The Labor Department has finally decided to increase disclosure requirements by retirement plan service providers regarding compensation arrangements and other potential conflicts of interest. In a nutshell, service providers of all types will be required by DOL regulation 408(b)(2) to have a written agreement which clearly elaborates on the various compensation arrangements within the plan which ultimately get paid by plan participants. The way it currently works, most investors in defined-contribution plans (401k & 403b) don’t have a clue about how, where, and when they pay the sum of these fees which often total up to 5% per year. The new regulations also apply to defined-benefit plans, but for the purpose of this article I’m primarily concerned with 401k and 403b (defined-contribution) plans. I’ve also touched below on some of the specifics of the desperately needed 403b regulations which will likely take affect next month.
I asked some friends before writing this article if they contributed to a 401k or 403b plan at work. Nearly all of them, especially those that received a matching contribution indicated that they defer thousands of dollars per year into these plans. I then asked what they paid annually in the way of plan fees and expenses. The response was an overwhelming “I have no idea.” This illustrates one of the major problems which these new regulation will address: There’s barely any transparency in retirement plans and that’s just how most of the retirement planning industry wants to keep it. The one person who did respond to my question quoted me some annual expense ratios for his 401k investments and an M&E figure charged by the insurance company. As savvy as this may have been for my friend, he’s still missing the majority of better hidden costs: 12b-1 fees, revenue-sharing arrangements, shareholder service fees, and sub-transfer agent fees would be the first that come to my mind.
Perhaps the most interesting reaction to these regulations–designed to help plan participants–will be from the plan providers and sponsors. Hopefully they will view these regulations as a mandate to not focus so much on profit going forward, but on better pricing for participants. What a novel concept!
Under 408(b)(2) the burden of figuring out the various compensation arrangements within a retirement plan will be shifted from the plan fiduciary to the service provider. The common sense here is that service providers already have a detailed knowledge of the fees and expenses inherent in their own plans. In the past, fiduciaries would inquire and try to make their own reasonable assessments about retirement plan fees and expenses. The plan providers will now have to offer clear, written facts about the plan for the fiduciary to evaluate with far less confusion than they may be used to. If they fail to do so, they will be in violation of the new regulations and be subject to reimbursing the plan sponsor and likely giving up their ability to provide further services to the plan.
New 403b rules
Along the same lines, the IRS has recently mandated that all 403b plans adopt a single statement which discloses key provisions of their plan to new and existing participants. This could easily become a sticky issue when considering how many vendors often service the same school district or hospital. The new regs will also require plan sponsors to take more responsibility for the decisions made by employees. This requirement is clearly following the multitude of scandals which have affected the 403b industry in the past few years, including unions receiving under-the-table payments in exchange for recommending high-priced service providers. Under the new rules, employers will be required to sign off on participant distributions, loans, contract exchanges, plan-to-plan transfers, etc. Ultimately, these changes are designed to prevent corruption and protect hard earned retirement savings.
So now the question becomes, will these new regulations actually help the investors who defer money each pay cycle into a 401k or 403b plan? According to an article in this month’s Financial Advisor magazine, The Labor Department estimates that these disclosures will save participants $6.1B over ten years, including $2.3B from lower fees as investment houses become more aware of costs and more competitive. Let’s hope that is true because investor’s faith in the honesty and integrity of the financial services community is practically non-existent at this point.
Question and comments always welcome.
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