosure of a comparable ‘all-in’ fee for plans of comparable size and composition.”
Mandated Fee Disclosures to Plan Sponsors and Plan Administrators: Correct Focus
Keep in mind that participants pay most of the fees for their 401(k) plans.[vi] So, most participants ended up with a net cost from the implementation of the mandated disclosures because, as described above:
- The disclosures are myopically focused on the amount of fees, instead of investment performance net, net of fees,
- Participants typically don’t have a choice of investments with the same risk/return characteristics, and
- The investment and administrative fee information is provided without appropriate context.
For comparison, “done right,” the disclosures to the plan sponsor/plan administrator, as required by ERISA §408(b)(2), could have significant value. Many plan sponsors are already laser-focused on fees.[vii]
Suggestions:
- First, before expending effort to identify options to improve participant fee disclosures, the DOL may want to update the initial cost/benefit estimates required by Executive Order 12866 and confirm which participants, if any, actually benefitted net of costs, from the first ten years of compliance with mandated fee disclosures.
- Second, instead of enhancing participant fee disclosures, the DOL might consider enhancing the value of the 408(b)(2) disclosures by gathering that information and reshaping it into a useful source of fee and investment performance information, stratified by plan size and characteristics, to create a clearinghouse of valuable, current, accurate fee data for use by plan administration and plan investment fiduciaries.
Please share any thoughts or suggestions you might have on how to improve fee disclosures. I always appreciate your criticisms, suggestions, corrections, and improvements. Contact me at: jacktowarnicky@gmail.com
SEE ALSO:
• 401k Fees Remain a ‘Black Box’ for Most Americans
• Why Employers Wanting to Attract and Retain Key Talent Look to NQDC Plans
Disclaimer No. 1: My comments are my own based on my experience in plan sponsor and consulting roles – they do not necessarily reflect those of any employer, group, council or association I have been employed by or affiliated with, past, present, or future.
Disclaimer No. 2: This information was provided by individuals with knowledge and experience in the industry and not as legal or tax advice. The issues presented here may have legal implications and you should discuss this matter with legal counsel prior to choosing a course of action. This article is intended to be informational only. It is not (and you/others should not use it as a substitute for) legal, accounting, actuarial, or other professional advice. Any advice contained in this article was not intended or written to be used, and cannot be used by anyone for the purpose of avoiding any Internal Revenue Code penalties that may be imposed on such person [or to promote, market, or recommend any transaction or subject addressed herein]. You (others) should seek advice based on your (their) particular circumstances from an independent tax advisor.
[i] Consolidated Appropriations Act, 2023, Pub. L. 117-328, Signed by President Biden on 12/29/22. DIVISION T—SECURE 2.0 ACT OF 2022. “SEC. 340. DEFINED CONTRIBUTION PLAN FEE DISCLOSURE IMPROVEMENTS. Not later than 3 years after the date of enactment of this Act, the Secretary of Labor shall— (1) review section 2550.404a–5 of title 29, Code of Federal Regulations (relating to fiduciary requirements for disclosure in participant-directed individual account plans); (2) explore, through a public request for information or otherwise, how the contents and design of the disclosures described in such section may be improved to enhance participants’ understanding of fees and expenses related to a defined contribution plan (as defined in section 3 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1002)) as well as the cumulative effect of such fees and expenses on retirement savings over time; and (3) report to the Committee on Health, Education, Labor, and Pensions of the Senate and the Committee on Education and Labor of the House of Representatives on the findings of the exploration described in paragraph (2), including beneficial education for consumers on financial literacy concepts as related to retirement plan fees and recommendations for legislative changes needed to address such findings.”
[ii] Government Accountability Office, 401(k) Retirement Plans: Many Participants Do Not Understand Fee Information, but DOL Could Take Additional Steps to Help Them, GAO-21-357, 7/27/21. GAO recommendations included: (1) A consistent term for asset-based investment fees (e.g. gross expense ratio), (2) Actual cost of asset-based investment fees (perhaps in dollars and cents?), (3) A website incorporating a graphic illustration on the cumulative effect of fees, (4) Fee benchmarks for in-plan investment options, and (5) Ticker information for in-plan investment options, where available. Accessed 4/6/23 at: https://www.gao.gov/products/gao-21-357
[iii] J. Chen, Equity Style Box, Investopedia, 6/22/22. “An equity style box is a visual representation of the key investment characteristics of stocks and stock mutual funds.” The style box is a nine-square grid with a vertical axis scaled by capital/size of the firm (large, medium, small), and a horizontal axis scaled by investment style (value, blend, growth). Accessed 4/6/23 at: https://www.investopedia.com/terms/e/equity_stylebox.asp See also: J. Chen, Fixed Income Style Box, Investopedia, 5/24/22. The horizontal axis is scaled by interest-rate sensitivity reflecting a bond fund’s duration: limited, moderate, and extensive. The vertical axis is scaled by credit quality ratings, comprised of a weighted average of the credit ratings of each fixed income security: high, medium and low. Accessed 4/6/23 at: https://www.investopedia.com/terms/f/fixed-incomestylebox.asp
[iv] Plan Sponsor Council of America (PSCA) 65th Annual Survey of Profit Sharing and 401(k) Plans, reflecting 2021 plan experience.
[v] Lia Mitchell, What Are Workers Paying to Save For Retirement? It depends on the size of your employer, according to our new research, Morningstar, 3/31/23. Accessed 4/6/23 at: https://www.morningstar.com/articles/1148181/what-are-workers-paying-to-save-for-retirement[vi] J. Towarnicky, “A Focus on Fees – Seven Years Later,” 10/20/19, Accessed 4/6/23 at: https://www.psca.org/news/blog/focus-fees-%E2%80%93-seven-years-later See also: J. McAllister, “DC Plans Continue Laser-Focus on Fees, Exclusive Callan Survey Finds,” Callan, 3/1/22, Accessed 4/6/23 at: https://www.callan.com/blog-archive/callan-dc-survey-2022/ See also: J. Rekenthaler, “The System Still Fails Small 401(k) Plans.” Workers at companies with small plans are burdened by high costs, 3/3/22, Accessed 4/6/23 at: https://www.morningstar.com/articles/1082795/the-system-still-fails-small-401k-plans
[vii] J. Towarnicky, Tripping Over Our Own Fee(t)s: Can Plan Sponsors Avoid a Myopic Focus on Fees? Benefits Quarterly, 3rdQuarter 2022.
Jack Towarnicky provides independent benefits consulting and serves as a member of aequum, LLC and of counsel for Koehler Fitzgerald, LLC.