ERISA Retirement Plan Participant Disclosures

Fort Worth QDRO LawyerBy now you received fee disclosure statements on your 401k, ESOP, 403(b) and profit sharing plans. These fee disclosure statements, known as 404a5 Participant Disclosures, ensure retirement plans provide participants with a minimum amount of information about the fees charged by plan investments and fees paid by the plan (often from those investment fees) to companies that provide services to the plan, such as auditing, accounting and investment management.

These disclosures provide participants with information necessary to adequately assess the investment options within your plan. Confused about the disclosures? Talk to an employment lawyer near you.

Why these 401k fee disclosures began

In the 1990s mutual fund and insurance companies realized the 401k and similar defined contribution retirement plans could be structured in a way that shifted the payment of plan expenses from the employer to the participants in a technique known in the industry as revenue sharing. Revenue sharing works by shifting costs away from employers to participants, making the plan services more attractive to employers.

Before revenue sharing began, employers would pay for the administration of defined contribution plans out of their own pocket. These plans are not cheap to run, although they are less expensive than defined benefit plans. In the mid 1990s mutual fund companies and insurers pushed for the Department of Labor to approve revenue sharing as a permissible form of payment for plan services.

Revenue sharing works like this: the service provider charges a fee per participant to the employer. The participant is charged a small percentage of each investment as a management fee to the mutual fund or other investment. The mutual fund then shares a portion of the management fee with the plan service provider in exchange for gaining access to participants’ savings. The service provider shares a portion of its revenue with the plan as a discount to get the plan’s business.

The amount shared back with the plan offsets the service provider’s fee per participant. The amount shared is usually a substantial amount of the cost of the plan administration services. So the employer ends up paying little or nothing.

In summary, it is a huge kickback scheme.

Why this is a problem for Texas employees

The major problem with this scheme is that it incentivizes the employer to select the service provider who can promise the lowest plan expenses which means the service provider has to offer investments with management fees high enough to cover most or all of the costs of the services. Everybody else profits while the participants foot much of the bill for the employer, service provider and investment provider.

The Employee Retirement Income Security Act (ERISA), the federal law that governs retirement plans, requires employers to choose investments that are prudent for the participants. Part of that duty includes selecting investments that are appropriate for participants and do not profit third parties or the employer itself at the expense of participants. So employers ended up choosing between their legal duties and their bottom line. ERISA requires them to satisfy their legal duties. That, unfortunately, does not always happen.

Who’s footing the bill?

In the early 2000s retiree groups and investor organizations began looking at how these revenue sharing agreements operated and found that participants were financing an excessive amount of profits for everybody in spite of the legal duties. They began investigating and suing plans for violating their legal duties on the theory that employers were choosing plan investments primarily to lower the amount they pay for plan services and the service providers were assisting them in that process.

These suits and the attention brought by them motivated Congress to start investigating the issue. The Department of Labor urged Congress to let them deal with the problem.

The resulting solution is the participant disclosure (and a separate disclosure made from service providers to the employer). Not a tremendous solution, really, because employers do make decisions based upon their own interests and service providers do solicit business on the basis of their ability to shift costs to participants. However, it is better than nothing and at least gives participants an opportunity to better understand the plan investments and make decisions accordingly.

What information 401k fee disclosures contain

The participant disclosure breaks down general operating information about the plan and its expenses and discloses investment performance and fees. The disclosure shows overall plan expenses. It then breaks down how the individual participant pays for a portion of the overall plan fees, whether it is through revenue sharing or fees directly charged to the participant’s account or both.

The disclosure then lists all investments, the performance and fees of each investment, often in chart form. Most plans already provided some of this information but generally not as concise that showed how fees affected their accounts.

Why the disclosure matters to 401k participants in Texas

The fees and investment performance disclosed can have a major impact on investment decisions. Plan fees reduce the overall return on investment. The Department of Labor reports that fees amounting to just one percent of your retirement account over the working years of an employee will forfeit twenty-eight percent of savings and investment returns over time.

That is a huge amount of money going to the investment managers, service providers and indirectly back to your employer. The greater the fees charged by individual investments the more savings are lost to the participant.

The performance data is similarly important, especially when compared to the performance of similar market indices. Generally 401k plans offer two classifications of funds. One classification is passively managed funds, often called index funds, in which the underlying investments in the fund just track a market index like the Dow or S&P 500.

The other classification are actively managed funds in which the fund has a specific investment objective and the fund manager “actively” works to find the investments that will perform the best within that objective. These funds usually carry higher fees than passive funds.

Are actively managed funds worth it?

Neither classification is necessarily better than the other and both may fit into your particular investment strategy. One relevant concern financial advisors tend to raise is whether the active management funds are worth the extra fees. If they charge more fees but produce same or worse performance then it seems disadvantageous to pay more for less. You can always compare those actively managed funds to the index funds in your plan. Sadly, most actively managed funds tend to perform about the same or worse than the index funds.

When you leave an employer you can keep your account in the retirement plan until 65 (many until you die). It may not be financially wise to do so. When the recession hit in 2008 a substantial amount of invested money evaporated. Along with it went the fees that paid the plan costs through revenue sharing. As a result many employers opted to include or increase existing flat fees on participant accounts.

The effect of 401k fees on retirement for Texas employees

These fees, while usually not substantial, whittle away at your retirement when you could have that money in an IRA or a new employer’s plan without paying administrative fees for keeping your account open. An IRA or new employer’s plan may have similar investments with lower fees. That would help cut down on how much retirement savings you give away in fees.

There is disagreement in the financial industry over how much weight to give investment fees. You can imagine there is an incentive on their side to make you ignore how much you pay in fees. You should make investment decisions neither solely based on fees nor by completely ignoring them. How much weight they play depends on the investments available, your risk tolerance, retirement savings goals and investment strategy.

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