Do you know how much the financial institution that provides your 401(k) plan is really charging you and your employees in fees? Most employers — especially small and midsize companies — don’t have a clue.
But you should know because, as the plan sponsor, you are ultimately accountable to your employees. High, gouging fees, often as much as 2 to 3 percent annually, can cut severely into employees’ retirement investment accounts.
New rules from the U.S. Department of Labor are seeking to change this by requiring that employers become aware by July 1 of all 401(k) fees and the services the fees cover — and that they then determine whether the fees are “reasonable” in the existing marketplace. The DOL is requiring that financial institutions that provide 401(k) plans disclose all fees to sponsoring employers.
Unfortunately, employers aren’t the only ones who don’t know all of these fees; most employees don’t either. But they’ll know in a few months, when they receive their quarterly account statements. The new rules require that all fees be disclosed in these statements in tabular form.
This has not been required since 401(k) plans were made possible by the passage of the federal Employee Retirement Income Security Act (ERISA) in 1974. But now, the new DOL rules will emphasize and expand some ERISA requirements that were never strongly enforced.
Currently, most fees are buried rather than clearly disclosed. Thus, all that employees see is what’s left — their returns after fees and commissions have been taken out. When employees see their fees for the first time, many will be shocked and upset that they’ve been paying so much to enrich financial institutions and sales people, as well as the mutual fund and insurance companies that supply plans with investment products.
Because of this, employers should brace themselves for a potential slew of discontent, when employees might storm into human resources offices, waving their account statements.
Also, DOL is ramping up to impose stiff fines on employers who don’t follow the new rules. Despite this, many employers, unaware of the rule changes or their seriousness, aren’t taking steps to comply. Unfortunately for them, the new rules also make it inviting for employees to sue employers over plans’ shortcomings. In fact, employees at some Fortune 500 companies have recently brought lawsuits over related ERISA violations.
It’s critical to be certain that you engage the services of a knowledgeable fiduciary consultant/adviser who will agree in writing to represent only you in an objective analysis. This can help eliminate the potential for conflicts of interest.
To avoid becoming the target of lawsuits and regulatory sanctions, companies should hustle to understand all existing fees, then determine whether they’re reasonable. The best and simplest way to determine this is to hire an independent consultant to conduct a comprehensive review of the existing plan, followed by objective reports that compare and benchmark it against similar size plans in similar industries — then, if necessary, evaluate other providers.
In addition to a thorough evaluation of expenses and fees, a comprehensive benchmarking report should also compare plan features and investment options and should make suggestions for increasing plan participation and effectiveness. By evaluating and fine-tuning a plan’s design, employers and their most highly compensated employees might also be able to substantially increase their tax-deductible contributions.
Unfortunately, in my work as a consultant, I regularly see cases where companies have been sold off-the-shelf “cookie cutter” plans that don’t allow highly compensated employees to take full advantage of significant potential increases in pretax contributions. However, with customized plan design, contributions could be substantially increased.
Also, note that federal rules typically prohibit brokers and their agents from serving your company as financial fiduciaries or advising employees as a fiduciary. Despite this, many of these brokers assume this role anyway.
The responsibility for fiduciary duties for these plans and the risk involved falls on employers. If the employer engages the services of a fiduciary consultant who agrees to serve as the designated adviser and investment manager, employers can transfer these liabilities and substantially reduce their risk and exposure to lawsuits from employees.
With the July 1 deadline looming, employers need to be sure they have required fee disclosures from plan providers and are prepared to act on them. Otherwise, it’s possible that employees, after learning of the new requirements from their friends at other firms, could report them to the DOL.
Then these employers might hear regulators knocking on their door, along with angry employees who have just learned how much of their investment returns are going into the pockets of insurance companies, banks, financial salespeople and Wall Street firms.
The better prepared you are now, the less stressful this transition will be and the more your employees will thank you for looking out for their interests.
Tim Decker, a fee-only financial planner, is president of ISI Financial Group in Lancaster. He is the author of “The Sleep-Well-At-Night Investor” and host of the radio program “Financial Freedom,” which airs at noon Saturdays on WHP-AM 580. Contact him at www.isifinancialgroup.com.