Private Pensions
401(k) Plan Participants and Sponsors Need Better Information on Fees Gao ID: GAO-08-95T October 24, 2007According to Labor's most recent data, there are an estimated 44 million active participants in 401(k) plans. As participants accrue earnings on their investments, they also pay a number of fees, associated with 401(k) plans. Over the course of the employee's career, fees may significantly decrease retirement account balances. For plan sponsors, understanding the fees they are being charged helps fulfill their fiduciary responsibility to act in the best interest of plan participants. GAO's prior work on 401(k) fees found that fee disclosures are limited and do not allow an easy comparison of investment options. GAO previously made recommendations to both Congress and Labor on ways to improve the disclosure of fee information to both plan participants and sponsors. 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 about the way fee information could be disclosed to benefit 401(k) participants and sponsors, focusing on 1) the information on fees that could be most useful for plan participants and plan sponsors and 2) how such information could be effectively presented. To complete this statement, GAO relied on previous work and also utilized information from Labor and from industry experts on the subject of fee disclosure to participants.
Fee disclosure serves different functions for plan participants and sponsors. Studies have shown that 401(k) participants often lack basic knowledge about the fees associated with their plan. Participants need information about the direct expenses that could be charged to their accounts. As we previously recommended and most experts agree, the expense ratio--a fund's operating fees as a percentage of its assets--is a fundamental piece of information for participants. Plan sponsors, in contrast, need a range of fee information to fulfill their fiduciary responsibilities. Sponsors need additional information on service providers, investment options, and revenue sharing arrangements to assist them in monitoring plan fees and determining whether they continue to be reasonable in light of the services provided. Labor 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. Whether participants receive only basic expense ratio information or more detailed information on fees, presenting the information in a clear, easily comparable format can help participants understand the content of the disclosure. GAO's prior reports found that certain practices help people understand complicated information. For example, using clear language and a straightforward layout in a brief document can enhance the accessibility of financial information. Also, providing graphics and less text can both attract recipient attention and make detailed information more quickly and easily understandable.
GAO-08-95T, Private Pensions: 401(k) Plan Participants and Sponsors Need Better Information on Fees
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Testimony:
Before the Special Committee on Aging, U.S. Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 10:30 a.m. EDT:
Wednesday, October 24, 2007:
Private Pensions:
401(k) Plan Participants and Sponsors Need Better Information on Fees:
Statement of Barbara D. Bovbjerg, Director Education, Workforce, and
Income Security Issues:
GAO-08-95T:
GAO Highlights:
Highlights of GAO-08-95T, a testimony before the Senate Special
Committee on Aging.
Why GAO Did This Study:
According to Labor‘s most recent data, there are an estimated 44
million active participants in 401(k) plans. As participants accrue
earnings on their investments, they also pay a number of fees,
associated with 401(k) plans. Over the course of the employee‘s career,
fees may significantly decrease retirement account balances. For plan
sponsors, understanding the fees they are being charged helps fulfill
their fiduciary responsibility to act in the best interest of plan
participants.
GAO‘s prior work on 401(k) fees found that fee disclosures are limited
and do not allow an easy comparison of investment options. GAO
previously made recommendations to both Congress and Labor on ways to
improve the disclosure of fee information to both plan participants and
sponsors. 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
about the way fee information could be disclosed to benefit 401(k)
participants and sponsors, focusing on 1) the information on fees that
could be most useful for plan participants and plan sponsors and 2) how
such information could be effectively presented. To complete this
statement, GAO relied on previous work and also utilized information
from Labor and from industry experts on the subject of fee disclosure
to participants.
What GAO Found:
Fee disclosure serves different functions for plan participants and
sponsors. Studies have shown that 401(k) participants often lack basic
knowledge about the fees associated with their plan. Participants need
information about the direct expenses that could be charged to their
accounts. As we previously recommended and most experts agree, the
expense ratio”a fund‘s operating fees as a percentage of its assets”is
a fundamental piece of information for participants. Plan sponsors, in
contrast, need a range of fee information to fulfill their fiduciary
responsibilities. Sponsors need additional information on service
providers, investment options, and revenue sharing arrangements to
assist them in monitoring plan fees and determining whether they
continue to be reasonable in light of the services provided. Labor 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.
Whether participants receive only basic expense ratio information or
more detailed information on fees, presenting the information in a
clear, easily comparable format can help participants understand the
content of the disclosure. GAO‘s prior reports found that certain
practices help people understand complicated information. For example,
using clear language and a straightforward layout in a brief document
can enhance the accessibility of financial information. Also, providing
graphics and less text can both attract recipient attention and make
detailed information more quickly and easily understandable.
Figure: Participants‘ Response to Survey Question on Awareness of Fees:
This is a pie graph showing how much people knew about fees and
expenses they are paying for their 401(k) plan. 17% were aware, and 83%
were not aware.
[See PDF for image]
Source: AARP‘S Survey of 401(k) Participants' Awareness and
Understanding of Fees, July 2007.
[End of figure]
To view the full product, including the scope and methodology, click on
GAO-08-95T.
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 be here to discuss how best to disclose fee information
to 401(k) participants and plan sponsors. Fees can significantly
decrease participants' retirement savings over the course of a career.
For 401(k) participants, 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. For plan sponsors,
understanding the fees being charged helps fulfill their fiduciary
responsibility to act in the best interest of plan participants.
Given that fees can have a large impact on an individual's account
balance over time, it is important that both participants, as
investors, and plan sponsors, typically the employer, receive the fee
information necessary to make informed decisions. The Department of
Labor (Labor) is currently drafting regulations on the disclosure of
fees to participants, and Congress is now considering legislation to
improve such disclosure. These efforts have generated debate about the
type of fee information participants and sponsors may need, and the
amount and format of fee information that should be disclosed. As
Congress considers these issues, you asked us to provide information
about the way fees could be disclosed to benefit 401(k) participants
and sponsors. My remarks today will focus on 1) the information on fees
that could be most useful for plan participants and sponsors and 2) how
such information can be presented to participants so that it is easily
understandable.
To describe the fee information that should be provided to 401(k) plan
participants and sponsors, 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 participants, and Labor's oversight of
fees. We also used information from Labor and from industry experts on
the subject of fee disclosure to participants. To consider how such fee
information should be provided to participants, we reviewed our
previous work on the understandability of Social Security and other
disclosures, and utilized available industry information on the
subject. We conducted our review from September 2007 through October
2007 in accordance with generally accepted government auditing
standards.
In summary, fee disclosure serves different functions for plan
participants and sponsors. Participants need information about the
direct expenses that could be charged to their accounts. As we
previously recommended and most experts agree, the expense ratio--a
fund's operating fees as a percentage of its assets--is a fundamental
piece of information for plan participants. Some experts also recommend
that other types of fees be disclosed, such as certain types of annual
fees, and fees that are not necessarily investment-specific. Plan
sponsors, in contrast, need a range of fee information to fulfill their
fiduciary responsibilities. Thus, sponsors need additional information
on service providers, investment options, and revenue sharing
arrangements to fulfill their duties as fiduciaries. Such information
assists them in monitoring plan fees and determining whether the fees
charged continue to be reasonable in light of the services provided.
Labor is currently considering what fee information should be provided
to participants and what format to enable participants to easily
compare fees across a plan's various investment options. The agency
also has ongoing efforts designed to help participants and sponsors
understand the importance of plan fees and the effect of those fees on
retirement savings.
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. The language, layout, length,
comparability, and distribution are among the important considerations
that can inform the design of fee disclosure. In our prior reports on
helping the public understand Social Security publications and on more
effective disclosures for credit cards, we found that certain practices
help people understand complicated information. For example, using
clear language and a straightforward layout in a brief document can
enhance the accessibility of financial information. Further, providing
graphics and less text can both attract recipient attention and make
detailed information more quickly and easily understandable.
Background:
According to Labor's most recent data, an estimated 41 million
participants in 401(k) plans are permitted to direct the investment of
all or a portion of their plans' accounts from among the choices
offered by their plans. As participants accrue earnings on their
investments, they also pay a number of fees, covering expenses,
commissions, or other charges associated with 401(k) plans. Over the
course of the employee's career, fees may significantly decrease
retirement account balances. For example, even a 1-percentage point
difference in fees can significantly reduce the amount of money
available for retirement. Figure 1 assumes an employee of 45 years of
age with 20 years until retirement changes employers and leaves $20,000
in a 401(k) account until retirement. If the average annual net return
is 6.5 percent--a 7 percent investment return minus a 0.5 percent
charge for fees--the $20,000 will grow to about $70,500 at retirement.
However, if fees are instead 1.5 percent annually, the average net
return is reduced to 5.5 percent, and the $20,000 will grow to only
about $58,400. The additional 1 percent annual charge for fees would
reduce the account balance at retirement by about 17 percent.
Figure 1: Effect of 1 Percentage Point in Higher Annual Fees on a
$20,000 401(k) Balance Invested over 20 Years:
This figure is GAO analysis in a combination line chart showing the
effect of 1 percentage point in higher annual fees on a $20,000 401(k)
balance invested over a period of 20 years. The lines represent
accumulated balance with 0.5 percent charge for fees, and accumulated
account balance with 1.5 percent charge for fees.
[See PDF for image]
Source: GAO analysis.
[End of figure]
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 basic knowledge about the fees
associated with their plan. As shown in figure 2, in a recent
nationwide survey, 83 percent of 401(k) participants reported not
knowing how much they pay in fees. When asked whether they pay any fees
for the 401(k) plan, less than one-fifth (17%) said they do pay fees.
As figure 3 shows, almost two-thirds responded that they do not pay
fees (65%) and 18% stated that they do not know.[Footnote 1]
Figure 2: Participants' Response to Survey Question on Awareness of
Fees:
This is a pie graph showing how much people knew about fees and
expenses they are paying for their 401(k) plan. 17% were aware, and 83%
were not aware.
[See PDF for image]
Source: AARP's Survey of 401 (k) Participants' Awareness and
Understanding of Fees, July 2007.
[End of figure]
Figure 3: Participants' Response to Survey Question on Awareness of
Fees:
This is a pie graph showing how many people knew whether they pay any
fees for their 401 (k) plan. 65% paid no fee, 18% did not know, and 17%
paid fees.
[See PDF for image]
Source: AARP's Survey of 401 (k) Participants' Awareness and
Understanding of Fees, July 2007.
[End of figure]
Industry professionals agree that making participants who direct their
investments more aware of fees would help them make more informed
investment decisions.
Enacted before these types of plans came into wide use, the Employee
Retirement Income Security Act (ERISA) of 1974[Footnote 2] 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 3] 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 4] 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.
In our November 2006 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.[Footnote 5] 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 6] 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 plan practitioners. 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 which facilitates comparison. However, most 401(k) investment
options have expense ratios that can be compared; according to industry
data, the majority of 401(k) assets are in investment options, such as
mutual funds that are generally required to present the expense ratio
in a prospectus.
Plan sponsors, on the other hand, may currently 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. In addition to investment fees,
sponsors may receive information about fees 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 7]
Generally, information on 401(k) fees is reported on two sections of
the Form 5500, Schedule A and Schedule C.[Footnote 8] However, our
November 2006 reported that the form is of little use to plan sponsors
and others in terms of understanding the cost of a plan.[Footnote 9]
While plan sponsors may receive information on investment and other
fees, they may not be receiving information on certain undisclosed
business arrangements. We previously reported that several
opportunities exist for 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. Without disclosing these arrangements, service
providers may be steering plan sponsors toward investment products or
services that may not be in the best interest of participants. 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 recommended that Congress consider amending
ERISA to require that service providers disclose to plan sponsors the
compensation that providers receive from other service providers.
H.R. 3185, the 401(k) Fair Disclosure for Retirement Security Act of
2007, was introduced in Congress on July 26, 2007, and H.R. 3765, the
Defined Contribution Plan Fee Transparency Act of 2007, was introduced
on October 4, 2007. The first bill if enacted would, among other
things, amend ERISA to require detailed fee disclosures from service
providers to plan sponsors, as well as from plans to participants, and
establish additional specific requirements related to the selection of
investment options by 404(c) plan sponsors. It would also require Labor
to take various steps related to the enforcement of these requirements
and would create statutory penalties for failure to comply. The second
bill would amend the Internal Revenue Code to impose taxes on any
defined contribution plan administrator failing to provide plan
participants with prescribed information about plan fees and expenses,
and on any plan service provider failing to provide defined
contribution plan administrators prescribed information about plan fees
and expenses. Both bills suggest that a satisfactory disclosure to
participants would include a statement explaining that investments
should not be selected based solely on the level of fees charged but
also on careful consideration of a range of factors including the
alternatives' risk level, historic returns, and investment objectives.
Basic Fee Information is Important for Participants to make Informed
Decisions but Plan Sponsors Require Broader Information:
Fee disclosure serves different functions for plan sponsors and
participants. Participants need fee information to make informed
decisions about their investments--primarily, whether to contribute to
the plan (and at what level) and how to allocate their contributions
among the investment options the plan sponsor has selected. As we
previously recommended and most experts agree, the expense ratio is a
fundamental piece of information for plan participants. Plan sponsors,
as fiduciaries, must consider a range of information, in addition to
information on fees, such as hiring and supervising plan service
providers, selecting investment options, and reviewing the
reasonableness of plan fees.
Participants Need Fee Information to Make Informed Comparisons and
Decisions about How to Direct their Investments:
Although it is clear that participants require fee information to make
informed decisions, it is not so clear what fee information is most
relevant. Better disclosure of fee information is important because
participants in 401(k) plans generally receive less information and
guidance from investment professionals regarding their investment
decisions than direct investors. According to industry experts,
participants need to be given information about the direct expenses
that could be charged to their accounts.
In our 2006 report on fees, we found that fees are charged by the
various outside companies that the plan sponsor hires to provide a
number of services necessary to operate a plan. Services can include:
* investment management (i.e., selecting and managing the securities
included in a mutual fund; marketing the fund and compensating brokers
who sell the fund;[Footnote 10] and providing other shareholder
services, such as distributing the fund prospectus);[Footnote 11]
* recordkeeping (i.e., tracking individual account contributions);
* consulting and providing financial advice (i.e., selecting vendors
for investment options or other services);
* custodial or trustee services for plan assets (i.e. holding the plan
assets in a bank); and:
* telephone or Web-based customer services for participants.
In our 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 12] As mentioned earlier, there have been 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, such options
have expense ratio equivalents that investment industry professionals
can identify. Despite the general consensus that the expense ratio is
the most fundamental piece of information that participants receive on
fees, industry officials also believe that other fees should be
disclosed to participants. For example, annual fees or fees on a per-
transaction basis could be disclosed, such as administrative and
recordkeeping fees, participant loan origination fees, and annual loan
charges.[Footnote 13]
In addition, industry professionals also recommended that additional
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 14]
Industry experts said that it was important that participants receive
information about their investment returns. For example, some officials
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, but not the only one, to consider when directing
their investments. In fact, most experts agree that risk and historical
performance are important factors for participants to also consider
when making investment decisions.
Although some industry experts believe that participants should be
provided comparative benchmarks for their investment options, not all
experts agreed.[Footnote 15] Most industry experts we consulted
believed that benchmarks would be more useful for plan sponsors. Since
plan participants do not have any control over the investment options
offered in a plan, experts 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. Experts also noted that although there are appropriate
benchmarks for mutual funds, benchmarks are not as readily available
for other types of investment products.
Industry experts agreed that overall there is certain minimum
information that participants should receive for each investment option
offered under all self-directed plans, such as 1) the types of
securities held and investment objectives of the product; 2) the
principal risks associated with investing in the product; 3) annual
fees and expenses expressed in a ratio or fee table; 4) information on
historical performance; and 5) the identity of the investment manager
of the plan's investments. Disclosure of this information is
appropriate for all types of investment options available under the
plan regardless of type and can fill in the gaps in the information
currently required to be provided to participants. For example, with
the exception of mutual funds, for most other types of investment
products, important information--such as operating expenses and
historical performance--is available only on request. Industry experts
support requiring the provision of a summary document for all self-
directed plans that provides, for each investment product, the type of
information that investors value and use.
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 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 proposed 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.
Broader Information Can Help Plan Sponsors Fulfill Their Fiduciary
Responsibilities:
Although participants' fee requirements are more specific to the
investment options offered to them by the plan sponsor, a broader
spectrum of information relating to fees is needed by plan sponsors. In
order to carry out their duties, plan sponsors have an obligation under
ERISA to prudently select and monitor plan investments, 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 continually need, in addition to information on fees,
information on service providers, investment options, and revenue
sharing arrangements in order to monitor a plan's fees and expenses to
determine whether they 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 16] 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.
Labor, in its comments to 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 17] 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.
Making Fee Information Easy to Understand and Compare Can Help 401(k)
Participants with Disclosed Information:
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 18] These practices include:
* language--writing information in clear language;
* lay-out--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.
Language: We previously noted that certain disclosure materials for the
public should be written at or below an eighth-grade reading level
given the diverse population receiving it. Unclear or highly technical
language can affect the understandability of disclosures to
participants. Plain English can reduce confusion and promote
comprehension. Currently, according to one industry expert,
prospectuses do not provide an understandable summary of investments or
their expenses to participants since prospectuses are largely written
to protect the fund. As disclosures address fees beyond the expense
ratio, clear language remains important so that participants understand
what key fees mean and when they apply.
Layout: Some consumer and industry groups emphasized the need for a
straightforward layout. In response to Labor's Request For Information
on fee disclosure to participants,[Footnote 19] one industry group
stated that disclosure with a simple format may lead some participants
to consider fees as one of many factors in their investment decisions.
The group added that complex language or layout hinders meaningful
disclosure. Similarly, in our previous work on Social Security
disclosures, we noted that the design of certain disclosures did not
clearly identify the most important information or easily lead the
reader through the document. For example, letters and statements to
beneficiaries were harder to follow when the order of information did
not flow logically or the most important information did not appear
first in the document. Another aspect of layout--the use of
inappropriate font sizes and styles--can make a disclosure more
difficult for consumers to read, as we found in our prior work on
credit card fee disclosures. For example, materials that excessively
use capital letters or a small font may be more difficult to read.
Our prior work also revealed that using graphics helps people
understand complicated information or information that needs to be
compared. Table 1 shows an example of how industry associations suggest
that the expense ratio and other fee information could be disclosed to
plan participants. Using a table can be a particularly effective way to
convey information. In a previous report, we noted that using graphics
to replace text and make some information more quickly and easily
understandable was a common theme that emerged in the suggestions made
by focus groups and a benefits consulting firm.
Table 1: Sample Participant Fee Disclosure Form:
Investment expenses: Investment option: AAA investment;
Investment expenses: Participant's assets: $5,000;
Investment expenses: Expense ratio (as a percentage): 0.30%;
Investment expenses: Additional fees: 0.00%.
Investment expenses: Investment option: BBB investment;
Investment expenses: Participant's assets: $6,000;
Investment expenses: Expense ratio (as a percentage): 0.22%;
Investment expenses: Additional fees: 0.00%.
Investment expenses: Investment option: CCC investment;
Investment expenses: Participant's assets: $12,000;
Investment expenses: Expense ratio (as a percentage): 0.36%;
Investment expenses: Additional fees: 2.00%.
Investment expenses: Investment option: DDD investment;
Investment expenses: Participant's assets: $0;
Investment expenses: Expense ratio (as a percentage): 0.43%;
Investment expenses: Additional fees: 1.50%.
Investment expenses: Investment option: EEE investment;
Investment expenses: Participant's assets: $0;
Investment expenses: Expense ratio (as a percentage): 0.27%;
Investment expenses: Additional fees: 0.00%.
Investment expenses: Investment option: FFF investment;
Investment expenses: Participant's assets: $42,000;
Investment expenses: Expense ratio (as a percentage): 0.18%;
Investment expenses: Additional fees: 0.00%.
Investment expenses: Investment option: GGG investment;
Investment expenses: Participant's assets: $3,000;
Investment expenses: Expense ratio (as a percentage): 0.60%;
Investment expenses: Additional fees: 1.00%.
Administrative and transactional expenses: Service: Annual
administrative and recordkeeping charge;
Administrative and transactional expenses: Amount of fee: $50 per year.
Administrative and transactional expenses: Service: Brokerage account;
Administrative and transactional expenses: Amount of fee: $60 per year.
Administrative and transactional expenses: Service: Participant loan
origination fee;
Administrative and transactional expenses: Amount of fee: $50 per loan.
Administrative and transactional expenses: Service: Annual loan charge;
Administrative and transactional expenses: Amount of fee: $25 per year.
Source: Industry associations, including the American Society of
Pension Professionals & Actuaries and the Council of Independent 401(k)
Recordkeepers.
[End of table]
Length: In addition to clear language and layout, the length of the
document can influence how useful it is for participants. Some groups
have concerns that too much information can overwhelm participants. For
participant-directed plans, a few studies have shown that more
investment options are correlated with reduced participation or other
outcomes, possibly because of too many choices or information overload.
Shorter disclosures are emerging for a number of vehicles for
retirement savings. For example, the Securities and Exchange Commission
(SEC) is currently considering rules to develop a streamlined
prospectus. This affects the presentation of information about mutual
funds, which constitute over half of 401(k) assets according to
industry data. Omitting unnecessary details from disclosure documents
makes recipients more likely to read and understand information they
contain.
Clear, short annual disclosures do not preclude making additional
information available, especially when using an electronic format. With
401(k) plans, the availability of additional material permits
participants to review greater detail about fees and other fund
characteristics through documents like a prospectus or fund profile.
These additional sources can be paper or electronic, and industry
groups noted that an electronic format can allow layered disclosure
with initial summary information and links to further material or
source documents. In addition, providing ways for participants to
obtain more detailed information is helpful. For example, experts we
consulted during our work on the Social Security Statements[Footnote
20] advised that statements should contain directions on how to obtain
additional information.
Comparability: Our November 2006 report on 401(k) fees emphasized the
importance of a single document that facilitates the comparison of fund
options. In their responses to Labor's Request for Information,
industry groups recently reiterated the importance of disclosures that
promote comparisons, which would assist participants and treat
providers of different types of investments evenly. As we recommended
to Congress, disclosure in a single document that includes expense
ratios should occur in a way that promotes easy comparison. Similarly,
additional fees like redemption fees or surrender charges that may
relate to certain investment options can also be compared in one
document enabling participants to know what fees they may incur for
activities like buying and selling in certain funds. Disclosures in
multiple documents may be more difficult for the reader to use because
they may require more work to find information, especially when
delivered over time.
Distribution: Possible ways to deliver 401(k) fee disclosure include
both paper and electronic distribution. Paper reports, such as summary
plan descriptions, prospectuses for mutual funds, and other documents,
traditionally have been used to provide pension and fee information.
Not all participants have computer or internet access, and many may
prefer paper disclosure, as indicated by a recent nationwide survey
about 401(k) fee disclosure. Although paper disclosure rather than
electronic delivery may suit certain participants, many industry groups
place emphasis on computer-based formats, partly to lower costs like
printing and mailing and to allow layered disclosure by clicking to
more detailed information or source documents. One industry association
commented that Internet-based information is easier to maintain and
update so that it tends to be more timely and accurate.
Recent pension legislation has discussed electronic disclosure in some
circumstances. The Pension Protection Act of 2006 allows paper,
electronic, or other formats for benefit statements to the extent that
the format is reasonably accessible to the participant or
beneficiary.[Footnote 21] In guidance about benefit statements issued
in 2006, Labor stated that continuous access to one or more secured Web
sites is one way of providing information as long as, among other
things, notification about the sites includes the right to request and
obtain free paper versions. In addition, Labor has issued a regulation
for the general use of electronic disclosure to participants and
beneficiaries.[Footnote 22] Also, SEC has recently adopted and proposed
rules with increased electronic disclosure, partly to reduce costs,
which allow for paper disclosure as well as electronic
delivery.[Footnote 23]
Conclusions:
It is apparent that both 401(k) plan participants and sponsors need fee
information in order to make the most informed decisions. However,
given the voluminous amount of information that could be disclosed to
participants, 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.
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. The mere act of requiring such
information may actually promote competition among the entities that
provide services to plans and possibly reduce the amount of fees
service providers charge.
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, Monika R. Gomez, Matthew J. Saradjian, Daniel F. Alspaugh,
Susannah L. Compton, Craig H. Winslow, and Walter K. Vance.
[End of section]
Footnotes:
[1] AARP Knowledge Management, 401(k) Participants' Awareness and
Understanding of Fees, (Washington, D.C.: July 2007). AARP commissioned
a nationally representative survey of 1,584 401(k) plan participants
ages 25 and older. The survey was fielded from June 8th through June
24th, 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.
[2] 29 U.S.C. §§ 1001-1461.
[3] 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).
[4] 29 U.S.C. § 1002(21).
[5] 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.: November 16, 2006).
[6] ERISA Section 404(c) 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).
[7] 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 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.
[8] 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.
[9] Labor's ERISA Advisory Council Working Group on Plan Fees and
Reporting on Form 5500 came to this conclusion, stating 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.
[10] 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.
[11] Investment fees are usually different for each investment option
available to participants in a 401(k) plan, account for the bulk of
plan fees, and are paid by participants.
[12] 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.
[13] 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.
[14] Wrap fees are for various expenses, such as sales commissions,
administrative expenses, and/or recordkeeping 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 recordkeeping and
administration.
[15] A benchmark is used to compare specific investment results with
that of the market or economy. Some industry experts believe that plan
sponsors, as they monitor investment alternatives, should review
investment-alternative results against appropriate benchmarks and
compare their plans' investment options to competing funds with similar
styles.
[16] Float revenue is revenue earned from the short-term investment of
plan assets.
[17] Statement of Bradford P. Campbell, Assistant Secretary of Labor,
Before the Committee on Education and Labor, U.S. House of
Representatives, Oct. 4, 2007.
[18] 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).
[19] 72 Fed. Reg. 20,457 (Apr. 25, 2007).
[20] GAO-05-192.
[21] Pub. L. No. 109-280, § 508(a), 120 Stat. 780, 949-51 (codified at
29 U.S.C. § 1025).
[22] 29 C.F.R. § 2520.104b-1(c) (2007).
[23] 72 Fed. Reg. 42,222 (Aug. 1, 2007).
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