Private Pensions
Increased Reliance on 401(k) Plans Calls for Better Information on Fees Gao ID: GAO-07-530T March 6, 2007Over 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). As more workers participate in 401(k) plans, they bear more of the responsibility for funding their retirement. Given the choices facing participants, specific information about the plan and plan options becomes more relevant than under defined benefit plans because participants are responsible for ensuring that they have adequate income at retirement. While information on historical performance and investment risk for each plan option are important for participants to understand, so too is information on fees because fees can significantly decrease participants' retirement savings over the course of a career. As a result of employees bearing more responsibility for funding their retirement under 401(k) plans, Congress asked us to talk about the prevalence of 401(k) plans today and to summarize our recent work on providing better information to 401(k) participants and the Department of Labor (Labor) on fees. GAO's remarks today will focus on (1) trends in the use of 401(k) plans, and (2) the types of fees associated with these plans.
There are an increasing number of active participants in 401(k) plans than in other types of employer-sponsored pension plans, a trend that has accelerated since the 1980s. Now, 401(k) plans represent the majority of all private pension plans; they also service the most participants and hold the most assets. These plans offer a range of investment options, but equity funds--those that invest primarily in stocks--accounted for nearly half of 401(k) assets at the close of 2005. Most 401(k) plans are participant-directed, meaning that a participant is responsible for making the investment decisions about his or her own retirement plan contributions. Inadequate disclosure and reporting requirements may leave participants without a simple way to compare fees among plan investment options, and Labor without the information it needs to oversee fees and identify questionable 401(k) business practices. The Employee Retirement Income Security Act (ERISA) of 1974 requires 401(k) plan sponsors to disclose only limited information on fees. Participants must collect various documents over time and may be required to seek out some documents in order to get a clear picture of the total fees that they pay. Furthermore, the documents that participants receive do not provide a simple way to compare fees--along with risk and historical performance--among the investment options in their 401(k) plan. The information reported to Labor does not identify all fees charged to 401(k) plans and therefore has limited use for effectively overseeing fees and identifying undisclosed business arrangements among consultants or service providers. As a result, participants may have more limited investment options and pay higher fees for these options than they otherwise would.
GAO-07-530T, Private Pensions: Increased Reliance on 401(k) Plans Calls for Better Information on Fees
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Testimony before the Committee on Education and Labor:
House of Representatives:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 11:00 a.m. EST:
Tuesday, March 6, 2007:
Private Pensions:
Increased Reliance on 401(k) Plans Calls for Better Information on
Fees:
Statement of Barbara D. Bovbjerg, Director:
Education, Workforce, and Income Security Issues:
GAO-07-530T:
GAO Highlights:
Highlights of GAO- 07-530T, a testimony before the Committee on
Education and Labor, House of Representatives
Why GAO Did This Study:
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).
As more workers participate in 401(k) plans, they bear more of the
responsibility for funding their retirement. Given the choices facing
participants, specific information about the plan and plan options
becomes more relevant than under defined benefit plans because
participants are responsible for ensuring that they have adequate
income at retirement. While information on historical performance and
investment risk for each plan option are important for participants to
understand, so too is information on fees because fees can
significantly decrease participants‘ retirement savings over the course
of a career. As a result of employees bearing more responsibility for
funding their retirement under 401(k) plans, you asked us to talk about
the prevalence of 401(k) plans today and to summarize our recent work
on providing better information to 401(k) participants and the
Department of Labor (Labor) on fees. My remarks today will focus on (1)
trends in the use of 401(k) plans, and (2) the types of fees associated
with these plans.
What GAO Found:
There are an increasing number of active participants in 401(k) plans
than in other types of employer-sponsored pension plans, a trend that
has accelerated since the 1980s. Now, 401(k) plans represent the
majority of all private pension plans; they also service the most
participants and hold the most assets. These plans offer a range of
investment options, but equity funds”those that invest primarily in
stocks”accounted for nearly half of 401(k) assets at the close of 2005.
Most 401(k) plans are participant-directed, meaning that a participant
is responsible for making the investment decisions about his or her own
retirement plan contributions. Inadequate disclosure and reporting
requirements may leave participants without a simple way to compare
fees among plan investment options, and Labor without the information
it needs to oversee fees and identify questionable 401(k) business
practices. The Employee Retirement Income Security Act (ERISA) of 1974
requires 401(k) plan sponsors to disclose only limited information on
fees. Participants must collect various documents over time and may be
required to seek out some documents in order to get a clear picture of
the total fees that they pay. Furthermore, the documents that
participants receive do not provide a simple way to compare fees”along
with risk and historical performance”among the investment options in
their 401(k) plan. The information reported to Labor does not identify
all fees charged to 401(k) plans and therefore has limited use for
effectively overseeing fees and identifying undisclosed business
arrangements among consultants or service providers. As a result,
participants may have more limited investment options and pay higher
fees for these options than they otherwise would.
Figure: Comparison of Defined Benefit Plans with Defined Contribution
Plans, 1985 and 2005:
[See PDF for Image]
Source: U.S. Department of Labor (1985-2003 data); Investment Company
Institute (2005 estimates).
[End of figure]
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-07-530T].
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Barbara D. Bovbjerg at
(202) 512-7215 or bovbjergb@gao.gov.
[End of figure]
Mr. Chairman and Members of the Committee:
I am pleased to be here to discuss American workers' increased
participation in 401(k) plans and the potential effects of the fees
associated with these plans on their retirement income. 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 more workers participate in 401(k) plans, they bear more of the
responsibility for funding their retirement than they do when covered
by traditional defined benefit plans. Under 401(k) plans, participants
are responsible for choosing how much of their pretax income to
contribute, how to invest their contributions in the choices offered by
the plan sponsor, and how to manage their 401(k) investments upon
retirement. Given the choices facing participants, specific information
about the plan and plan options becomes more relevant than under
defined benefit plans because participants are responsible for ensuring
that they have adequate income at retirement. Although information on
historical performance and investment risk for each plan option are
important for participants to understand, so too is information on fees
because fees can significantly decrease participants' retirement
savings over the course of a career. As a result of employees bearing
more responsibility for funding their retirement under 401(k) plans,
you asked us to talk about the prevalence of 401(k) plans in the
private pension system today and to summarize our recent work on
providing better information to 401(k) participants and the Department
of Labor (Labor) on fees. My remarks today will focus on (1) trends in
the use of 401(k) plans, and (2) the types of fees associated with
these plans and the information available to participants and Labor.
To describe the current trend toward the increased use of 401(k) plans,
we relied on our previous work on the nature of the private pension
system and information from Labor and industry research. Regarding plan
fees, we also relied on our previous work that looked at the types of
fees associated with 401(k) plans, who pays these fees, how information
is disclosed to participants, and Labor's oversight of fees and certain
related business arrangements.[Footnote 2] We conducted our review from
February 2007 through March 2007 in accordance with generally accepted
government auditing standards.
In summary, there are more active participants now in 401(k) plans than
other types of employer-sponsored pension plans, a trend that has
accelerated since the 1980s.[Footnote 3] Now, 401(k) plans represent
the majority of all private pension plans; they also service the most
participants and hold the most assets. These plans offer a range of
investment options, but equity funds--those that invest primarily in
stocks--accounted for nearly half of 401(k) assets at the close of
2005. Most 401(k) plans are participant-directed, meaning that a
participant is responsible for making the investment decisions about
his or her own retirement plan contributions.
Inadequate disclosure and reporting requirements may leave participants
without a simple way to compare fees among plan investment options, and
Labor without the information it needs to oversee fees and identify
questionable 401(k) business practices. The Employee Retirement Income
Security Act of 1974 (ERISA)[Footnote 4] requires 401(k) plan sponsors
to disclose only limited information on fees. Participants must collect
various documents over time and may be required to seek out some
documents in order to get a clear picture of the total fees that they
pay. Furthermore, the documents that participants receive do not
provide a simple way to compare fees--along with risk and historical
performance--among the investment options in their 401(k) plan. The
information reported to Labor does not identify all fees charged to
401(k) plans and therefore has limited use for effectively overseeing
fees and identifying undisclosed business arrangements among
consultants or service providers. As a result, participants may have
more limited investment options and pay higher fees for these options
than they otherwise would.
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. Examples of defined
contribution plans include 401(k) profit-sharing and thrift-savings
plans, stock bonus plans, and annuity plans.
Labor's Employee Benefits Security Administration (EBSA) oversees
401(k) plans--including the fees associated with running the plans--
because they are considered employee benefit plans under ERISA. Enacted
before 401(k) plans came into wide use, ERISA 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 5] A plan fiduciary includes a
person who has discretionary control or authority over the management
or administration of the plan, including the plan's assets. ERISA
requires that plan sponsors responsible for managing employee benefit
plans carry out their responsibilities prudently and do so solely in
the interest of the plans' participants and beneficiaries.
The law also provides Labor with oversight authority over pension
plans.[Footnote 6] However, the specific investment products commonly
contained in pension plans--such as company stock, mutual funds,
collective investment funds, and group annuity contracts--fall under
the authority of the applicable securities, banking, or insurance
regulators:
* The Securities and Exchange Commission (SEC), among other
responsibilities, regulates registered securities including company
stock and mutual funds under securities law.[Footnote 7]
* The federal agencies charged with oversight of banks--primarily the
Federal Reserve Board, the Treasury Department's Office of the
Comptroller of the Currency, and the Federal Deposit Insurance
Corporation--regulate bank investment products, such as collective
investment funds.
* State agencies generally regulate insurance products, such as
variable annuity contracts. Such investment products may also include
one or more insurance elements, which are not present in other
investment options. Generally, these elements include an annuity
feature, interest and expense guarantees, and any death benefit
provided during the term of the contract.[Footnote 8]
An Increasing Number of Employees Participate in Defined Contribution
Plans, and This Trend Has Been Increasing Since the 1980s:
The number of defined contribution plans has increased since 1985,
while the number of defined benefit plans has declined
dramatically.[Footnote 9] Figure 1 shows the growth of defined
contribution plans relative to that of defined benefit plans from 1985
to 2005.
Figure 1: Changes in the Number of Defined Benefit Plans and Defined
Contribution Plans, 1985-2005:
[See PDF for image]
Source: U.S. Department of Labor (1985-2003 data); Investment Company
Institute (2005 estimates).
Note: The Investment Company Institute's estimates for 2005 are based
on the Department of Labor, Form 5500 Annual Reports, and other
information.
[End of figure]
In 2005, more workers were covered by defined contribution plans than
by defined benefit plans. In 1985, defined benefit plans covered
approximately 29 million active participants, compared to 33 million
active participants in defined contribution plans. By 2005, the
difference in the numbers had become more pronounced, with roughly 21
million active participants covered by defined benefit plans and
approximately 55 million active participants in defined contribution
plans. Figure 2 shows the shift in active participants from defined
benefit to defined contribution plans since 1985.
Figure 2: Changes in the Number of Active Participants in Defined
Benefit Plans and Defined Contribution Plans, 1985-2005:
[See PDF for image]
Source: U.S. Department of Labor (1985-2003 data); Investment Company
Institute (2005 estimates).
Note: The Investment Company Institute's estimates for 2005 are based
on the Department of Labor, Form 5500 Annual Reports, and other
information.
[End of figure]
With the growth in plans and participants, the majority of private
pension plan assets are now held in defined contribution plans. As
shown in figure 3, defined benefit plan assets decreased from $2.0
trillion in constant 2006 dollars, or about 66 percent of total private
pension assets, in 1985 to $1.5 trillion, or just over 40 percent of
the total, in 2005.[Footnote 10]
Figure 3: Changes in Defined Benefit and Defined Contribution Plan
Assets, 1985-2005:
[See PDF for image]
Source: U.S. Department of Labor (1985-2003 data); Investment Company
Institute (2005 estimates).
Note: The Investment Company Institute's estimates for 2005 are based
on the Department of Labor, Form 5500 Annual Reports, and other
information.
[End of figure]
Similarly, the number of 401(k) plans grew from less than 30,000 in
1985, or less than 7 percent of all defined contribution plans, to an
estimated 417,000 plans, or about 95 percent of all defined
contribution plans in 2005. During this same time period, the number of
active participants in 401(k) plans increased from 10 million to 47
million, and plan assets increased from $270 billion to about $2.5
trillion in constant 2006 dollars.
Based on industry estimates, equity funds accounted for nearly half of
the 401(k) plan assets at the close of 2005.[Footnote 11] Equity funds
are investment options that invest primarily in stocks, such as mutual
funds, bank collective funds,[Footnote 12] life insurance separate
accounts, and certain pooled investment products (see fig. 4). Other
plan assets were invested in company stock; stable value
funds,[Footnote 13] including guaranteed investment contracts; balanced
funds;[Footnote 14] bond funds; and money funds. Several of these
options can be held in mutual funds, which in total represent about 51
percent of 401(k) plan assets. Common plan features, like the type and
number of investment options provided to participants in their 401(k)
plans, is a topic being studied under other GAO work on plan sponsor
practices requested by this committee.
Figure 4: 401(k) Plan Average Asset Allocation in 2005:
[See PDF for image]
Source: Investment Company Institute.
Note: The Investment Company Institute's estimates for 2005 are based
on the Department of Labor, Form 5500 Annual Reports; and other
information:
[End of figure]
With the growth in 401(k) plans, more workers now bear greater
responsibility for funding their retirement income. According to the
most recent data from Labor, the majority of 401(k) plans are
participant-directed, meaning that a participant makes investment
decisions about his or her own retirement plan contributions. In 2003,
about 88 percent of all 401(k) plans--covering 93 percent of all active
401(k) plan participants and 92 percent of all 401(k) plan assets--
generally allowed participants to choose how much to invest, within
federal limits, and to select from a menu of diversified investment
options selected by the employer sponsoring the plan.[Footnote 15]
While some participants have account balances of greater than $100,000,
most have much smaller balances. Based on industry estimates for 2005,
37 percent of participants had balances of less than $10,000, while 16
percent had balances greater than $100,000.[Footnote 16] The median
account balance was $19,328, while the average account balance was
$58,328. Participants' account balances also include any contributions
employers make on their behalf.
Fees are charged by the various outside companies that the plan
sponsor--often the employer offering the 401(k) plan--hires to provide
a number of services necessary to operate the plan. Services can
include investment management (i.e., selecting and managing the
securities included in a mutual fund); consulting and providing
financial advice (i.e., selecting vendors for investment options or
other services); record keeping (i.e., tracking individual account
contributions); 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. Generally there are two ways to provide
services: "bundled" (the sponsor hires one company that provides the
full range of services directly or through subcontracts) and
"unbundled" (the sponsor uses a combination of service providers).
Fees are one of many factors--such as the historical performance and
investment risk for each plan option--participants should consider when
investing in a 401(k) plan because fees can significantly decrease
retirement savings over the course of a career. As participants accrue
earnings on their investments, they pay a number of fees, including
expenses, commissions, or other charges associated with operating a
401(k) plan. Over the course of the employee's career, for example, a 1
percentage point difference in fees can significantly reduce the amount
of money saved for retirement. Figure 5 assumes an employee who is 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 5: Effect of 1 Percentage Point in Higher Annual Fees on a
$20,000 401(k) Balance Invested over 20 Years:
[See PDF for image]
Source: GAO analysis.
[End of figure]
Investment and Record-Keeping Fees Account for Most 401(K) Plan Fees,
but Information on These Fees May Be Limited or Unavailable to
Participants and Labor:
Various fees are associated with 401(k) plans, but investment and
record-keeping fees account for most 401(k) plan fees. However,
inadequate disclosure and reporting requirements may leave participants
and Labor without important information on these fees. The information
on fees that plan sponsors are required to disclose to participants
does not allow participants to easily compare the fees for the
investment options in their 401(k) plan. In addition, Labor does not
have the information it needs to oversee fees and identify questionable
401(k) business practices. Labor has several initiatives under way to
improve the information it has on fees and the various business
arrangements among service providers.
Investment Fees Account for Most 401(k) Plan Fees and Are Usually Borne
by Plan Participants:
Investment fees account for the largest portion of total fees
regardless of plan size, as figure 6 illustrates. 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.
Figure 6: Investment Fees as a Percentage of Total Plan Fees, 2005:
[See PDF for image]
Source: Investment Company Institute.
Note: The results of HR Investment Consultants' survey are based on
responses from 125 vendors that service 401(k) plans. This response
represents about 85 percent of the assets invested in 401(k) plans but
may not be representative of the universe of 401(k) plans.
[End of figure]
Plan record-keeping fees generally constitute the second-largest
portion of plan fees. Plan record-keeping fees are usually charged by
the service provider to set up and maintain the 401(k) plan. These fees
cover activities such as enrolling plan participants, processing
participant fund selections, preparing and mailing account statements,
and other related administrative activities. Unlike investment fees,
plan record-keeping fees apply to the entire 401(k) plan rather than
the individual investment options. As shown in figure 7, these fees
make up a smaller proportion of total plan fees in larger plans,
indicating economies of scale.
Figure 7: Plan Record-Keeping Fees as a Percentage of Total Plan Fees,
2005:
[See PDF for image]
Source: HR Investment Consultants.
Note: The results of HR Investment Consultants' survey are based on
responses from 125 vendors that service 401(k) plans. This response
represents about 85 percent of the assets invested in 401(k) plans but
may not be representative of the universe of 401(k) plans. While these
data include primarily record keeping, they include a negligible amount
of other administrative fees, according to the survey author.
[End of figure]
There are a number of other fees associated with establishing and
maintaining a plan, such as fees to communicate basic information about
the plan to participants. However, these fees generally constitute a
much smaller percentage of total plan fees than investment and plan
record-keeping fees.
Whether and how participants or plan sponsors pay these fees varies by
the type of fee and the size of the 401(k) plan. Investment fees, which
are usually charged as a fixed percentage of assets and deducted from
investment returns, are typically borne by participants. Plan record-
keeping fees are charged as a percentage of a participant's assets, a
flat fee, or a combination of both. Although plan sponsors pay these
fees in a considerable number of plans, they are increasingly being
paid by participants.
Required Disclosures Provide Limited Fee Information to Assist
Participants in Comparing Investment Options:
ERISA requires that plan sponsors provide all participants with a
summary plan description, account statements, and the summary annual
report, but these documents are not required to disclose information on
fees borne by individual participants. Table 1 provides an overview of
each of these disclosure documents, and the type of fee information
they may contain.
Table 1: Required Disclosure Documents to All Participants:
Disclosure document: Summary plan description;
Document purpose: To explain to participants how the plan operates;
Information on fees: May contain information on how various fees such
as investment, record- keeping, and loan fees are charged to
participants, but not required by ERISA to do so.
Disclosure document: Account statement;
Document purpose: To show the account balance due to a participant;
Information on fees: Typically identifies fees, such as for loans,
which are directly attributable to an account during a specific period.
Also, may show investment and record-keeping fees, but not required by
ERISA to do so.
Disclosure document: Summary annual report;
Document purpose: To disclose the financial condition of the plan to
participants;
Information on fees: Contains total plan costs incurred by plan
participants during the year.
Source: GAO analysis.
[End of table]
ERISA also requires 401(k) plan sponsors that have elected liability
protection from participants' investment decisions to provide
additional fee information.[Footnote 17] Most 401(k) plan sponsors
elect this protection and therefore must provide, among other
information, a description of the investment risk and historical
performance of each investment option available in the plan and any
associated transaction fees for buying or selling shares in these
options. Upon request, these plans must also provide participants with
the expense ratio--a fund's operating fees as a percentage of its
assets--for each investment option.
Plan sponsors may voluntarily provide participants with more
information on fees than ERISA requires. For example, plans may
distribute prospectuses or fund profiles for individual investment
options in the plan. Although not required, plan sponsors may provide
record-keeping or other information on fees in participants' account
statements.
Although participants are responsible for directing their investments
in the plan, they may not be aware of the different fees that they pay.
In a nationwide survey, more than 80 percent of 401(k) participants
report not knowing how much they pay in fees.[Footnote 18] Some
industry professionals said that making participants who direct their
investments more aware of fees would help them make more informed
investment decisions.
Participants may not have a clear picture of the total fees they pay
because plan sponsors provide this information in a piecemeal fashion.
Some documents that contain fee information are provided to
participants automatically, such as annually or within 90 days of
joining the plan, while others, such as prospectuses, may require that
participants seek them out.
Furthermore, the documents that participants receive do not provide a
simple way for participants to compare fees among the investment
options in their 401(k) plan. Industry professionals suggested that
comparing the expense ratio across investment options is the most
effective way to compare fees within a 401(k) plan.[Footnote 19] The
expense ratio is useful because it includes investment fees, which
account for most of the fees participants pay, and is generally the
only fee measure that varies by option. However, as noted above, not
all plan sponsors are required to provide expense ratios to
participants.
Labor Has Authority Over 401(k) Plan Fees and Certain Types of Business
Arrangements, but Lacks Information for Effective Oversight:
Labor has authority under ERISA to oversee 401(k) plan fees and certain
types of business arrangements involving service providers, but lacks
the information it needs to provide effective oversight. Under ERISA,
Labor is responsible for enforcing the requirements that plan sponsors
(1) ensure that fees paid with plan assets are reasonable and for
necessary services; (2) be prudent and diversify the plan's investments
or, if plan sponsors elect liability protection, provide a broad range
of investment choices for participants; and (3) report information
known on certain business arrangements involving service providers.
Labor does this in a number of ways, including collecting some
information on fees from plan sponsors, investigating participants'
complaints or referrals from other agencies on questionable 401(k) plan
practices, and conducting outreach to educate plan sponsors about their
responsibilities.
However, the information plan sponsors are required to report to Labor
is limited, and the lack of information hinders the agency's ability to
effectively oversee fees. Many of the fees are associated with the
individual investment options in the 401(k) plan, such as a mutual
fund; they are deducted from investment returns and not included on the
annual reporting form plan sponsors submit to Labor, Form 5500. As a
result, the Form 5500 does not include the largest type of fee, even
though plan sponsors receive this information from the mutual fund
companies in the form of a prospectus. In 2004, the ERISA Advisory
Council concluded that Form 5500s are of little use to policy makers,
government enforcement personnel, and participants in terms of
understanding the cost of a plan and recommended that Labor modify the
form and its accompanying schedules so that all fees incurred directly
or indirectly can be reported or estimated. Without information on all
fees, Labor's oversight is limited because it is unable to identify
fees that may be questionable.
Labor and plan sponsors also may not have information on arrangements
among service providers that 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 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 20] Plan sponsors
pay pension consultants to give them advice on matters such as
selecting investment options for the plan and monitoring their
performance and selecting other service providers, such as custodians,
administrators, and broker-dealers. The report highlighted concerns
that these arrangements may provide incentives for pension consultants
to recommend certain mutual funds to a 401(k) plan sponsor and create
conflicts of interest that are not adequately disclosed to plan
sponsors. Plan sponsors may not be aware of these arrangements and thus
could select mutual funds recommended by the pension consultant over
lower-cost alternatives. As a result, participants may have more
limited investment options and may pay higher fees for these options
than they otherwise would.
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. For
example, a mutual fund normally provides record-keeping services for
its retail investors, i.e., those who invest outside of a 401(k) plan.
The same mutual fund, when associated with a plan, might compensate the
plan's record keeper for performing the services that it would
otherwise perform, such as maintaining individual participants' account
records and consolidating their requests to buy or sell
shares.[Footnote 21]
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. Labor's position is that plan
sponsors must know about these fees in order to fulfill their fiduciary
responsibilities. However, if the plan sponsors do not know that a
third party is receiving these fees, they cannot monitor them, evaluate
the worthiness of the compensation in view of services rendered, and
take action as needed.
Labor Has Several Initiatives Under Way to Improve Information It Has
on Fees and the Various Business Arrangements Among Service Providers:
Labor officials told us about three initiatives currently under way to
improve the disclosure of fee information by plan sponsors to
participants and to avoid conflicts of interest:
* Labor is considering promulgating a rule regarding the fee
information required to be furnished to participants in plans where
sponsors have elected liability protection. According to Labor
officials, they are attempting to define the critical information on
fees that plan sponsors should provide to participants and what format
would enable participants to easily compare the fees across the plan's
various investment options.
* Labor has proposed changes to the Form 5500 Schedule A and Schedule C
to improve reporting of fees.[Footnote 22]
- Labor proposed to add a check box on Schedule A to improve the
disclosure of insurance fees and commissions and identify insurers who
fail to supply information to plan sponsors. According to a 2004 ERISA
Advisory Council report,[Footnote 23] many employers have difficulty
obtaining timely Schedule A information from insurers.
- Consistent with recommendations made by the ERISA Advisory Council
Working Groups and GAO, Labor proposed changes to the Schedule C to
clarify that the plan sponsor must report any direct and indirect
compensation (i.e., money or anything else of value) it pays to a
service provider during the plan year. Plan sponsors also would be
required to disclose the source and nature of compensation in excess of
$1,000 that certain key service providers, including, among others,
investment managers, consultants, brokers, and trustees as well as all
other fiduciaries, receive from parties other than the plan or the plan
sponsor, such as record keepers. Labor officials told us that the
revision aims to improve the information plan sponsors receive from
service providers. The officials acknowledge, however, that this
requirement may be difficult for plan sponsors to fulfill without an
explicit requirement in ERISA for service providers to give plan
sponsors information on the fees they pay to other providers.
* The third initiative involves amending Labor's regulations under
section 408(b)(2) of ERISA to define the information plan sponsors need
in deciding whether to select or retain a service provider. According
to Labor, plan sponsors need information to assess the reasonableness
of the fees being paid by the plan for services rendered and to assess
potential conflicts of interest that might affect the objectivity with
which the service provider provides its services to the plan. This
change to the regulation would be intended to make clear what plan
sponsors need to know and, accordingly, what service providers need to
provide to plan sponsors.
To ensure that participants have a tool to make informed comparisons
and decisions among plan investment options, we recommended in our
previous report that Congress consider amending ERISA to require all
sponsors of participant-directed plans to disclose fee information of
401(k) investment options to participants in a way that facilitates
comparison among the options. To better enable the agency to
effectively oversee 401(k) plan fees, we recommended that the Secretary
of Labor should require plan sponsors to report a summary of all fees
that are paid out of plan assets or by participants. To allow plan
sponsors, and ultimately Labor, to provide better oversight of fees and
certain business arrangements among service providers, we also
recommended that Congress should consider amending ERISA to explicitly
require that 401(k) service providers disclose to plan sponsors the
compensation that providers receive from other service providers. In
response to our draft report, Labor generally agreed with our findings
and conclusions. Specifically, Labor stated that it will give careful
consideration to GAO's recommendation that plans be required to provide
a summary of all fees that are paid out of plan assets or by
participants. Labor and SEC also provided technical comments on the
draft, which we incorporated as appropriate.
Conclusions:
The pension plan universe has changed: 401(k) plans have emerged to
cover most plan participants and the majority of plan assets. With this
shift, participants now bear more responsibility for ensuring they have
adequate income in retirement, emphasizing the importance of having
sufficient information to make informed 401(k) investment decisions.
Information about investment options' historical performance is useful,
but alone is not enough. Thus, giving participants key information on
fees for each of the plan's investment options in a simple format--
including fees, historical performance, and risk--will help
participants make informed investment decisions within their 401(k)
plan. In choosing between investment options with similar performance
and risk profiles but different fee structures, the additional
provision of expense ratio data may help participants build their
retirement savings over time by avoiding investments with relatively
high fees.
Regulators, too, will need to have better information to provide more
effective oversight, especially of the fees associated with 401(k)
plans. Amending ERISA and updating regulations to better reflect the
impact of fees and undisclosed business arrangements among service
providers will help put Labor in a better position to oversee 401(k)
plan fees. Furthermore, requiring plan sponsors to report more complete
information to Labor on fees--those paid out of plan assets or by
participants--would put the agency in a better position to effectively
oversee 401(k) plans.
Contacts and Acknowledgements:
For further information regarding this testimony, please contact
Barbara D. Bovbjerg, Director, or Tamara Cross, Assistant Director,
Education, Workforce, and Income Security Issues at (202) 512-7215 or
bovbjergb@gao.gov. Individuals making key contributions to this
testimony include Daniel Alspaugh, Monika Gomez, Michael P. Morris,
Rachael Valliere, Walter Vance, and Craig H. Winslow.
FOOTNOTES
[1] Traditional defined benefit 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. 2006).
[3] Active participants include any worker currently in employment
covered by a plan and workers who are earning or retaining credited
service under a plan. It does not include retired participants and
vested participants not yet in pay status.
[4] 29 U.S.C. §§ 1001-1461.
[5] A plan fiduciary is anyone who exercises discretionary authority or
control over plan management (or any authority or control over the
management or distribution of plan assets), renders or is responsible
for rendering investment advice for a fee, or has discretionary
authority or responsibility in plan administration. 29 U.S.C. §
1002(21)(A).
[6] The Internal Revenue Service also oversees various aspects of
401(k) contributions under the authority of the Internal Revenue Code.
Roth contributions to 401(k) plans were created under the Economic
Growth and Tax Relief Reconciliation Act of 2001 effective for plan
years beginning on or after January 1, 2006. This new account type was
subsequently made permanent under the Pension Protection Act of 2006.
Designated Roth contributions are a new type of contribution that can
be accepted by new or existing 401(k) plans. If a plan adopts this
feature, employees can designate some or all of their elective
contributions as Roth contributions (which are included in gross
income) rather than pre-tax elective contributions.
[7] 15 U.S.C. § 78a. Generally, public offerings and the sale of
securities must be registered with the SEC.
[8] The variable annuity contract "wraps" around investment options,
often a number of mutual funds. Participants select from among the
investment options offered, and the return to their individual accounts
varies with their choice of investments. If registered securities make
up the underlying investments, they are regulated by the SEC.
[9] For 1985 data, see "Private Pension Plan Bulletin Abstract of 1999
Form 5500 Annual Reports," U.S. Department of Labor (1985 data); for
2005 estimates, see Sarah Holden, Peter Brady, Michael Hadley, "401(k)
Plans: A 25-Year Retrospective," Investment Company Institute, Research
Perspective, vol. 12, no. 2, (2006).
[10] To calculate 2006 constant dollars, we used consumer price index
information for the most current year available from the 2007 Economic
Report of the President, p.302.
[11] The 2005 data gathered by the Employee Benefit Research Institute
(EBRI)/Investment Company Institute (ICI) joint project represents
about 42 percent of estimated 401(k) plan assets, 37 percent of the
estimated plan participant universe and about 11 percent of the
estimated total number of 401(k) plans. See Sarah Holden and Jack
VanDerhei, "401(k) Plan Asset Allocation, Account Balances, and Loan
Activity in 2005," Research Perspective, vol. 12, no. 1, (2006) and
"Appendix: Additional Figures for the EBRI/ICI Participant-Directed
Retirement Plan Data Collection Project for Year-End 2005," Research
Perspective, vol. 12, no. 1A, (2006).
[12] A collective investment fund is a trust managed by a bank or trust
company that pools investments of retirement plans or other large
institutional investors.
[13] The stable value funds typically offered as 401(k) investment
options by insurance companies and banks generally provide a guaranteed
rate of return over a specific period of time, such as 3 to 5 years.
[14] Balanced funds are pooled accounts invested in both stocks and
bonds.
[15] "Private Pension Plan Bulletin Abstract of 2003 Form 5500 Annual
Reports," U.S. Department of Labor (Washington, D.C.: Oct. 2006).
[16] Sarah Holden and Jack VanDerhei, "Appendix: Additional Figures for
the EBRI/ICI Participant-Directed Retirement Plan Data Collection
Project for Year-End 2005," 10.
[17] Section 404(c) of ERISA generally relieves the fiduciaries of
participant-directed plans from liability for any loss or breach that
results from a participant's investment decisions about his or her plan
assets. 29 U.S.C. § 1104(c) (2000). To be entitled to this relief, the
plan must meet the standards promulgated by Labor. 29 C.F.R. §
2550.404c-1 (2006).
[18] AARP Policy Institute, "Pension Participant Knowledge About Plan
Fees," Data Digest (November 2004).
[19] Mutual funds include their expense ratios in their prospectuses.
Other investment options may not provide prospectuses but have expense
ratio equivalents that investment industry professionals can identify.
[20] Office of Compliance Inspections and Examinations, Staff Report
Concerning Examinations of Select Pension Consultants, U.S. Securities
and Exchange Commission (Washington, D.C.: May 16, 2005).
[21] Final Report of the 2004 ERISA Advisory Council Working Group,
Health and Welfare Form 5500 Requirements (Washington, D.C.: Nov. 10,
2004).
[22] 71. Fed. Reg. 41,392 (July 21, 2006).
[23] Final Report of the 2004 ERISA Advisory Council Working Group,
Health and Welfare Form 5500 Requirements (Washington, D.C.: Nov. 10,
2004).
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