New Disclosure Rules Shine Spotlight on 401(k) Fees

The Department of Labor recently put the finishing touches on new 401(k) disclosure rules designed to offer plan participants greater transparency on investment- and management-related fees. The new rules don't go into effect until this summer, but David Wray, president of the Plan Sponsor Council of America, gave us a preview of what to expect, along with a look at other trends shaping 401(k) plans.

1. New 401(k) disclosure rules will provide plan participants with more details on how much their plans are costing them. Can you describe what new information plan participants can expect to see on their 401(k) statements? Will investors have tools for evaluating whether their plans' costs are high, low, or in the right ballpark?
Previously, fee information for both plan sponsors and participants has generally been available if the sponsor or participant sought it out. For example the prospectus describing a plan investment has always included information about the fee structure the mutual fund company charged to manage the fund. To find it, however, the sponsor or participant had to dig it out. The new disclosure rules change this by requiring a report to sponsors and participants of the fees paid out of plan assets. These plan-paid fees are required to be provided to plan sponsors in significant detail.

Participants will receive a report that lists the plan's investments and the management fees charged for each investment. In addition, the report will include how much of a participant's plan assets are invested in each investment and an expression of what investing $1,000 in a fund would cost in dollar terms per year. The report will also describe the funds offered by the plan as well as provide educational information to help participants properly consider the disclosed investment-management fees as they decide how to allocate their plan assets to the funds the plan provides. Also, participants will be informed of fees paid from their plan assets in addition to those paid as investment-management fees. For example, if there is an additional fee to help pay for administration it will be reported, as will fees generated by individual participant actions like those charged when taking or maintaining a plan loan.

2. There has been speculation that the new disclosure rules will increase competition to provide low-cost funds for 401(k) plans and might be a boon for lower-cost index funds. Have you seen any evidence of this happening yet?
Most plans currently have both actively managed and passively managed funds. According to Plan Sponsor Council of America's 54th Annual Survey, 63% of plan assets invested in domestic-equity funds was invested in actively managed funds at the end of 2010. Thirty-seven percent was invested in passively managed funds. It should be noted that most defined-benefit pension plan and foundation assets are actively managed. Finally, only a very few companies have recently gone from either all actively managed funds or a mix of actively and passively managed funds to passively managed funds only. Fees are an important consideration, but of primary importance is a determination by the fiduciary that the fees, whatever they may be, are delivering appropriate value. It is hard to know at this point whether fee disclosure will affect the current plan sponsor approach to active and/or passive management.

3. Companies continue to auto-enroll workers in 401(k) plans, but critics say the contribution levels used by such programs--often 3% of pay or less--are much too low to provide adequate savings for retirement. Do you think auto-enrollment contribution levels will inevitably be raised, will there be a renewed effort to get workers to voluntarily raise their contribution levels, or will it be a combination of the two?
The most common default deferral rate has been 3%--about 60% of plans--since we began tracking it. Now that automatic enrollment has become widely accepted, the focus is more on increasing deferral rates. Rather than increase the initial deferral rate, more than half of plans with automatic enrollment use an auto-escalation feature, where the deferral rates are automatically increased annually; that's up from 31.2% of companies using auto-escalation in 2006. One company stated on a recent survey that it uses an auto-boost feature in which it automatically increases deferral rates to 6.0% annually, for those saving less, unless they opt out. The trend is to use automatic escalation to achieve desired deferral levels rather than changing the initial rate of deferral.

4. The Roth 401(k) is still a relatively new offering in the retirement-plan marketplace. How popular has it been and have you noticed any trends in terms of which workers are choosing it over a traditional 401(k)?
The availability of a Roth feature in 401(k) plans is growing rapidly. Usage by participants in plans with a Roth feature is also growing, though not as quickly. Among plans that permit participant contributions, 45.5% allowed Roth contributions in 2010, up from 30.3% in 2007, and 16.1% of participants in plans with a Roth feature made Roth contributions in 2010, up from 12.6% in 2007.   

5. The government is proposing allowing annuities to be offered as part of 401(k) plans. How do you see these being used in conjunction with existing 401(k) investment vehicles such as stock, bond, and stable-value funds?
The recent regulatory changes designed to encourage the use of annuities by 401(k) participants are laudable, especially the changes affecting longevity insurance (a type of annuity in which income is deferred, typically used to guarantee income later in life). However, plan sponsors continue to feel there is significant fiduciary liability if they provide annuities through their plans. Until that liability is mitigated, most defined-contribution plan sponsors will continue not to offer annuities as either a plan investment or plan distribution option. Annuitization will continue to occur after participants have rolled their plan distributions into an IRA.