Perhaps for the first time ever, as a result of new Department of Labor disclosure requirements coming on April 1, many small businesses will get critical information on the true cost of their employee retirement plans — and the unnecessary fees that they are paying.
The new rule is in response to numerous lawsuits filed by employees who learned after the fact that they were paying large hidden fees to investment firms managing their accounts. Under the new requirement, insurance companies, payroll services and to some extent mutual fund companies will no longer be able to hide their unconscionable fees to people participating in their retirement plans.
This will be a big help to small business owners who don’t have the human resources or legal staff to investigate the true cost of the retirement plans.
It isn’t unusual to find 401(k) plans with total costs paid by the participant exceeding 3 percent of account total annually, with investment choices limited to subpar proprietary funds, and with payments to the various providers not related to services rendered.
Confusion about who provides what service, how much is their direct and indirect compensation, and whether the various parties are acting in a fiduciary capacity is the rule. The combined impact on participant accounts and retirement funding is devastating. For instance, a 1 percent unwarranted cost might impact final accumulations over an employee’s career by 30 to 50 percent.
However, without critical information, comparisons and informed decision making are impossible. The new regulation — DOL Reg 408(b)(2) — aims to fix that. By April 1, plan sponsors must disclose their costs. By May 31, according to another new regulation, the same information must be shared with plan participants.
The expectation is that better information will lead inevitably to selection of better plans provided to employees.
If you are a plan sponsor each service provider must supply you with a revised service agreement that includes:
●A complete description of the services they provide.
●A full disclosure of the costs of each service.
●A disclosure of any direct or indirect compensation they receive from associated providers.
●Information on whether they assume fiduciary responsibility for each function (Hint: if the service agreement does not specifically assume fiduciary responsibility for a function, they are unable or unwilling to assume that liability.)
●Any potential conflicts of interest and how they are managed and mitigated.
Red flags might include:
●A total cost for all services including investment advice, recordkeeping/administration, fund fees, transaction costs, custody or trustee fees and any mortality and expense charges that exceed 1.5 percent.
●Any single fee disproportionate to services rendered or economic value.
●Direct or indirect compensation between the parties which might cause conflicts of interest.
●Revenue sharing not fully accounted for and credited back to the plan.
●Failure to specifically assume fiduciary status by investment advisers, consultants and other plan providers.
But the benefits of disclosure are conditional on the willingness to actually review the provided information and take appropriate action on it.
Be aware that as a plan sponsor you are a fiduciary and reviewing the quality of your retirement plan is not optional. Failure to comply with the many detailed requirements of the Employee Retirement Income Security Act (ERISA) generates personal liability for the plan fiduciaries.
The regulations should put small business owners in the driver’s seat.
Given that your business is probably a service provider or builds, services or sells widgets, even armed with this new information, you may not feel qualified to perform a plan audit or make comparisons.
Hiring a competent plan fiduciary adviser will relieve you of significant personal liability while bringing discipline to the process of providing quality benefits at reasonable costs to your work force.
These new regulations will force insurance companies and investment firms to clean up their act. And it will give employees and small business owners necessary information to sue plan sponsors for excessive plan costs or to find other plans.
Frank Armstrong III is president and founder of Investor Solutions Inc., based in Coconut Grove, Fla.