There are an estimated 483,000 individual retirement account plans, covering 72 million participants, the Labor Department says. These accounts hold roughly $3 trillion in assets. Greater transparency couldn’t be more important.
The new rules are intended to ensure that the fees in 401(k) plans are reasonable. The Labor Department says it hopes that the disclosures will help investors compare various investment offerings and see how costs eat away at account balances.
Two main fees are extracted from 401(k) plans: investment management fees and administrative costs. Under the new rules, companies administering 401(k)’s — often mutual fund concerns — must provide employers who sponsor the plans with details of all fees associated with running the accounts. For example, fees for general plan administrative services, like legal work, accounting and recordkeeping, will have to be disclosed.
Plan sponsors are supposed to use this information to analyze whether the fees in their plans are too high. But they won’t have to pass along all of this data to participants. Instead, the sponsors will be required to calculate expense ratios for the investments offered in a plan, showing participants the charges per $1,000 invested.
According to a Deloitte/Investment Company Institute study released last November, the median 401(k) expense ratio was 0.78 percent. But the range of ratios is wide, the report noted: from 0.28 percent to 1.38 percent.
Expense ratios on 401(k) plans are supposed to be lower than those on investments offered to individuals. That’s because the combined assets in many retirement plans should be large enough to qualify for lower-cost institutional funds. In general, the greater the assets held in a plan, the lower the fees.
Brent L. Glading, founder of the Glading Group, a consulting firm that analyzes 401(k)’s, says he welcomes the disclosure requirements but fears that the new rules will confuse plan participants. Employers will have to work much harder to educate participants about costs and benefits of various fund offerings, he says.
Unfortunately, he adds, employers are not up to the task. “The disclosure is going to make index funds look better in some cases, and that’s fine,” he says. “But you will find many active managers with fees that are justifiable because their performance outperforms the index. It is clearly going to be the responsibility of the plan sponsor to help participants understand what it all means, and I am not sure they are prepared for it.”
If plan sponsors are to help their employees use the disclosures to make better investment choices, they have a lot of boning up to do. A study issued by the Government Accountability Office in April found that half of the 1,000 sponsors surveyed either did not know if they or their participants paid investment management fees or believed, incorrectly, that such fees were waived by service providers.
Investment management fees are a rather large cost to be unsure about. According to the Deloitte/I.C.I. study, these fees make up 84 percent of total 401(k) expenses.
Such ignorance might be understandable for sponsors of small plans, but large plan overseers can also be clueless. According to the G.A.O. study, 31 percent of large plan sponsors didn’t know whether they or their participants paid investment management fees.
The report also said 29 percent of plan sponsors did not know if their plans paid for trustee, legal or audit services.
If plan sponsors don’t even know that fees are levied, they are surely not putting any effort into aggressively managing the costs that their employees are paying in their 401(k)’s. The G.A.O. study confirms that.