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With 401(k) Fees, Employers Better Get Ahead ... or Fall Behind

May 8, 2007
Related Topics: Retirement/Pensions, Benefit Design and Communication, Featured Article, Compensation
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Everywhere employers turn, they find controversy over 401(k) fees. On Capitol Hill, Congress is considering amending securities laws to make 401(k) plan fees more transparent for participants. The Department of Labor is considering new regulations that would require plan sponsors to improve the expense information they disclose in their Form 500 401(k) annual reports.

    Meanwhile, a St. Louis-based law firm has filed a slew of class-action lawsuits during the past several months, claiming that, among other things, employers violated pension laws by allowing 401(k) participants to be overcharged by the managers of the plans.

    The suits, filed by the firm Schlichter, Bogard & Denton, name ABB, Bechtel Group, Boeing, Northrop Grumman, Lockheed Martin, Boeing, General Dynamics, United Technologies, Caterpillar, Exelon, International Paper and Kraft Foods.

    The crux of the issue is that no one knows what 401(k) plan sponsors are paying in fees, says Don Stone, president of Plan Sponsor Advisors, a Chicago-based 401(k) consultant. It’s up to employers to get in front of the issue and act now to make sure they know what they are paying and why they are paying it, experts say.

    This entails working with independent third parties to get a sense of how their plan’s fees compare with other plans of their size, making sure they negotiate for the lowest fees possible and understanding all aspects of the fees that they and their 401(k) participants are paying to the companies administering their plans.

    "The problem with the industry is that the way revenue is generated for the vendors doesn’t relate to the costs of providing the services," Stone says. "The cost to provide services has grown at a rate of 3 to 4 percent a year, while revenue for the vendors is 6 to 8 percent annually."

    But 401(k) administrators often don’t even recognize this discrepancy because they don’t know what they are charging, or where their revenues are coming from, he says.

    This is particularly true with revenue-sharing agreements. In the agreements, investment managers in 401(k) plans share with the 401(k) plan administrator the money they make from investment management fees that are charged to participants.

    Stone recalls one instance where he spoke to a client’s 401(k) plan administrator who said that the company was receiving only five basis points in revenue sharing from an investment manager.

    The investment manager, however, told Stone that it was paying 40 basis points, which meant that participants were paying an extra 35 basis points and the record keeper wasn’t even aware of this.

    Such examples don’t mean that 401(k) plan administrators are intentionally trying to deceive plan sponsors, Stone says. Often these companies are so big and the fee arrangements so varied and complex that they simply can’t keep track of them.

    "And the problem for employers is that often they don’t know what questions to ask to get to the bottom of all of this," he says.

Taking the right steps
    Once a plan sponsor figures out what fees it is paying, the question becomes whether those fees are reasonable, says David Wolfe, a partner in the benefits practice of Drinker Biddle & Reath.

    This requires companies to first figure out what services the fees cover, and then to figure out how the fees they are paying compare with other plans of the same size, structure and scope, he says.

    "Ultimately what you are trying to determine is whether you are getting a reasonable deal based on your asset size and level of service," Wolfe says.

    Employers should monitor the fees they pay at least every year, he says. "A year ago I might have told employers to do this every two years, but the industry is changing so much now I think these discussions should happen annually," Wolfe says.

    The National Futures Association, a Chicago-based organization for the futures industry with 249 employees and a $51 million 401(k) plan, reviews its fees semiannually, says Michael Crowley, the association’s associate general counsel.

    On top of this, the company has a third-party advisor, PFE Group, continuously monitor fees "to make sure nothing unusual happens," Crowley says.

    PFE keeps track of all fees paid by the 401(k) participants as well as by the National Futures Association. These fees include investment management fees, distribution and marketing fees, record keeping fees and fees related to auditing and legal expenses, says Wayne Bogosian, president of PFE, which is based in Scarborough, Massachusetts.

    "Plan sponsors should have a list of fees being paid, with clarification of whether they are paying it or the participants are paying it," Bogosian says.

Getting ready for regulation
    While the Department of Labor’s pending regulation will focus on plan sponsors disclosing to the agency the fees they pay, Congress is more concerned with employers disclosing these fees to 401(k) plan participants.

    But disclosing 401(k) fees has sparked controversy among certain industry groups because there is concern that by disclosing all of the fees, it might cause some employees not to participate in the plan.

    "We do not want a 401(k) participant to use fee disclosure as an excuse not to save in the plan," says David Wray, president of the 401(k)/Profit Sharing Council of America.

    The National Futures Association discloses what the plan pays in expenses altogether, but does not provide a dollar amount of what the average participant pays, Crowley says.

    "I think the easiest thing to do is tell participants, ‘This is how much it costs to run the plan,’ " he says.

    Disclosing what the average participant pays in a dollar amount could be misleading when seen out of context, Crowley says. For example, in 2006 the average participant paid $946 annually in 401(k) expenses. But the average account balance at the NFA is $132,000.

    "That context is important," Crowley says.

    If the new regulations require employers to disclose in dollars what participants are paying in 401(k) expenses, the association will make sure to do a lot of education on what these expenses entail.

    For $946 a year, the association’s plan participants are not only getting a wide array of investment options, online tools and services, but they also have access to investment advice through Charles Schwab & Co.’s GuidedChoice platform, Crowley says.

    But before figuring out how plan sponsors will disclose fees to 401(k) participants, these companies need to start figuring out the fees they are paying, Stone says.

    "You can’t go wrong with disclosing information now to employees—unless you haven’t done your homework," Stone says. "You may want to clean your house before you have people live in it."

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