Investments in traditional 401(k) plans have been limited to mutual funds representing a variety of asset classes. However, exchange-traded funds (ETFs) are beginning to attract greater attention for participant-directed individual account plans, especially since the introduction of a new fee disclosure mandate and greater interest in ETF-based 401(k)s from big-name brokerage firms.
Mutual funds tend to have higher costs and potentially overweight specific sectors or stocks. The higher costs associated with mutual funds come from the active management fees allocated to conduct research and trade securities.
It is no big surprise that ETFs are becoming the go-to alternative for 401(k)s. ETFs have been lauded for their low expenses and diversification, which have become key selling points for ETF-based 401(k) plans.
Since the passive management of index-based funds incurs low costs, ETFs can have much lower expense ratios as compared to mutual funds. Through low-cost investment options such as ETFs, expenses in participant-directed individual account plans may be reduced by half or more.
The New Labor Department Ruling
A new piece of legislation regarding fee disclosures will give employers more clarity into 401(k) plans through complete transparency of all holdings and investments within the plan.
The U.S. Department of Labor’s Employee Benefits Security Administration (EBSA) will implement the new Employee Retirement Income Security Act (ERISA) Section 408(b)(2) regulation on Jan. 1, 2012; however, employers have been given 120 days after the effective date to comply with the disclosure of fees and expense information to participants.
“This action will provide that plan fiduciaries have all required information from service providers before they must disclose information to their workers, ensuring that workers receive accurate information about their retirement plan and investment costs,” stated Phyllis Borzi, assistant labor secretary for EBSA.
The main point of the regulation will require plan sponsors to develop and distribute a comparative chart that outlines investment-related information, such as fees and expenses.