All too often, small businesses sponsoring 401(k) plans sign contracts with service providers that call for outrageously high fees that are passed on to participating employees.
Many plan sponsors have no inkling that their fees may be unreasonable for the services they’re receiving because they don’t even know the amounts involved. Under new regulations from the federal Department of Labor (DOL) that go into effect this year (see “The 401(k) Regulatory Tsunami”), plan sponsors are now required to determine these amounts and whether they’re reasonable.
The new regulations present a series of compliance hurdles that employers must clear, beginning with a requirement to demonstrate that they’ve determined their plans’ arrangements for fees and services (see “April 1 deadline for 401(k) plans is no April Fool’s joke”). The original deadline was April 1, but the DOL has extended it until an as-yet-unspecified date in July. This extension merely delays the inevitable, so plan sponsors should begin obtaining fee and service disclosures now rather than waiting until the last minute.
The federal government has mounted a regulatory drive to keep workers’ accounts from being drained by 401(k) plan service providers. There is ample evidence to suggest that many of the large financial institutions in this industry (primarily insurance companies offering plans through investment brokers) have long charged fees that are exorbitant.
Under the new DOL rules, workers’ quarterly account statements will now include a listing of fees, so workers will be able to see this drainage. Previously, they received only investment return figures net of fees.
As fiduciaries — a legal status that carries great potential liability — employers have long failed to comply with federal rules designed to protect employees from high fees. Because of the new regulations and their disclosure provisions, employers who continue in this failure will face not only steep fines from regulators, but also hostility from employees when they see just how much they’re paying in fees.
In fees applied to 401(k) accounts over a lifetime of employment, every fraction of a percentage point is significant. Half a percentage point can make the difference between a comfortable retirement and an uncomfortable one.
One would think that, like many products and services, these fees would become homogenized. This is the case in efficient markets. But the market for 401(k) plan services is by no means efficient because plan sponsors, who are busy running their businesses, don’t pay enough attention. They tend to haplessly enter into arrangements with service providers that persist for decades without scrutiny. As a result, fees in this market are all over the map.
For many plan sponsors, especially small companies that lack in-house benefits expertise, this market is foreign terrain. Now, the DOL is requiring that sponsors explore it. This process is known as benchmarking fees — determining where a given plan’s fees stand relative to what’s available on the open market. The data for this is fairly accessible. Far more difficult than finding the data is interpreting it and applying it to a given company’s situation.
For sponsors seeking to avoid apples-to-oranges fee comparisons, the logical move would be to break down fees for each service. Yet many service providers historically haven’t itemized services. They take a sizeable percentage from accounts according to the terms of a vaguely worded contract that guarantees little — except the fees. The new rules require service providers to specifically disclose fees for each service provided.
With this detailed information in hand, sponsors can go about the time-consuming task of researching the market to make fee comparisons. Yet, there’s a way that sponsors can save the time it takes to scroll through endless screens of fee data. They can use a tool with which they are probably already familiar: a request for proposals (RFP).
Instead of going to the market, sponsors issuing RFPs can bring the market to their doorsteps. If much lower fees come in for the same services, then sponsors can engage new service providers. Then, to monitor an ever-shifting market over time, plan sponsors can periodically run spot checks (preferably, every three years) on where their fees stand, issuing RFPs to take serial snapshots of fees against which to benchmark their current arrangements. Thus, sponsors can convincingly demonstrate to employers and regulators that they are continuously endeavoring to determine where their fees stand in relation to what the market has to offer and, if appropriate, changing providers to contain fees.
Procedurally, using RFPs is fairly simple, but the devil lies in the RFP details. Care must be taken to construct the RFP to elicit fee-itemized proposals from firms that are accustomed to servicing plans of the company’s size and contribution levels. As the RFPs should be constructed with this kind of market knowledge, it’s a good idea for smaller companies to engage the services of a qualified advisor to write their RFPs.
Companies that engage qualified fiduciaries for this function have the advantage of actually outsourcing some of their fiduciary responsibility and attendant liability. But when sponsors use brokers, few of whom are fiduciaries, they retain all liability.
The key to complying with the DOL requirement for reasonable fees is to establish a clear, sensible benchmarking process. Plans sponsors can take comfort in the fact that regulators are more interested in seeing a clear process than in a given set of fees, as there is no right or wrong fee solution in this subjective arena. The point is to make an effort by adopting and steadfastly following a sound process.
Yet, employers whose efforts not only result in a good process but also identify reasonable fees for high-quality services — and take advantage of them — will fulfill not just the letter but the spirit of their fiduciary duties. And, most importantly, they will assure a better retirement for their employees.
Anthony Kippins is president of Retirement Plan Advisors LLC, a Cincinnati-based financial services company that provides retirement-plan fiduciary services and employee-benefit solutions to small companies. Kippins holds the AIFA (Accredited Investment Fiduciary Analyst) designation. He can be reached at firstname.lastname@example.org.