401K participants don't understand fees

The Department of Labor (DOL) released a groundbreaking final rule in 2012 that required plan sponsors to issue plainly written information about 401(k) fees. The Government Accountability Office (GAO) issued a study showing that despite plan sponsors’ efforts, 41 percent of plan participants don’t think they pay a dime for their 401(k)s.

Helping participants better understand 401(k) fees not only can improve participants’ financial wellness—it may reduce the risk of litigation for plan sponsors.
 

Both the DOL and Plan Sponsors Have Fallen Short

The DOL’s regulation in 2012 aimed to give plan participants the information necessary to make informed decisions on investments in their 401(k) accounts. The rule required plan sponsors to provide investment and administrative fee information on an ongoing basis. Plan sponsors must clearly show participants’ account-specific fees on a quarterly basis.

For many participants, disclosure statements can be confusing, the GAO found. For example, the DOL regulation does not specify or define the proper terminology for investment fees. As a result, the GAO found that 10 large 401(k) plans use 11 different terms for investment fees. This inconsistency in terminology may make it challenging for plan participants to compare fees on their plan investments versus other investment options.

The GAO made five specific recommendations for the DOL to amend its original regulation:

  1. Require consistent terms and measures for investment fees
  2. Show the actual cost of the investment fees
  3. Educate participants on the cumulative effect of fees over time
  4. Require fee benchmark information so participants can weigh the competitiveness of their investments
  5. Require investment ticker information so participants can research and compare their options

In its response to the GAO report, the DOL admitted that plan and investment fee information can be very complicated and that the GAO’s study demonstrated this. The DOL said the recommendations pose significant technical and feasibility challenges, and applying the suggestions would force it to forgo other initiatives. The GAO noted that the status of the recommendations remains open.

Plan Sponsors Can Help Themselves While Helping Participants

Ensuring that their participants get the information they need to make informed decisions is especially important given the recent uptick in fee-related litigation targeting plan sponsors. There are several ways that plan sponsors can implement changes before being on the defense in court.

A sensible place to start is with service providers. The DOL requires service providers to disclose their fee information to 401(k) plan fiduciaries. Plan sponsors must review and clearly understand this data, because any lack of clarity about the fees charged by service providers may eventually lead to confusion about participants’ fees.

The GAO reviewed methods used in Europe, Australia and New Zealand to improve participants’ understanding of fees and other plan-related information. Examples include:

  • Financial literacy: Educate participants on basic financial concepts such as compound interest.
  • Visual elements: Use histograms and icons to show cost information.
  • Cost breakdowns: Instead of issuing one final figure, break down fee information so participants can compare investment options.
  • Performance and fee information: Provide investment return estimates on participants’ accounts.
  • Page limits: Use fewer pages to help empower participants, not overwhelm them.
  • Standardized formats: Provide uniform retirement plan and product information to help participants compare investment options.
  • Promotion of fee awareness: Use advertising, social media, television and other outlets to increase fee awareness.

Insight: Get to Know Your Participants

Before embarking on a financial education campaign or revamping your communications, plan sponsors should start by engaging with their participants to gain a better understanding of their specific needs. Some participants may need financial literacy education, while others may need visual or auditory elements to help with their decision making. Plan sponsors should seek to develop a plan that works for their particular group of participants.

If you have questions about employee benefit plans, please reach out to Kevin Hamaker for more information.