Retirement Plan Participant Disclosures

texas-wage-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 these retirement plans provide plan 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.

Why these retirement plan 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 shifts costs away from employers to the participants, thereby making the plan services more attractive to employers. Before revenue sharing, employers paid 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 the Department of Labor to approve revenue sharing for plan services.

Revenue sharing works like this: the service provider charges a fee per participant to the employer. The participant pays a small percentage of each investment as a management fee to the fund manager. The mutual fund then shares a portion of the management fee with the plan service provider in exchange for the benefit of accessing all that money in the plan. The service provider then agrees to share a portion of its revenue with the plan to get the plan’s business. The amount shared back with the plan is treated as an offset on the 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.

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. That means everybody else profits while the participants, trying to save for retirement, are footing the bill for the employer, the service provider and the investment provider.

ERISA plan requirements

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.

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 is disclosed on your retirement plan

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 and 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 in such a concise manner.

Why the disclosure matters for your retirement plan

The fees and investment performance disclosed can have a major impact on investment decisions. Plan fees reduce the overall return on investment in a retirement plan. The Department of Labor reports that fees of just one percent 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 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 includes actively managed funds in which the fund has a specific investment objective. The fund manager “actively” works to find the investments that will perform the best within that objective. These funds usually carry higher fees.

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 money but get the same or worse performance than passively managed funds it seems disadvantageous to select those investments. You can always compare those actively managed funds to the index funds in your plan or even the indices themselves. Sadly, most actively managed funds tend to perform about the same or worse than the index funds.

When you leave an employer you can stay in the retirement plan until at least 65 (some until you die); but 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.

These fees, while usually not substantial, whittle away at your retirement. 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 are giving away to other people.

There is disagreement in the financial industry over how much weight to give investment fees; but 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 they play in your decision depends on investments available, risk tolerance, retirement savings goals and investment strategy.

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