A new era in fee disclosure is about to begin in the 401(k) industry. New regulations implemented this year by the U.S. Department of Labor will improve transparency and expose hidden 401(k) administrative costs for all to see.
Currently, an estimated 72 million participants with nearly $3 trillion in assets are utilizing participant-directed plans covered by the new regulation. Many of these participants have been left in the dark for years when it comes to plan costs. In fact, according to a study done by AARP, 70 percent of plan participants were under the impression that their 401(k) was free.
With actual fees ranging from 1 percent to more than 3 percent of plan balances, employees will finally be equipped with details about the costs associated with their company retirement plan. The new fee disclosures provide an opportunity for participants to make better informed decisions when it comes to the management of their 401(k) nest eggs.
Only retirement plans subject to ERISA (the Employee Retirement Income Security Act) are covered by the disclosure requirements. These include defined benefit, profit sharing, 401(k) and some 403(b) plans, but not IRAs, Simple IRAs, Simplified Employee Pension Plans, or 403(b)s that are not covered by ERISA.
The new regulation requires detailed information be provided on both plan-related and investment-related fees. Plan-related fees generally involve expenses associated with the administration of the plan including plan record-keeping, accounting, legal and trust services.
Investment-related disclosures include information about the name and type of each designated investment alternative available under the plan, along with performance data, expenses, contact information, comparative data and a glossary of terms.
In addition, individual service fees associated with optional features such as a 401(k) loan offered under the plan will also be disclosed.
The growth of your retirement portfolio is dependent upon a few things. While larger contributions and positive investment returns may increase the future value of your portfolio, taxes and investment fees can have the opposite effect.
Let’s take a closer look at the impact of fees on a 401(k) plan. Assume that you are an employee with 30 years until retirement and annual savings of $10,000. If your average annual return is 7 percent and investment expenses are 1 percent, your account may be expected to grow to $790,000 at retirement. However, if expenses are closer to 2 percent, the future value of your savings is $664,000. Fees would have reduced your retirement portfolio by a staggering $126,000, or 16 percent.
Clearly, the purpose of the new disclosure law is to reduce the costs associated with 401(k) plans for participants and plan sponsors. According to Scott Schlafer, a senior benefits consultant at Paychex, “Transparency will lead to a reduction in 401(k) fees for participants in the long run.”
The Department of Labor’s Employee Benefits Security Administration (EBSA) estimates $12.2 billion in savings will be realized from the new regulation over the first 10 years alone. The belief is that plan sponsors will use the new information to shop around for more competitive options for their employees while participants will choose cheaper investment options within their plan.
Transparency is a big win for savers. However, some plan administrators have shared concerns regarding the adverse effects the new disclosures could have on participants. Investors must be careful not to use the new disclosures to chase past performance or choose only the cheapest investment options available within the plan. Avoiding asset classes such as emerging markets because they are traditionally more expensive could be detrimental to a long-term allocation.
Plan participants still need to review the performance, fees and overall asset allocation as they relate to the achievement of their long-term goals when selecting investments.
Kurt J. Rossi, MBA, is a Certified Financial Planner Practitioner. He can be reached for questions at (732) 280-7550 and kurt.rossi@Independentwm.com. LPL Financial Member FINRA/SIPC.