408(B)2 Fee Disclosure Rules

It would seem obvious that 401(k) plan service providers should fully disclose all fees that they charge to 401(k) plan clients. Equally obvious is that employers should want to know about all fees before retaining a particular provider. In the real world neither of these things are always happening.

Perhaps it’s not surprising but there has been a lot of push back against 408(b)2 disclosure requirements from industry lobbyists. To our way of thinking, and perhaps it's because we have always fully disclosed this information, if a group of plan service providers are going to complain about this then perhaps they have something to hide. And if not outright hiding fees in the past many plan service providers have not made finding these fees very easy. There are also payments made to recordkeepers, for example, that just never show up anywhere for the plan sponsor to see. The service provider has to volunteer to talk about these payments which many are loath to do.

408(b)2 should have the effect of standardizing how fees and plan expenses are reported making comparisons between providers much easier. And along with these diclosures there is new imputus for employers to make sure the fees being charged to their plan are in fact reasonable. Unfortunately, the lack of a full understanding of the intricacies of just how fees are structured may endure as the disclosure format suggested by the Department of Labor is intended to help participatants compare investment options rather than truely educate employers and participants as to exactly what it is they are looking at. That true understandng probably requires the help of an experienced advisor as differentiated from an experienced salesperson which more aptly describes the "advisors" many, particularly smaller plans employ.

For example, many plan sponsors aren’t in full understanding of things like the varying expenses between share classes. One half of a percent in the difference in expense between an "A" share and an "R" share might not sound like a lot until you translate it into dollars and particularly when viewed over a period of many years. Many mutual funds have as many as 10 different share classes - same fund just 10 different fee structures. The new rules require that the fee be translated into dollars but only dollars per thousand in assets. Presumably people will be able to recognize there is a difference between $10 per thousand (1%) and $20 (2%) dollars per thousand but it would certainly have more impact if the person with $500,000 in the plan saw that number expressed as $5,000 per year as opposed to $10,000 per year in fees. As employers start to look at the fees being charged to their plans many will find that these extra 1% and 2% fees are in addition to fund management costs.

Investors need to consider the value received for any fees paid. Hedge fund managers, for example, routinely get paid a 2% management fee plus a share of the profits generated by the manager. Hedge fund investors are willing to pay high fees for what they hope will be high returns - no comment on the wisdom of that expectation. In the context of a 401(k) plan those fees would be clearly unreasonable and for that matter, the investment is also clearly inappropriate.

401(k) fees need to be reasonable, absolutely, but we don’t buy into the argument that the only sensible investment is to buy index mutual funds because they generally have the lowest costs. Several active managers we are familiar with while charging higher but still reasonable fees have regularly outperformed a comparible index over time, and this net of all fees. We have reams of evidence supporting this position. We only point this out because we believe that participants deserve the best possible investment managers we can find to help them on their journey to retirement.

It’s also clear that even the best managers may only provide an extra return of 2% per year on average so when fund expenses are too high it makes outperforming a relevant index very unlikely. Some plans, smaller plans in particular pay up to 3% in asset based fees. It's easy to understand why a plan service provider charging that kind of fee might not want to point out that fact but fees that high make investment success virtually impossible.

We have always been proponents of fee transparency. Whether using our internal recordkeeping systems or consulting with clients on provider search or their existing plan platform we want to make sure that the fiduciaries to the plan understand all revenue sources the service provider(s) receives and what they receive in return for those dollars. We also want them to know how those fees compare to alternate providers.

Providing these disclosures is business as usual for us but we are pleased to see that all providers of services to retirement plans will need to rise to this standard as well.

Not talked about as much as the fee disclosure aspects of 408(b)2 is the requirement that service providers declare whether they are acting as a fiduciary to the plan or not. That is a entirely different but equally important subject. Plan sponsors will now know which side of the table their advisors sit on.

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