Private Pensions
Information That Sponsors and Participants Need to Understand 401(k) Plan Fees
Gao ID: GAO-08-222T October 30, 2007
Employers are increasingly moving away from traditional pension plans to what has become the most dominant and fastest growing type of plan, the 401(k). For 401(k) plan sponsors, understanding the fees being charged helps fulfill their fiduciary responsibility to act in the best interest of plan participants. Participants should consider fees as well as the historical performance and investment risk for each plan option when investing in a 401(k) plan because fees can significantly decrease retirement savings over the course of a career. GAO's prior work found that information on 401(k) fees is limited. GAO previously made recommendations to both Congress and the Department of Labor (Labor) on ways to improve the disclosure of fee information to plan participants and sponsors and reporting of fee information by sponsors to Labor. Both Labor and Congress now have efforts under way to ensure that both participants and sponsors receive the necessary fee information to make informed decisions. These efforts on the subject have generated significant debate. This testimony provides information on 401(k) plan fees that (1) sponsors need to carry out their responsibilities to the plan and (2) plan participants need to make informed investment decisions. To complete this statement, GAO relied on previous work and additional information from Labor and industry professionals regarding information about plan fees.
Information on 401(k) plan fee disclosure serves different functions for plan sponsors and participants. Plan sponsors need to understand a broad range of information on expenses associated with their plans to fulfill their fiduciary responsibilities. Sponsors need information on expenses associated with the investment options that they offer to participants and the providers they hire to perform plan services. Such information would help them meet their fiduciary duty to determine if expenses are reasonable for the services provided. In addition, sponsors also need to understand the implication of certain business arrangements between service providers, such as revenue sharing. Despite some disagreements about how much information is needed, industry professionals have made various suggestions to help plan sponsors collect meaningful information on expenses. Labor has also undertaken a number of activities related to the information on plan fees that sponsors should consider. Participants need fee information to make informed decisions about their investments--primarily, whether to contribute to the plan and how to allocate their contributions among the investment options the plan sponsor has selected. However, many participants are not aware that they pay any fees, and those who are may not know how much they are paying. Most industry professionals agree that information about an investment option's relative risk, its historic performance, and the associated fees is fundamental for plan participants. Some industry professionals also believe that other fees that are also charged to participants should be understood, so that participants can clearly see the effect these fees can have on their account balances.
GAO-08-222T, Private Pensions: Information That Sponsors and Participants Need to Understand 401(k) Plan Fees
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Testimony before the Committee on Ways and Means, House of
Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 10:00 a.m. EDT:
Tuesday, October 30, 2007:
Private Pensions:
Information That Sponsors and Participants Need to Understand 401(k)
Plan Fees:
Statement of Barbara D. Bovbjerg, Director:
Education, Workforce, and Income Security Issues:
GAO-08-222T:
GAO Highlights:
Highlights of GAO-08-222T, a testimony before the Committee on Ways and
Means, House of Representatives
Why GAO Did This Study:
Employers are increasingly moving away from traditional pension plans
to what has become the most dominant and fastest growing type of plan,
the 401(k). For 401(k) plan sponsors, understanding the fees being
charged helps fulfill their fiduciary responsibility to act in the best
interest of plan participants. Participants should consider fees as
well as the historical performance and investment risk for each plan
option when investing in a 401(k) plan because fees can significantly
decrease retirement savings over the course of a career.
GAO‘s prior work found that information on 401(k) fees is limited. GAO
previously made recommendations to both Congress and the Department of
Labor (Labor) on ways to improve the disclosure of fee information to
plan participants and sponsors and reporting of fee information by
sponsors to Labor. Both Labor and Congress now have efforts under way
to ensure that both participants and sponsors receive the necessary fee
information to make informed decisions. These efforts on the subject
have generated significant debate. This testimony provides information
on 401(k) plan fees that (1) sponsors need to carry out their
responsibilities to the plan and (2) plan participants need to make
informed investment decisions. To complete this statement, GAO relied
on previous work and additional information from Labor and industry
professionals regarding information about plan fees.
What GAO Found:
Information on 401(k) plan fee disclosure serves different functions
for plan sponsors and participants. Plan sponsors need to understand a
broad range of information on expenses associated with their plans to
fulfill their fiduciary responsibilities. Sponsors need information on
expenses associated with the investment options that they offer to
participants and the providers they hire to perform plan services. Such
information would help them meet their fiduciary duty to determine if
expenses are reasonable for the services provided. In addition,
sponsors also need to understand the implication of certain business
arrangements between service providers, such as revenue sharing.
Despite some disagreements about how much information is needed,
industry professionals have made various suggestions to help plan
sponsors collect meaningful information on expenses. Labor has also
undertaken a number of activities related to the information on plan
fees that sponsors should consider.
Participants need fee information to make informed decisions about
their investments”primarily, whether to contribute to the plan and how
to allocate their contributions among the investment options the plan
sponsor has selected. However, many participants are not aware that
they pay any fees, and those who are may not know how much they are
paying. Most industry professionals agree that information about an
investment option‘s relative risk, its historic performance, and the
associated fees is fundamental for plan participants. Some industry
professionals also believe that other fees that are also charged to
participants should be understood, so that participants can clearly see
the effect these fees can have on their account balances.
Figure: Participants' Response to Survey Questions on Awareness of
Fees: Do you know how much in fees and expenses you are paying for your
401(k) plan?
This is a pie chart showing the percentage of people surveyed who knew
how much they were paying in fees and expenses for their 401(k) plan.
83% were not aware, and 17% were aware of how much they were paying.
[See PDF for image]
Source: AARP's Survey of 4019k) Participants' Awareness and
Understanding of Fees, developed and deployed by Knowledge Networks,
July 2007.
[End of figure]
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.GAO-08-222T]. For more information, contact
Barbara D. Bovbjerg at (202) 512-7215 or bovbjergb@gao.gov.
[End of section]
Mr. Chairman and Members of the Committee:
I am pleased to discuss the information that sponsors and participants
need to better understand the fees associated with their 401(k) plans.
Named after section 401(k) of the Internal Revenue Code, 401(k) plans
are private sector pension plans that typically allow workers to save
for retirement by diverting a portion of their pretax income into an
investment account that can grow tax-free until withdrawn in
retirement. Over the past two decades there has been a noticeable shift
in the types of plans employers are offering employees. Employers are
increasingly moving away from traditional defined benefit plans to what
has become the most dominant and fastest growing type of defined
contribution plan, the 401(k).[Footnote 1] As workers accrue earnings
on their investments, they also pay a number of fees, including
expenses, commissions, or other charges associated with a 401(k) plan.
For plan sponsors, understanding their expenses helps fulfill their
fiduciary responsibility to act in the best interest of plan
participants. Given this responsibility and the potentially large
impact on an individual's account balance over time, it is important
that both plan sponsors, typically the employer, and participants, as
investors, receive and understand the fee information necessary to make
informed decisions. Even a small fee deducted from a worker's assets
today could represent a large amount of money years later had it
remained in the account to be reinvested. The Department of Labor
(Labor) is currently finalizing regulations on the disclosure of fees
to participants, and several bills have been introduced to improve such
disclosure. These efforts have generated debate about the type of fee
information sponsors and participants may need, and the amount and
format of fee information that should be disclosed. As Congress
considers these issues, you asked us to describe information sponsors
and participants need about fees. My remarks today will focus on the
information on fees that (1) sponsors need to carry out their
responsibilities to the plan and (2) plan participants need to make
informed investment decisions.
To describe the fee information needed by 401(k) plan sponsors and
participants, we relied on our previous work that examined the types of
fees associated with 401(k) plans and who pays these fees, how
information is disclosed to sponsors and participants, and Labor's
oversight of fees.[Footnote 2] We also used information from Labor and
from industry professionals on the subject of fee disclosure to plan
sponsors. We conducted our review in October 2007 in accordance with
generally accepted government auditing standards.
In summary, plan sponsors need to understand a broad range of
information on expenses associated with their 401(k) plans to fulfill
their fiduciary responsibilities. For example, sponsors need
information on expenses associated with the investment options that
they offer to participants and the providers they hire to perform plan
services. Such information would help them meet their fiduciary duty to
determine if expenses are reasonable for the services provided. In
addition, sponsors need to understand the implication of certain
business arrangements between service providers, such as revenue
sharing. While industry professionals might agree about some of the
information that sponsors need, they disagree about how much
information is needed about individual expense components when a
package of plan services, known as a "bundled" arrangement, is sold to
a sponsor for a single price. Despite this disagreement, industry
professionals have made various suggestions to help plan sponsors
collect meaningful information on expenses. Labor has also undertaken a
number of activities related to the information on plan expenses that
sponsors should consider.
Participants need fee information to make informed decisions about
their investments--primarily, whether to contribute to the plan and how
to allocate their contributions among the investment options the plan
sponsor has selected. To make informed decisions, participants need to
be made aware of an investment option's relative risk, its historic
performance, and the fees they pay. However, many participants are not
aware that they pay any fees, and of those who are, most may not know
how much they are paying. Most industry professionals agree that
information about investment fees, such as the expense ratio--a fund's
operating fees as a percentage of its assets--is fundamental for plan
participants. Some industry professionals also believe that other fees
that are also charged to participants should be understood so that
participants can clearly see the effect these fees can have on their
account balances.
Background:
Roughly half of all workers participate in an employer-sponsored
retirement, or pension, plan. Private sector pension plans are
classified as either defined benefit or defined contribution plans.
Defined benefit plans promise to provide, generally, a fixed level of
monthly retirement income that is based on salary, years of service,
and age at retirement, regardless of how the plan's investments
perform. In contrast, benefits from defined contribution plans are
based on the contributions to and the performance of the investments in
individual accounts, which may fluctuate in value.
The Employee Retirement Income Security Act of 1974 (ERISA) [Footnote
3] establishes the responsibilities of employee benefit plan decision
makers and the requirements for disclosing and reporting plan fees.
Typically, the plan sponsor is a fiduciary.[Footnote 4] A plan
fiduciary includes a person who has discretionary authority or control
over plan management or any authority or control over the management or
disposition of plan assets.[Footnote 5] ERISA requires that plan
sponsors responsible for managing employee benefit plans carry out
their plan responsibilities prudently and solely in the interest of the
plan's participants and beneficiaries. Plan sponsors, as fiduciaries,
are required to act on behalf of plan participants and their
beneficiaries. These responsibilities include:
* selecting and monitoring service providers to the plan,
* reporting plan information to the government and to participants,
* adhering to the plan's investment policy statement and other plan
documents (unless inconsistent with ERISA),
* identifying parties-in-interest to the plan and taking steps to
monitor transactions with them,
* selecting investment options the plan will offer and diversifying
plan investments, and:
* ensuring that the services provided to their plan are necessary and
that the cost of those services is reasonable.
Plan sponsors may receive some information on an investment option's
expenses that includes management fees, distribution and/or service
fees, and certain other fees, such as accounting and legal fees. These
fees are usually disclosed in the fund's prospectus or fund profile. To
better enable the agency to effectively oversee 401(k) plan fees, we
recommended in November 2006 that the Secretary of Labor should require
plan sponsors to report to Labor a summary of all fees that are paid
out of plan assets or by participants. This summary should list fees by
type, particularly investment fees that are being indirectly incurred
by participants.
In addition to receiving information about investment fees, sponsors
may receive information about expenses for administration and other
aspects of plan operations. Sponsors can also have providers fill out
the Form 5500, which ultimately gets filed with Labor,[Footnote 6] and
includes information about the financial condition and operation of
their plans. Generally, information on 401(k) expenses is reported on
two sections of the Form 5500, Schedule A and Schedule C.[Footnote 7]
However, our November 2006 study reported that the form is of little
use to plan sponsors and others in terms of understanding the cost of a
plan.[Footnote 8]
While plan sponsors may receive information on investment and other
fees, they may not be receiving information on certain relevant
business arrangements. In November 2006, we reported that several
opportunities exist for such business arrangements to go undisclosed,
given the various parties involved in creating and administering 401(k)
plans. Problems may occur when pension consultants or other companies
providing services to a plan also receive compensation from other
service providers. Service providers may be steering plan sponsors
toward investment products or services in which they have a direct
business interest themselves without disclosing such arrangements. In
addition, plan sponsors, being unaware, are often unable to report
information about these arrangements to Labor on Form 5500 Schedule C.
Our November 2006 report also recommended that Congress consider
amending ERISA to require that service providers disclose to plan
sponsors the compensation that providers receive from other service
providers.
In our prior report on 401(k) fees, we found that the fee information
that ERISA requires 401(k) plan sponsors to disclose is limited and
does not provide participants with an easy way to compare investment
options. All 401(k) plans are required to provide disclosures on plan
operations, participant accounts, and the plan's financial status.
Although they often contain some information on fees, these documents
are not required to disclose the fees borne by individual participants.
Overall, we found that the information currently provided to
participants does not provide a simple way for them to compare plan
investment options and their fees, and are provided to participants in
a piecemeal fashion.
Additional fee disclosures are required for certain--but not all--plans
in which participants direct their investments. ERISA requires
disclosure of fee information to participants where plan sponsors seek
liability protection from investment losses resulting from
participants' investment decisions. Such plans--known as 404(c) plans-
-are required to provide participants with a broad range of investment
alternatives, descriptions of the risks and historical performance of
such investment alternatives, and information about any transaction
fees and expenses in connection with buying or selling interests in
such alternatives.[Footnote 9] Upon request, 404(c) plans must also
provide participants with, among other information, the expense ratio
for each investment option. Plan sponsors may voluntarily provide
participants with more information on fees than ERISA requires,
according to industry professionals. For example, plan sponsors that do
not elect to be 404(c) often distribute prospectuses or fund profiles
when employees become eligible for the plan, just as 404(c) sponsors
do. Still, absent requirements to do so, some plan sponsors may not
identify all the fees participants pay.
Some participants may be able to make comparisons across investment
options by piecing together the fees that they pay, but doing so
requires an awareness of fees that most participants do not have.
Assessing fees across investment options can be difficult for
participants because the data are typically not presented in a single
document that facilitates comparison. However, most 401(k) investment
options have expense ratios that are provided in prospectuses or fund
profiles and can be compared; based on industry data, expenses for the
majority of 401(k) assets, which are in investment options such as
mutual funds, can be expressed as an expense ratio.
Sponsors Must Consider a Broad Range of Information to Fulfill Their
Fiduciary Responsibilities:
Plan sponsors, as fiduciaries, must consider plan fee information
related to a broad range of functions. According to Labor, ERISA
requires that sponsors evaluate fee information associated with the
investment options offered to participants and the providers they hire
to perform plan services and consider the reasonableness of the
expenses charged by the various providers of services to the plan. In
addition, the sponsor must understand information concerning certain
arrangements, such as when a service provider receives some share of
its revenue from a third party. While industry professionals might
agree about some of the information that sponsors need, they disagree
about how much information is needed about individual expense
components when a package of plan services, known as a bundled
arrangement, is sold to a sponsor for a single price. Some pension plan
associations and practitioners have made various suggestions to help
plan sponsors collect meaningful information on expenses. Labor has
also undertaken a number of activities related to the information on
plan expenses that sponsors should consider.
Sponsors Need Information to Evaluate Fees and Expenses Associated with
Investment Options and Plan Services:
In order to carry out their duties, plan sponsors have an obligation
under ERISA to prudently select and monitor plan investment options
made available to the plan's participants and beneficiaries and the
persons providing services to the plan. Understanding and evaluating
the fees and expenses associated with a plan's investments and services
are an important part of a fiduciary's responsibility. Plan sponsors
need to monitor the fees and expenses associated with the plan's
investment options and the services provided by outside vendors,
including any revenue sharing arrangements, to determine whether the
expenses continue to be reasonable for the services provided.
Industry experts have suggested that plan sponsors be required to
obtain complete information about investment options before adding them
to the plan's menu and obtain information concerning arrangements where
a service provider receives some share of its revenue from a third
party. A number of associations recently put together a list of service-
and fee-related data elements they believe defined contribution plan
sponsors and service providers should discuss when entering into
agreements. The data elements include such information as payments
received by plan service providers from affiliates in connection with
services to the plan, float revenue,[Footnote 10] and investment-
related consulting services. The list is meant as a reference tool for
plan sponsors and providers to use to determine the extent to which a
service provider receives compensation in connection with its services
to the plan from other service providers or plan investment products
(e.g., revenue sharing or finders' fees). According to the associations
that formulated this tool, the information can aid plan sponsors to
evaluate any potential conflicts of interest that may arise in how fees
are allocated among service providers.
In our prior work, we noted that plan sponsors may not have information
on arrangements among service providers that, according to Labor
officials, could steer plan sponsors toward offering investment options
that benefit service providers but may not be in the best interest of
participants. For example, the Securities and Exchange Commission (SEC)
released a report in May 2005 that raised questions about whether some
pension consultants are fully disclosing potential conflicts of
interest that may affect the objectivity of the advice.[Footnote 11] In
addition, specific fees that are considered to be "hidden" may mask the
existence of a conflict of interest. Hidden fees are usually related to
business arrangements where one service provider to a 401(k) plan pays
a third-party provider for services, such as record keeping, but does
not disclose this compensation to the plan sponsor. The problem with
hidden fees is not how much is being paid to the service provider, but
with knowing what entity is receiving the compensation and whether or
not the compensation fairly represents the value of the service being
rendered.
While there is general agreement that understanding the fees and
expenses associated with a plan's services is an important part of a
fiduciary's responsibility, pension professionals disagree about how
much information is needed about the expense components of bundled fee
arrangements. One representative speaking on behalf of five industry
associations stated he did not believe that the requirement to
"unbundle" bundled services and provide individual costs in many
detailed categories was particularly helpful because the information
provided would not be very meaningful and the costs of providing this
information would ultimately be passed on to plan participants through
higher administrative fees. He also raised concerns about how a service
provider would disclose component costs for services that are not
offered outside a bundled contract. In addition, he said that posting
such information could force public disclosure of proprietary
information regarding contracts between service providers and plan
sponsors. Finally, he stated that as long as they are fully informed of
the services being provided, many plan sponsors might prefer reviewing
aggregate costs so that they can compare and evaluate whether the
overall fees are reasonable without analyzing each itemized fee.
On the other hand, a representative of another pension association
contended that it is possible with very little cost to develop an
allocation methodology to provide a reasonable breakdown of fees for
plan services. He believes that not disclosing component pricing
provides a competitive advantage, enabling bundled providers to tell
plan sponsors that they can offer certain retirement plan services for
free--when fees are deducted from investment returns--while unbundled
providers are required to disclose the fees for the same services. He
further stated that any disclosure requirements should apply uniformly
to all service providers. In his view this would allow plan fiduciaries
to assess the reasonableness of fees by comparison and thereby allow
fiduciaries to determine whether certain services are needed, which
could lead to lower fees.
Plan Sponsors Need to Collect and Evaluate Meaningful Information on
Expenses:
Industry professionals have suggested that, before hiring a service
provider or adding investment options to the plan's menu, plan sponsors
should obtain complete fee information, including information
concerning arrangements in which a service provider receives some share
of its revenue from a third party. Pension plan associations and
practitioners have made various suggestions to help plan sponsors
collect meaningful information on expenses.
In 2004 the ERISA Advisory Council on Employee Welfare and Pension
Benefit Plans created a Working Group to study retirement plan
investment management fees and expenses as they were currently reported
to Labor.[Footnote 12] In addition to issues related to annual
reporting, the Working Group was also interested in determining whether
plan sponsors currently receive adequate data from the service
providers in order to both understand and report fees. In its final
report, the Working Group made the following recommendations, among
others, in an effort to further educate plan sponsors and fiduciaries
about plan fees:[Footnote 13]
* Plan sponsors should avoid entering transactions with vendors who
refuse to disclose the amount and sources of all fees and compensation
received in connection with plan.
* Plan sponsors should require plan providers to provide a detailed
written analysis of all fees and compensation (whether directly or
indirectly) to be received for its services to the plan prior to
retention.
* Plan sponsors should obtain all information on fees and expenses as
well as revenue sharing arrangements with each investment option. Plan
sponsors should also determine the availability of other mutual funds
or share classes within a mutual fund with lower revenue sharing
arrangements prior to selecting an investment option.
* Plan sponsors should require vendors to provide annual written
statements with respect to all compensation, both direct and indirect,
received by the provider in connection with its services to the plan.
* Plan sponsors need to be aware that with asset-based fees, fees can
grow just as the size of the asset pool grows, regardless of whether
any additional services are provided by the vendor, and as a result,
asset-based fees should be monitored periodically.
* Plan sponsors should calculate the total plan costs annually.
More recently in 2007, one witness before the ERISA Advisory Council
recommended further that plan sponsors should evaluate fees associated
with three categories of services:[Footnote 14]
* Net investment expenses would not only include investment expenses,
such as the expense ratio of a mutual fund, but would also subtract any
fees or commissions paid to a broker, consultant, or advisor for
services in the categories below.
* Administrative expenses would include specific charges for
operational services, such as record keeping, administration,
compliance, and communication, as well as revenue sharing or other
payments from investments.
* Advisory expenses would include amounts paid directly by the plan to
consultants, advisors, or brokers, as well as indirect payments from
sources such as investments or related companies.
In addition, some industry professionals believe that plan sponsors, as
they monitor investment alternatives, should review investment
alternative results against appropriate benchmarks and compare their
plans' options to competing funds with similar investment
goals.[Footnote 15] A benchmark is used to compare specific investment
results with that of the market or economy. Industry professionals also
noted that although there are appropriate benchmarks for mutual funds,
benchmarks are not as readily available for other types of investment
products. According to one industry professional that we spoke with,
plan sponsors do not have good benchmarks to assess the reasonableness
of investment options' expense ratios. Only limited information is
available, and a national database of funds and their expense ratios
does not exist. He further stated that without such a source, selecting
which funds constitute a meaningful comparison set is not an easy task,
and may be open to interpretation. Disclosure encourages price
competition, but in his opinion, because of the lack of available
information, the 401(k) market is relatively ineffective at fostering
price competition.
Labor's Initiatives Related to 401(k) Plan Sponsors:
Labor, in its comments on our November 2006 report, stated that the
agency has proposed a number of changes to the Form 5500, including
changes that would expand the information required to be reported on
the Schedule C. The changes are intended to assist plan sponsors in
assessing the reasonableness of compensation paid for services and
potential conflicts of interest that might affect those services.
According to testimony earlier this month from the Assistant Secretary
of Labor, the agency will be issuing a final regulation requiring
additional public disclosure of fee and expense information on the Form
5500 within the next few weeks.[Footnote 16] This change will be
helpful to plan sponsors as they look retrospectively at the preceding
plan year. In addition, Labor was considering an amendment to its
regulation under section 408(b)(2) of ERISA, expected to be issued this
year. This amendment would help to ensure that plan sponsors have
sufficient information on the compensation to be paid to the service
provider and the revenue sharing compensation paid by the plan for the
specific services and potential conflicts of interest that may exist on
the part of the service provider.
Labor's ERISA Advisory Council currently has a working group focusing
on fiduciary responsibility and revenue sharing. One area of focus is
what service providers should be required to provide when they enter
into a revenue sharing or rebate arrangement. Labor also provides a
model form on its Web site specifically designed to assist plan
fiduciaries and service providers in exchanging complete disclosures
concerning the costs involved in service arrangements. Other
associations and entities continue to develop model fee disclosure
forms for plan sponsors.
We are currently conducting work in the area of 401(k) plan sponsor
practices, identifying how plan sponsors decide which features to
include in the plans they establish and how plan sponsors oversee plan
operations. Part of our work will consider how plan sponsors monitor
the fees charged to their plans. We expect to issue a report in 2008.
Basic Fee Information Is Important for Participants to Make Informed
Decisions:
Before making informed decisions about their 401(k) plan investments,
participants must first be made aware of the types of plan fees that
they pay. For example, according to one nationwide survey, some
participants do not even know that they pay plan fees. In 2006, we
reported that investment fees constitute the majority of fees in 401(k)
plans and are typically borne by participants. Most industry
professionals agree that information about investment fees--such as the
expense ratio, a fund's operating fees as a percentage of its assets--
is fundamental for plan participants. Participants also need to be
aware of other types of fees--such as record-keeping fees and
redemption fees or surrender charges imposed for changing or selling
investments--to gain a more complete understanding of all the fees that
can affect their account balances. Whether participants receive only
basic expense ratio information or more detailed information on various
fees, presenting the information in a clear, easily comparable format
can help participants understand the content of the disclosure.
Participants May Not Be Aware of the Fee Information Needed to Make
Informed Decisions:
Currently, most participants are responsible for directing their
investments among the choices offered by their 401(k) plans, but may
not be aware of the different fees that they pay. According to industry
professionals, participants are often unaware that they pay any fees
associated with their 401(k) plan. In fact, studies have shown that
401(k) participants often lack the most basic knowledge--that there are
fees associated with their plan. When asked in a recent nationwide
survey whether they pay any fees for the 401(k) plan, as figure 1
shows, 65 percent of 401(k) participants responded that they do not pay
fees.[Footnote 17] Seventeen percent said they do pay fees, and 18
percent stated that they do not know. When this same group was asked
how much they pay in fees, as shown in figure 2, 83 percent reported
not knowing.
Figure 1: Participants' Response to Survey Question on Awareness of
Fees: Do you know whether you pay any fees for your 401(k) plan?:
This figure is a pie chart showing the percentage of people who knew
whether they were paying any fees for their 401 (k) plan. 65% said that
they paid no fees. 18% did not know, and 17% paid fees.
[See PDF for image]
Source: AARP's Survey of 401(k) Participants' Awareness of
Understanding of Fees, developed and deployed by Knowledge Networks,
July 2007.
[End of figure]
Figure 2: Participants' Response to Survey Questions on Awareness of
Fees: Do you know how much in fees and expenses you are paying for your
401(k) plan?
This figure is a pie chart showing the percentage of people surveyed
who knew how much they were paying in fees and expenses for their
401(k) plan. 83% were not aware, and 17% were aware of how much they
were paying.
[See PDF for image]
Source: AARP's Survey of 4019k) Participants' Awareness and
Understanding of Fees, developed and deployed by Knowledge Networks,
July 2007.
[End of figure]
Participants Need Information on Investment Fees:
Although it is clear that participants require fee information to make
informed decisions, it is not so clear what fee information is most
relevant. In 2006, we reported that investment fees constitute the
majority of fees in 401(k) plans and are typically borne by
participants. Investment fees are, for example, fees charged by
companies that manage a mutual fund for all services related to
operating the fund. These fees pay for selecting a mutual fund's
portfolio of securities and managing the fund; marketing the fund and
compensating brokers who sell the fund; and providing other shareholder
services, such as distributing the fund prospectus.[Footnote 18] These
fees are charged regardless of whether the mutual fund or other
investment product, such as collective investment funds or group
annuity contracts, is part of a 401(k) plan or purchased by individual
investors in the retail market.[Footnote 19] As such, the fees are
usually different for each investment option available to participants
in a 401(k) plan.
In our previous report, we recommended that Congress consider amending
ERISA to require all sponsors of participant-directed plans to disclose
fee information on 401(k) investment options to participants in a way
that facilitates comparison among the options, such as via expense
ratios.[Footnote 20] As mentioned earlier, there have been at least two
bills recently introduced in Congress on the subject. Industry
professionals have also suggested that comparing the expense ratio
across investment options is the most effective way to compare options'
fees. They generally agree that an expense ratio provides valuable
information that participants need and can be used to compare
investment options because it includes investment fees, which
constitute most of the total fees borne by participants. According to
an industry official, the disclosure of expense ratios might include a
general description of how expense ratios vary depending on the type
and style of investment. For example, investment options with
relatively high fees, such as actively managed funds, tend to have
larger expense ratios than funds that are not actively managed. Also,
investment options that are only available to institutional investors
tend to have lower expense ratios than other types of funds.
Most of the investment options offered in 401(k) plans have expense
ratios that can be compared, but this information is not always
provided to participants. In addition, investment options other than
mutual funds may not be required to produce prospectuses that include
expense ratios, but according to industry professionals, most options
have expense ratio equivalents that investment industry professionals
can identify.
Participants Also Need Information on Other Fees That Affect Their
Account Balances:
Industry professionals also believe that participants need information
on other fees that are not included in the expense ratio but still
affect their account balances. For example, annual fees or fees on a
per transaction basis that can be deducted from account balances should
be disclosed, such as administrative and record-keeping fees,
participant loan origination fees, and annual loan charges.[Footnote
21]
In addition, industry professionals also recommended that certain
investment-specific fees be disclosed, including:
* redemption fees or sales charges--fees that may be imposed by the
provider as a result of changing investments in a given period,
* surrender charges--fees that may be imposed as a result of selling or
withdrawing money from the investment within a given number of years
after investing, and:
* wrap fees--fees that are assessed on the total assets in a
participant's account.[Footnote 22]
Some industry professionals recommended that plan participants be
provided information on their returns net of all fees so that they can
clearly see what their investments have earned after fees. Others
recommended that information be disclosed that explains how the
investment and administrative costs of the plan affect their investment
returns and their overall retirement savings in the plan. These
officials believed that such information would help participants
understand that fees are an important factor to consider when directing
their investments.
Whether participants are provided with basic expense ratio information
or more detailed information on various fees, or both, providing the
information in a clear, easily comparable format can assist
participants in understanding the information disclosed. In our prior
reports on helping the public understand Social Security information
and on more effective disclosures for credit cards, we found that
certain practices help people understand complicated
information.[Footnote 23] These practices include:
* language--writing information in clear language,
* layout--using straightforward layout and graphics,
* length--providing a short document,
* comparability--making options easy to compare in a single document,
and:
* distribution--offering a choice of paper or electronic distribution.
Labor's Initiatives Related to 401(k) Plan Participants:
In our prior work, we noted that Labor is considering the development
of a new rule regarding the fee information required to be furnished to
participants under its section 404(c) regulation. According to Labor
officials, they are attempting to identify the critical information on
fees that plan sponsors should disclose to participants of 404(c) plans
(but not all participant-directed plans) and the best way to do so. The
initiative is intended to explore what steps might be taken to ensure
that participants have the information they need about their plan and
available investment options, without imposing additional costs, given
that such costs are likely to be charged against the individual
accounts of participants and affect their retirement savings. The
officials are currently considering what fee information should be
provided to participants and what format would enable participants to
easily compare the fees across a plan's various investment options.
Labor is also currently evaluating comments received from consumer
groups, plan sponsors, service providers, and others as it develops its
regulation.
Labor also has ongoing efforts designed to help participants and plan
sponsors understand the importance of plan fees and the effect of those
fees on retirement savings. Labor has developed and makes available on
its Web site a variety of educational materials specifically designed
to help plan participants understand the complexities of the various
fee and compensation arrangements involved in 401(k) plans. Its
brochure titled A Look at 401(k) Plan Fees is targeted to participants
and beneficiaries of 401(k) plans who are responsible for directing
their own investments.
Conclusions:
Both 401(k) plan sponsors and participants need fee information in
order to make the most informed decisions. For plan sponsors, requiring
that certain information on fees be disclosed can help them understand
what services they are paying for, who is benefiting, and whether their
current arrangements are in the best interest of plan participants.
Requiring plan sponsors to report more complete information to Labor on
fees--including those paid out of plan assets by participants--would
put the agency in a better position to effectively oversee 401(k) plans
and, in doing so, to protect an increasing number of participants. The
mere act of requiring such information may actually promote competition
among the entities that provide services to plans and possibly reduce
the fees service providers charge.
For plan participants, given the voluminous amount of information that
could be disclosed, determining the relevant information that
participants most need is key. At a minimum, providing information such
as expense ratios or other investment-specific fee information could be
the place to start. Also, making sure that the information is
accessible in terms of the language, layout, length, comparability, and
distribution can ensure that participants actively utilize the
information disclosed. As participants become more sophisticated or
demand more information, decisions can then be made about the type and
format of additional fee information.
Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions you or other members of the committee may have
at this time.
Contacts and Acknowledgements:
For further information regarding this testimony, please contact
Barbara D. Bovbjerg, Director, Education, Workforce, and Income
Security Issues, at (202) 512-7215 or bovbjergb@gao.gov. Contact points
for our Offices of Congressional Relations and Public Affairs may be
found on the last page of this statement. Individuals making key
contributions to this testimony include Tamara E. Cross, Assistant
Director; Daniel F. Alspaugh; Monika R. Gomez; Matthew J. Saradjian;
Susannah L. Compton; Craig H. Winslow; and Walter K. Vance.
Footnotes:
[1] Defined benefit plans, sometimes referred to as traditional pension
plans, generally provide a fixed level of monthly retirement income
that is based on salary, years of service, and age at retirement
regardless of how the plan's investments perform. In contrast, benefits
from defined contribution plans are based on the contributions to and
the performance of the investments in individual accounts, which may
fluctuate in value.
[2] GAO, Private Pensions: Changes Needed to Provide 401(k) Plan
Participants and the Department of Labor Better Information on Fees,
GAO-07-21 (Washington, D.C.: Nov. 16, 2006).
[3] 29 U.S.C. §§ 1001-1461.
[4] Any person who makes investment decisions with respect to a
qualified employee benefit plan's assets is generally a fiduciary. The
duties the person performs for the plan rather than their title or
office determines whether that person is a plan fiduciary. 29 U.S.C. §
1002(21)(A).
[5] 29 U.S.C. § 1002(21).
[6] The Form 5500 includes information on the plan's sponsor, the
features of the plan, and the number of participants. The form also
provides more specific information, such as information about plan
assets, liabilities, insurance, and financial transactions. Filing this
form satisfies the requirement for the plan administrator to file
annual reports concerning, among other things, the financial condition
and operation of plans. Labor uses this form as a tool to monitor and
enforce plan sponsors' responsibilities under ERISA.
[7] Schedule A is used to report fees and commissions paid to brokers
and sales agents for selling insurance products. Schedule C includes
information on the fees paid directly to service providers for all
other investment products, but excludes investment fees deducted from
returns. Schedule C also identifies service providers with fees in
excess of $5,000 by name.
[8] Labor's ERISA Advisory Council Working Group on Plan Fees and
Reporting on Form 5500 came to this conclusion, finding that only the
fees that are billed explicitly and are paid from plan assets are
deemed reportable. Many of the fees are associated with the individual
investment options in the 401(k) plan, such as a mutual fund, and are
deducted from investment returns and not reported to plan sponsors or
on the Form 5500.
[9] Section 404(c) of ERISA generally provides relief for plan
fiduciaries of certain individual account plans, such as 401(k) plans,
from liability for losses resulting from investment decisions made by
plan participants and beneficiaries. 29 U.S.C. § 1104(c). Implementing
regulations provide specifics for complying with section 404(c). 29
C.F.R. § 2550.404c-1 (2007).
[10] Float revenue is revenue earned from the short-term investment of
plan assets.
[11] U.S. Securities and Exchange Commission, Office of Compliance
Inspections and Examinations, Staff Report Concerning Examinations of
Select Pension Consultants, (Washington, D.C.: May 2005).
[12] Section 512 of ERISA provides for the establishment of an Advisory
Council on Employee Welfare and Pension Benefit Plans. The duties of
the council are to advise the Secretary and submit recommendations
regarding the Secretary's functions under ERISA. The council consists
of 15 members appointed by the Secretary of Labor: Three members are
representatives of employee organizations; three members are
representatives of employers; there is one representative each from the
fields of insurance, corporate trust, actuarial counseling, investment
counseling, investment management, and accounting; and three members
are representatives of the general public. 29 U.S.C. § 1142.
[13] Final Report of the 2004 ERISA Advisory Council Working Group,
Health and Welfare Form 5500 Requirements (Nov. 10, 2004).
[14] Written Comments of C. Frederick Reish, Reish Luftman Reicher &
Cohen, for Testimony before the 2007 U.S. Department of Labor Advisory
Council on Employee Welfare and Pension Benefits Plans Working Group on
Fiduciary Responsibilities Update and Revenue Sharing Practices, (Sept.
20, 2007).
[15] Although some industry professionals believe that participants
should be provided comparative benchmarks for their investment options,
not all industry professionals agreed. Most industry professionals we
consulted believed that benchmarks would be more useful for plan
sponsors than for participants. Since plan participants do not have any
control over the investment options offered in a plan, industry
professionals said that benchmarking is less useful to plan
participants than plan sponsors, since plan sponsors use benchmarks in
evaluating alternatives to their plans' investment options.
[16] Statement of Bradford P. Campbell, Assistant Secretary of Labor,
Before the Special Committee on Aging, U.S. Senate, Oct. 24, 2007.
[17] AARP Knowledge Management, 401(k) Participants' Understanding and
Awareness of Fees, (Washington, D.C.: July 2007). AARP commissioned a
nationally representative survey of 1,584 401(k) plan participants age
25 and older. The survey was fielded from June 8 through June 24, 2007,
by Knowledge Networks of Menlo Park, California, to members of its
nationally representative online panel. The overall sample was designed
to be nationally representative of 401(k) plan participants age 25 and
older.
[18] Fees related to marketing and compensating brokers to sell the
fund are known as 12b-1, or distribution fees, and are limited by the
Financial Industry Regulatory Authority, the entity that succeeded the
National Association of Securities Dealers Inc., to a maximum of 1
percentage point of the total expense ratio per year.
[19] Mutual funds that use brokers to sell shares may also impose a
sales fee, or "load," when a fund is bought, transferred, or sold to
compensate the broker. SEC does not limit the size of the sales load a
fund may charge, but the Financial Industry Regulatory Authority does
not permit exceeding 8.5 percent of the purchase price. A "front-end
load" is incurred when a mutual fund is purchased and reduces the
amount available to purchase fund shares. A "back-end load" is a fee
that is charged when a mutual fund is sold or transferred. Back-end
loads generally decrease over time in steps until they are eventually
eliminated.
[20] We found that it is hard for participants to make comparisons
across investment options because they have to piece together the fees
that they pay, and assessing fees across investment options can be
difficult because data are not typically presented in a single document
that facilitates comparison.
[21] Plan record-keeping fees cover individual account maintenance for
plan participants. They cover a variety of activities, such as
enrolling participants, processing fund selections, preparing and
mailing account statements, and other related administration
activities. A loan origination fee is charged to a participant who
elects to take a loan from the plan. The fee covers document
preparation and loan processing expenses. Annual loan charges are
imposed for account maintenance.
[22] Wrap fees are for various expenses, such as sales commissions,
administrative expenses, and/or recording keeping fees. However, wrap
fees can also be assessed against specific investment options and/or at
the plan level based on total plan assets. For example, a wrap fee may
be assessed against a "low fee" investment option because the
investment provider does not contribute toward the cost of plan record-
keeping and administration.
[23] GAO, Social Security Statements: Social Security Administration
Should Better Evaluate Whether Workers Understand Their Statements, GAO-
05-192 (Washington, D.C.: Apr. 1, 2005); GAO, Social Security
Administration: Longstanding Problems in SSA's Letters to the Public
Need to Be Fixed, GAO/HEHS-00-179 (Washington, D.C.: Sept. 26, 2000);
GAO, Credit Cards: Increased Complexity in Rates and Fees Heightens
Need for More Effective Disclosures to Consumers, GAO-06-929
(Washington, D.C.: Sept. 12, 2006); and GAO, SSA Benefit Statements:
Well Received by the Public but Difficult to Comprehend, GAO/HEHS-97-19
(Washington, D.C.: Dec. 5, 1996).
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