New federal rules regulating 401(k) plans will ultimately have the effect of driving down fees — but, in many cases, at a cost. One result of an increased emphasis on price will be a lack of attention to value. The result of this could be a commoditization of plans that makes them less expensive but not necessarily any better for participants, and in some cases worse.
The new rules from the federal Department of Labor (DOL) require employers to determine, and all service providers to disclose, all fees and the services they cover by July 1. Though the DOL has sent plan sponsors reams of documents outlining its requirements under the new rules — and listing fines that could befall them for not complying — many of these employers remain unaware of this deadline.
Those who are dutifully on schedule for this compliance are also probably aware that they must then determine whether these fees are reasonable — that is, where these charges fall in the national market. If employers find that these fees are relatively high, they must make arrangements to assure that they’re reasonable, perhaps by changing service providers.
Previously, federal rules didn’t require these service providers, including the large financial institutions that package 401(k) plans and sell them to companies, to disclose all fees. Though service providers have long been required to disclose fees when asked, mandatory disclosure rules stemming from the Employee Retirement Income Security Act (ERISA) of 1974 haven’t come close to covering the plethora of fees charged by plan providers, investment companies supplying investments for plans and the advisors engaged by sponsors.
Thus ensued decades of murkiness about fees, further beclouded by the benign neglect of overworked HR people at small and midsize companies. Aware that this state of affairs has led to excessive fees in many cases, the DOL is trying to do something about it to stanch the unnecessary hemorrhaging from employees’ retirement accounts. By requiring employers to know these fees and seek out lower ones when appropriate, goes the federal logic, excessive fees will inevitably shrink under the sunlight of disclosure.
There’s little doubt that the new rules will have this effect — accelerated by the entrée of low-cost providers in what will be an increasingly low-cost arena — but they will also have an unintended consequence: commoditizing 401(k) plans, often to the detriment of participants. Like most quantitative analyses, benchmarking fees will inevitably result in apples-to-oranges comparisons. How else can one say, without reams of nettlesome footnotes, precisely where one service provider’s fees land relative to those of its competitors?
The DOL is seeking to retain a focus not just on price, but on value, as the new rules require employers to determine and benchmark fees “for services provided.” Yet in plan sponsors’ rush to benchmark fees — and, in many cases, after getting eye-opening results, to seek lower ones — this stipulation doubtless will receive short shrift unless sponsors steadfastly maintain a quality orientation.
The rationale for preventing excessive fees is to enable employees to accumulate more wealth to get them through retirement. Yet if employers fail to also focus on services, plans won’t be able to serve participants by delivering the best returns for their particular situations: their age (time horizon for retirement), retirement goals, risk tolerance, retirement goals and existing wealth.
It’s entirely possible that after plans’ fees are benchmarked, some sponsors will find service providers who will do the same work as their current providers but at a far lower cost. Or these sponsors might hit the jackpot by finding lower fees accompanied by much better service. Yet the powerful tide of commoditization will surge against the likelihood of these outcomes unless sponsors view the new rules as a wake-up call for positive action; they should view them as an opportunity to lower fees and improve service.
This conscientious mentality compels consideration of what the components of good service might be. These include governance to maintain a steadfast dedication to employees’ interests, investment evaluation to examine the worthwhileness of specific items such as mutual funds, and education to empower employees to make intelligent, unbiased choices for their 401(k) portfolios.
Without sufficient plan education, a 60-year-old employee might end up with the same portfolio risk levels as 25-year-old, exposing him to potential losses from which he will never have time to recover and thus jeopardizing his retirement.
The new rules also require sponsors to make clear distinctions between fiduciaries, who are legally bound to advise clients in their best interests, and brokers, who are prohibited by ERISA rules from advising participants on the suitability of specific investment products.
So, at a time when the lead service provider in many 401(k) plans is a broker whose services may be fraught with conflicts of interest, it’s more important than ever for plan sponsors who want to enhance plan quality to seek the advice of a wholly independent fiduciary. Moreover, in an era when people change jobs and investment markets put on different faces from year to year, such advisors can play a highly beneficial role in assessing the fees of plan providers on a regular basis, preferably every 90 days.
Discipline is essential not only to get plans in shape, but also to keep them that way. Staying in shape may require a personal trainer working with you in your interest; this doesn’t necessarily come with the lowest-price gym membership.
Aside from doing the right thing for your employees, there’s another reason to assure that the rush to lower fees doesn’t eclipse considerations of quality: It’s smart business.
Remember that one reason your company has a 401(k) plan in the first place is to be competitive in the marketplace for skilled employees. Sponsors whose plans have the best returns and best employee outcomes will have an edge as the economy recovers and the labor market gradually ceases to be a buyer’s market.
This is not a lure that you can fashion in short order. To attract the best employees five years from now, you must begin work on your plans today. The new DOL rules present an unprecedented opportunity to do so.
Anthony Kippins is president of Retirement Plan Advisors, Ltd., a Registered Investment Advisory firm that addresses the needs of retirement plans and the employees who invest in them.
An Accredited Investment Fiduciary Analyst (AIFA®) with more than 30 years of experience domestically and abroad, Kippins specializes in providing fiduciary advice to retirement plans on governance, investments and educational services. He also advises individual clients on retirement planning and investment management after retirement.
Kippins also serves as managing director of Institutional Fiduciary Assurance LLC, an organization that provides fiduciary advice to trustees of endowments, foundations, non-profit organizations and charitable trusts. He can be reached at [email protected]