In a supreme irony this election year, sweeping new government regulations are expected to inject free-market price competition into a service that more than 70 million Americans buy regularly but have virtually no idea how much they are or should be paying.
Thirty years into the 401(k) era, and after repeated bureaucratic delays, retirement fund sponsors and participants will learn this summer just how much they’ve been paying in fees, both direct and indirect.
Industry observers predict an epidemic of sticker shock to be followed by a prompt correction in the pricing structure.
(Click here for a glossary of terms.)
(Click here for a related story on litigation over 401(k) fees.)
(Click here for Expert Advice on fiduciary responsibilities.)
"It’s exciting stuff," Jay Gadberry of Gadberry Financial Group in Little Rock said last week, sounding almost giddy. "People will know what they are paying, and they need to know. As a result of that, the overall cost will come down. … The savings it will generate over a lifetime is significant."
And it will be an educational experience for all but the savviest savers.
"It would be rare for me to say this, but in this particular case, [more government regulation] is probably a good thing," said Eric Hutchinson of Hutchinson Financial in Little Rock.
"Because if you look at a participant who is in their 20s and 30s and they are putting aside dollars now that will be in those plans for 20 or 30 years, even a half-percent difference in total costs will make a big difference in what their balance will be when they retire."
Also predicted:
• A rash of litigation filed by employees who feel cheated out of retirement income; and
• Huge new demand for "benchmarking" services that allow plan sponsors to see what other retirement funds of similar size are paying for services, totals that can range from less than 1 percent of assets under management to as much as 4 percent.
Sponsors, Then Participants
Before plan participants – the rank-and-file employees who make payroll-deducted contributions into their personal 401(k) accounts – get their new information on or before Aug. 30, their employers, the plan sponsors, will get their first look at what Hutchinson called the "all-in" fees by July 1.
Disclosure of fees to plan sponsors is required of any provider who gets a piece of the 401(k) pie under the U.S. Department of Labor’s final regulation implementing Section 408(b)(2) of ERISA, the Employee Retirement Income Security Act, which governs retirement funds.
This alone is likely to create considerable heartburn since plan sponsors are often as ignorant of their plan costs as their employees, despite having the legal responsibility – the fiduciary duty – to act in the best interest of the plan participants.
"Here’s a problem: The average employer doesn’t have a clue what they are paying," Hutchinson said. "They haven’t looked into it. They haven’t done their due diligence. And employers who are in that category stand to be facing a rude awakening."
(Because they may not write a check directly, some employers naively believe they pay no fees at all, according to Teressa Rambo, a chartered retirement plans specialist at DataPath Retirement Services Inc. of Little Rock. "They ought to know," she said, "but you’d be surprised how many don’t, and they don’t want to fool with it.")
The second new regulation, known as 404(a)(5), gives plan sponsors until Aug. 30 to share 401(k) details and investment fees with employees who participate in their plans.
And employees who study those details – which must be presented in plain language and comparative tables – "may be coming to the employer and asking, ‘Have you done your job?’ I think there will be employees holding sponsors’ feet to the fire," Hutchinson said.
A cottage industry of class-action suits on behalf of 401(k) participants already exists (see sidebar), but the new disclosures will be the fertilizer that makes it grow, Hutchinson said.
And employers will, in turn, have new leverage with providers and a newfound understanding of their fiduciary duties and that of their service providers.
So serious and absolute are the new disclosure requirements that a plan sponsor must terminate the business relationship with any provider who doesn’t respond to a request for fee information, Rambo said.
The Price Is Right
Stephens Capital Management will enter new agreements with all of its 401(k) clients that spell out fiduciary roles and fees, Executive Vice President Larry Middleton said last week.
"Employers are going to be able to discern whether the person who has been serving them is serving in a broker capacity and just giving them information or as a fiduciary and assuming responsibility," he said.
Like Gadberry and Hutchinson, Middleton predicted that the transparency requirements will drive down fees.
But even full disclosure will be of limited use because participants, and even sponsors, may not know what a reasonable price is. And it isn’t like pricing a hamburger or even a mortgage interest rate.
"There’s not a good way to answer that, truly, because size does make a difference," Hutchinson said.
There are fixed costs for any plan, and that means the fees, expressed as a percentage of assets under management, will be higher for small plans than for larger ones. "That’s just the nature of the beast," Hutchinson said.
Plans with assets of $3 million to $5 million should expect all-inclusive costs of 1-1.5 percent, according to Hutchinson.
Gadberry said most plans in Arkansas pay total fees of between 0.85 percent and 1.85 percent of total assets under management, with the lowest rates available only to the very largest plans.
But some plans are paying between 1 and 2 percent to plan administrators just for financial advice, Gadberry said. And Hutchinson said some plans – especially those that include insurance company mutual funds – can run up fees of 3 to 4 percent a year.
Hutchinson recommended a book published by 401KSource.com called "The 401(k) Averages Book." But there are also consultants, including DataPath, that have geared up for expected new demand for customized benchmarking services.
About a year ago, DataPath contracted with a service that collects and crunches 401(k) fee data from plans all over the country. For a price – generally in the hundreds of dollars – DataPath will prepare a benchmark report that compares the fees paid by the client company with those paid by at least 25 other plans of similar size and characteristics.
"They really are eye-opening," Rambo said.