“I’m From The Government and I’m Here To Help.”
Ronald Reagan called the above quote “the nine scariest words in the English language” and I am afraid he may be right.
On July 1st of 2012 the Government is requiring 401(k) providers to disclose their fees to business owners. Sixty days later on August 30th, similar disclosures around retirement plan costs will be provided to the 401(k) participants.
This is the governments second try at shining a light on excessive 401(k) costs. The first was the release (many years ago) of the Department of Labors Fee Disclosure Form found at http://www.dol.gov/ebsa/pdf/401kfefm.pdf. It took the government eleven pages to explain how to evaluate 401(k) fees. Eleven pages is ten pages to many, and the form never got widespread use.
My guess is that the new fee disclosure requirements will meet the same fate. They will be overly complicated and ineffective. If you want to get a handle on cost look for three basic items in all of that fine print headed your way:
Item One. Administrative Cost: What is paid each year in hard dollars for testing and administration? Generally this will be broken down as a “base fee” and/or a “per participant fee” and it is usually paid by the employer.
Item Two. Expense Ratios: What is the average “Gross expense ratio” (a percentage which acts as a drag on investment performance) for the funds you have? This will be expressed as a percentage and usually runs around 1.00%. If you have a gross expense ratio of 1% and total plan assets are $1,000,000, than investments & advice are costing the plan an average of $10,000 per year.
If you work with a broker, adviser or insurance agent their compensation will be the difference between the gross and the net expense ratio you find on the new fee disclosures. Net expense ratios pay for the investment, gross expense ratios include pay for the broker and can be further broken down into sub-transfer fees, 12(b) 1 fees and sales charges.
Item 3. Other Asset Based Costs: Sometimes advisers and insurance companies charge “wrap fees” in addition to, or instead of, high gross fund expense ratios explained above in item two. Like expense ratios, asset based fees are expressed as a percentage and are usually under 1%. So if the plan is charged a wrap fee of 0.50% and the total plan assets are $1,000,000, than the wrap fee is another $5,000 a year. This fee may not be listed on the initial disclosures in July, so verify this cost by asking to see your plans “Investment Adviser or Services Contract” or “Group Annuity Contract.” If the fee is sucked out of participant accounts (which most are) it will now be shown on participant statements starting with the August 30th disclosures to participants.
Other: If plan participants take out a loan or request a distribution they will be charged a seperate fee. It is usually listed under “participant services” but compared to the ongoing costs above, it is noise.
Now that we have a handle on the items above, ask everyone that is associated with your plan what they get paid. Generally the record-keeper gets the fees in item one. The broker or salesperson gets the 12b1 fees built into the gross investment expense ratio in item 2, and other advisers or the insurance company get the compensation from any wrap fees in item three.
A finial note of caution: 401(k) cost is like a shell game. If the business owner complains about the cost of the 401(k) plan, it can just be shifted into higher investment expenses, wrap fees or hard dollar costs the employees are paying. Magic. Now the plan looks free to the business owner. Please remember that there is no free lunch and that the three items above must be evaluated as a whole.
The government is trying to help us on 401(k) fee disclosure. It is time we became educated consumers and help ourselves. I hope the three points above help.