American author John Jay Chapman said, “Everybody in America is soft and hates conflict. The cure for this, both in politics and social life, is the same—hardihood. Give them raw truth.” If the truth is hard to hear, then January 1st, 2012 should be a really hard day for all those who participate in a company 401(k).
On January 1, 2012, the new Department of Labor guidelines on fee disclosure take effect, and roughly 72 million Americans will begin to receive quarterly statements concerning the true cost of their retirement. The new DOL guidelines have been in the works for years now and are primarily as a result of the many fees that are commonly associated with the average 401(k). The potential number of people that will see their charges for the first time is staggering according to the study done by AARP entitled, 401(k) Participants’ Awareness and Understanding of Fees.
A Dearth of Information on Costs
According to the study, even though 79% of poll participants made retirement decisions based on cost, 83% acknowledged that they were unsure how much they paid in fees associated with their retirement plan. Cost remains an important factor to people, yet many participants lack the information necessary to make informed decisions.
In my own experience, when I personally ask participants how much they pay for retirement plan costs, “Nothing” is the reply that I receive all too often. Before you rush to judgment, consider that even many with a finance or accounting background scratch their heads over uncovering the true cost associated with their own retirement plan, since many of the asset-based fees do not come in the form of a monthly or quarterly statement, but remain buried within plan documents or in arrangements between providers and mutual fund companies. A recent release by the Government Accountability Office (GAO), addressed the issue of revenue sharing arrangements and the lack of impartial advice from many retirement service providers, saying “such conflicts could lead to higher costs for the plan.”
Revenue sharing is defined as compensation paid to plan service providers out of the retirement plan assets. Some of the more common forms of revenue sharing include 12b-1 fees, which offset the cost of sales and/or marketing materials; sub-transfer agency fees, also known as the sub-TA, which many times goes to pay the record keeper of a retirement plan; and fees paid to a broker-dealer as a commission for meeting sales targets.
Revenue sharing arrangements are legal under current law and are common in the retirement market-place. The determination of whether these fees are reasonable in light of services received by the retirement plan is left to the discretion of the plan sponsor. What the GAO is concerned with is the hidden nature and lack of transparency of the revenue sharing arrangements, as they happen many times without the knowledge of plan sponsors and participants. Plan sponsors all too often lack the information and disclosures necessary to prudently monitor fees and change plan providers if needed to keep costs in check.
Another potentially serious problem in the 401(k) marketplace, that the GAO attempts to address, is the lack of objectivity on the part of many service providers. Potential conflicts of interest occur as retirement plan consultants, in many cases, are paid incentives to push certain funds at the expense of lower-cost options. Plan sponsors are not made aware of these compensation arrangements and could potentially choose funds that place a higher burden on participants. What is significant about the GAO findings is that retirement plans studied from 2000-2004 suffered a loss of as much as 1.2% to 1.3% in returns where consultants were not disclosing incentive arrangements.
What Difference Does it Make?
How much money does a participant lose to extra fees created by revenue sharing arrangements? According to the GAO’s study, even a slight increase in fees can drastically affect retirement savings. The GAO compared the difference a 1% fee increase would make on a $20,000 balance calculated over a 20-year period with a reasonable rate of return. At the end of the period, even a 1% increase reduced the final amount by over $10,000. Now imagine what that number would be if you were talking about a 401(k) participant with $800,000 in retirement savings and the number becomes startling. When the extra fees are coupled with the loss in returns from undisclosed compensation arrangements, the losses for a participant could be catastrophic over the course of their work history.
So how can plan providers avoid conflicts of interest and undisclosed revenue sharing arrangements?Plan sponsors must demand transparency from all vendors associated with the retirement plan and obtain costs in writing. Any vendor that is unwilling to provide compensation arrangements is placing undue liability on the company. ERISA law already requires that the plan sponsor have a prudent process in place where all aspects of the plan are being considered. As a part of that process, retirement plan sponsors must have an understanding of what plans of similar size and participants are charged in the marketplace.
Every plan should be independently priced every one to three years by an outside vendor to ensure that fees for services are in line with industry standards. Having your plan independently priced is even more important in scenarios where the retirement plan has been in place for more than 5-10 years, as fees in most cases should come down as account balances increase over time. Plan sponsors should consider consulting with fee-only advisors to avoid revenue sharing arrangements and to ensure that advice is as objective as possible.