While business owners have always had a fiduciary obligation to ensure their retirement plans benefit their employees, a new federal rule will put even more onus on employers to decide if the costs involved are reasonable as required by the 1974 federal law, the Employee Retirement Income Security Act.
Issued in February, the Department of Labor’s Employee Benefits Security Administration’s new regulations are designed to shed light on how much employees are paying in retirement plan fees and investment fund expenses. They take effect this summer: By July 1, pension plan providers must send disclosure to employers; by Aug. 30, employers (or the plan provider, if the employer designates) must send disclosures to employees.
The agency, which oversees about 708,000 private pension plans with nearly $3 trillion in assets and 72 million participants, is requiring plan providers to inform employees of “direct and indirect compensation certain service providers receive in connection with the services they provide.” It applies to defined benefit and defined contribution plans, such as 401(k)s, but not to SEPs, SIMPLEs, IRAs, or individual retirement annuities. (IRAs are not covered by ERISA. And since SEPs/SIMPLEs can be rolled over to any IRA provider, the reasoning goes that they should get their disclosures from the financial institutions receiving the rollover, not from their employer plans.)
Employers need to be aware of their new responsibility. “Although service providers are required to disclose their fees, it is up to the plan sponsor to make certain that the fees they are being charged are reasonable for the services they are receiving,” Rich Rausser, senior vice president at Pentegra Retirement Services in White Plains, N.Y., writes in an e-mail. “There are only two ways for the small business owner to do this: one, benchmark their plan against other plans, which may be challenging for a small business owner to do on their own; or two, seek quotes from other service providers in order to gauge the reasonableness of the fees they are paying for plan services.”
Frank Armstrong, the president and founder of Investor Solutions in Coconut Grove, Fla., says the transparency will be a “blessing,” not a burden, for small business owners. The independent registered investment adviser, who says he manages $120 million in pension plan assets, believes both employers and employees will benefit: “From a small business owner’s perspective, this will enable him to offer better plans at lower costs because he’ll have the data [from plan providers] for the first time. He’s been operating without the information he really needs to make the decisions up until now,” Armstrong says.
Currently, many small business owners turn their pension administration duties over to mutual funds, insurance companies, and third-party record keepers, some of which administer the plans at no cost to the employer. But the true costs can come in fees and expenses to the employee that can drastically reduce retirement savings over time, Armstrong says, adding that some plans suffer from excess costs, undisclosed conflicts of interest, and sustained underperformance.
“The average employee is paying for the entire cost of the plan and its administration, and they’re being grossly overcharged,” he says. Many employees have no idea they’re paying 3 percent or more of their total assets in fees and expenses, he says. If that cost could be cut in half, the amount of money accumulated by the time the individual retires could be boosted by 40 percent or more. “This [disclosure requirement] is the best thing to happen to the 401(k) since its inception,” he says.
Information that is typically buried in a mutual fund prospectus, such as performance benchmarks, loan fees, and distribution fees, will now be provided annually in a comparative chart, says Kevin Wiggins, an ERISA attorney with Pittsburgh law firm Thorp, Reed & Armstrong and a former member of the ERISA Advisory Council, a 15-member panel that advises the labor secretary on Employee Retirement Income Security Act matters.
In addition, participants will receive quarterly statements that show the expenses that were taken out of their accounts during the previous quarter. Those statements will arrive by Nov. 14 under the new rules. “I suspect at first that most individuals will take a good look at” their statements, Wiggins says. “But after a while they may just glance at them or ignore them completely.”
Armstrong suggests that small business owners look over the disclosure documents closely and replace plans that are overcharging and underperforming. If they don’t, newly empowered employees could take legal action. “Ignore this at your peril. It only takes one employee to figure out they’re paying 3 percent or 5 percent a year and that isn’t right. The bar association will be happy to jump on that and get settlements,” he says. Consider independent advisers who are non-commission and willing to sign on as plan fiduciaries—taking some of the legal liability off the business owners, he adds.
One more item for employers’ checklists: Those that have union employees should consider explaining the new disclosures to the union, Wiggins says: “There’s a chance that once they start seeing these [expenses on their quarterly statements], they’ll want to bargain over who should pay them: the employees or the plan sponsor.”
Wiggins surmises that as employers shift to lower-cost plans, the plans’ service providers will be looking for ways to hang on to their fees. One way they can do that is through revenue sharing, which is like a commission paid by a mutual fund to those who distribute the fund to the market. “I’m seeing consultants and record keepers tell plan sponsors to pick mutual funds that pay more revenue-sharing,” which can be used to offset the employer’s costs to administer the plan, he says. “Courts have said that an employer should not consider how an investment will benefit the employer. Instead, the decision has to be based on what is the best investment for participants. If an administrator or an employer picks a mutual fund to reduce the employer’s expenses, that’s an issue because the employer could be considered to be using plan money to benefit the employer.”