How to interpret 401(k) disclosure laws

Legislation that took effect last summer was a huge step toward clarifying and enlightening plan sponsors and participants about the fees they are paying for their 401(k) plans.

Each plan must provide plan sponsors and their fiduciaries a 408(b)2 document, also known as a fee-disclosure report. Many studies have revealed that the majority of plan participants feel they are not paying any fees to participate in their 401(k) plan. Plan participants must now receive a 404(a)5 fee-disclosure, which usually is incorporated into their quarterly statements. Unfortunately, most plan sponsors and participants do not know what to do once they receive these fee disclosures and often are overwhelmed by all of the jargon that is used in the disclosure documents.

Taking several steps can ensure that the fees for the 401(k) plan are fair and reasonable for the size of the plan.

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First, hire an outside professional/consultant to review the fee disclosures. Fee disclosures are complex and complicated, making it difficult to understand the information provided. Typically, a professional with a certified financial planner, a background in finance or specific training regarding 401(k) plan consulting will be able to decipher and interpret the disclosures.

Another good practice to better analyze a company’s 401(k) plan is to benchmark the plan. The plan sponsor must determine if the fees are reasonable for the services provided to the plan. Benchmarking the plan will compare the company’s 401(k) plan to plans of similar size in terms of total overall assets in the plan. With benchmarking, side-by-side comparisons show how the company’s plan measures up, while fee disclosure documents simply report on the plan’s fees, with no comparison to other plans.

A good 401(k) benchmark report should include the following:

Plan fees summary: Comparison of the plan’s fees to the appropriate benchmark group.

Service provider’s fee disclosure: Summarizes the fees which are paid to the primary service providers.

Investment lineup summary: Summarizes the investment expenses of the plan choices compared with the benchmark group.

Relative plan complexity: Compares an estimate of the plan’s complexity relative to other similar-sized plans.

Participant success measure: Depicts how well the participants are utilizing the plan to prepare themselves for retirement.

Adviser/consultant services: Highlights the key services the advisor/consultant is providing to the plan and its participants.

The appendix of the benchmarking report should include:

Investment offering and plan fees summary: Compares the plan’s diversity of offerings with other plans and summarizes the total plan’s fees.

Total expense ratio: Provides a breakdown of the fees associated with each investment option compared with the benchmark group.

Investment fees paid to recordkeepers, adviser consultants, investment managers and others: A total summary of fees paid to each person/entity associated with the plan.

Managed accounts: Summarizes the managed account portion of the plan (if offered)

Self-directed accounts: Summarizes the managed account portion of the plan (if offered).

Participant fees: Overview of the other fees paid by participants for options such as loans, hardship withdrawals, etc.

Finally, one of the most important pieces of information divulged in the 408(b)2 document is detailed information about the investment manager’s ERISA fiduciary status. Within the document, there is a disclosure about the investment manager or managers and whether they are acting in the best interest of the plan and the plan sponsor, or in their best interest. Make sure there is a 3(38) investment manager overseeing/guiding the company plan. A 3(38) investment manager has the requirements to always act in the plan’s best interests when making any and all recommendations.

These new disclosure rules do not apply to businesses that offer a Simple IRA or SEP IRA and some 403(b) plans. Therefore, as a plan participant or sponsor, you have to ask for information about plan expenses and hope the information is given to you and is understandable. In general, plan sponsors and participants need training in financial verbiage to be able to understand the information provided.

Here are some key terms that will appear in the disclosures:

Expense ratio: This is the mutual fund annual cost expressed as a percentage of assets. This can range from 0.05 percent to more than 3 percent annually.

Category/class/investment objective: These terms are used to classify what type of investments the mutual fund purchases within the fund. These terms may be one of the hardest to interpret because there are terms such as large cap, small cap, REITs, international, international emerging, government bonds, corporate bonds, etc.

12b-1 fees: This is a marketing/operation fee that is passed through to the investors. This number is represented in the fund’s expense ratio. This can range from 0.25 percent to 1 percent of the fund’s net assets.

Utilization of a benchmarking report will help interpret these and other fees pertaining to the plan and help you decipher if the plan fees are reasonable.

The new regulations are a great step toward full disclosure of fees, but interpreting them is the final step to determining whether your company plan has an appropriate set of investment choices and the expenses associated with the plan and its investment offerings are reasonable. We have suggested many different approaches to interpret retirement plan information. The most important thing is that, as a plan sponsor/participant, you have an understanding of your plan — or seek the necessary guidance to develop an understanding.

Robert J. Pyle is president of Boulder-based Diversified Asset Management Inc., an investment adviser registered with the state of Colorado. This column reflects the writer’s views and is not a recommendation to buy or sell any investment. It does not constitute investment advice. Contact Pyle at 303-440-2906 or info@diversifiedassetmanagement.com.