Private Pensions: Increased Reliance on 401(k) Plans Calls for	 
Better Information on Fees (06-MAR-07, GAO-07-530T).		 
                                                                 
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, 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.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-530T					        
    ACCNO:   A66485						        
  TITLE:     Private Pensions: Increased Reliance on 401(k) Plans     
Calls for Better Information on Fees				 
     DATE:   03/06/2007 
  SUBJECT:   401(k) plans					 
	     Assets						 
	     Employee retirement plans				 
	     Fees						 
	     Financial disclosure				 
	     Funds management					 
	     Information disclosure				 
	     Investment planning				 
	     Pensions						 
	     Private sector					 
	     Reporting requirements				 
	     Retirement 					 
	     Stocks (securities)				 
	     Strategic planning 				 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-07-530T

   

     * [1]Background
     * [2]An Increasing Number of Employees Participate in Defined Con
     * [3]Investment and Record-Keeping Fees Account for Most 401(K) P

          * [4]Investment Fees Account for Most 401(k) Plan Fees and Are Us
          * [5]Required Disclosures Provide Limited Fee Information to Assi
          * [6]Labor Has Authority Over 401(k) Plan Fees and Certain Types
          * [7]Labor Has Several Initiatives Under Way to Improve Informati

     * [8]Conclusions
     * [9]Contacts and Acknowledgements
     * [10]GAO's Mission
     * [11]Obtaining Copies of GAO Reports and Testimony

          * [12]Order by Mail or Phone

     * [13]To Report Fraud, Waste, and Abuse in Federal Programs
     * [14]Congressional Relations
     * [15]Public Affairs

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

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).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.2 We conducted our review from February 2007
through March 2007 in accordance with generally accepted government
auditing standards.

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.

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.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)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.

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. SS 1001-1461.

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.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.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:

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. S 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.

           o The Securities and Exchange Commission (SEC), among other
           responsibilities, regulates registered securities including
           company stock and mutual funds under securities law.7 
           o 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.
           o 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.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.9 Figure 1
shows the growth of defined contribution plans relative to that of defined
benefit plans from 1985 to 2005.

7 15 U.S.C. S 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).

Figure 1: Changes in the Number of Defined Benefit Plans and Defined
Contribution Plans, 1985-2005

Note: The Investment Company Institute's estimates for 2005 are based on
the Department of Labor, Form 5500 Annual Reports, and other information.

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

Note: The Investment Company Institute's estimates for 2005 are based on
the Department of Labor, Form 5500 Annual Reports, and other information.

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 2005.10

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.

Figure 3: Changes in Defined Benefit and Defined Contribution Plan Assets,
1985-2005

Note: The Investment Company Institute's estimates for 2005 are based on
the Department of Labor, Form 5500 Annual Reports, and other information.

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 2005.11 Equity funds are investment
options that invest primarily in stocks, such as mutual funds, bank
collective funds,12 life insurance separate accounts, and certain pooled
investment products (see fig. 4). Other plan assets were invested in
company stock; stable value funds,13 including guaranteed investment
contracts; balanced funds;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.

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.

Figure 4: 401(k) Plan Average Asset Allocation in 2005

Note: The Investment Company Institute's estimates for 2005 are based on
the Department of Labor, Form 5500 Annual Reports; and other information

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.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 $100,000.16 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.

15 "Private Pension Plan Bulletin Abstract of 2003 Form 5500 Annual
Reports," U.S. Department of Labor (Washington, D.C.: Oct. 2006).

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.

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.

Figure 5: Effect of 1 Percentage Point in Higher Annual Fees on a $20,000
401(k) Balance Invested over 20 Years

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

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.

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

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.

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 Document purpose     Information on fees               
Summary plan        To explain to        May contain information on how    
description         participants how the various fees such as investment,  
                       plan operates        record-keeping, and loan fees are 
                                            charged to participants, but not  
                                            required by ERISA to do so.       
Account statement   To show the account  Typically identifies fees, such   
                       balance due to a     as for loans, which are directly  
                       participant          attributable to an account during 
                                            a specific period. Also, may show 
                                            investment and record-keeping     
                                            fees, but not required by ERISA   
                                            to do so.                         
Summary annual      To disclose the      Contains total plan costs         
report              financial condition  incurred by plan participants     
                       of the plan to       during the year.                  
                       participants                                           

Source: GAO analysis.

ERISA also requires 401(k) plan sponsors that have elected liability
protection from participants' investment decisions to provide additional
fee information.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.

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. S 1104(c) (2000). To be entitled to this relief, the
plan must meet the standards promulgated by Labor. 29 C.F.R. S 2550.404c-1
(2006).

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.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.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.

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.

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.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.

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).

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.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:

           o 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.
           o Labor has proposed changes to the Form 5500 Schedule A and
           Schedule C to improve reporting of fees.22

                        o 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,23 many employers have
                        difficulty obtaining timely Schedule A information
                        from insurers.

                        o 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.

           o 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.

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).

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
[email protected] . Individuals making key contributions to this
testimony include Daniel Alspaugh, Monika Gomez, Michael P. Morris,
Rachael Valliere, Walter Vance, and Craig H. Winslow.

(130646)

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

GAO's Mission

The Government Accountability Office, the audit, evaluation and
investigative arm of Congress, exists to support Congress in meeting its
constitutional responsibilities and to help improve the performance and
accountability of the federal government for the American people. GAO
examines the use of public funds; evaluates federal programs and policies;
and provides analyses, recommendations, and other assistance to help
Congress make informed oversight, policy, and funding decisions. GAO's
commitment to good government is reflected in its core values of
accountability, integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony

The fastest and easiest way to obtain copies of GAO documents at no cost
is through GAO's Web site ( [www.gao.gov ). Each weekday, GAO posts
newly released reports, testimony, and correspondence on its Web site. To
have GAO e-mail you a list of newly posted products every afternoon, go to
www.gao.gov and select "Subscribe to Updates."

Order by Mail or Phone

The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent of
Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more
copies mailed to a single address are discounted 25 percent. Orders should
be sent to:

U.S. Government Accountability Office 441 G Street NW, Room LM Washington,
D.C. 20548

To order by Phone: Voice: (202) 512-6000 TDD: (202) 512-2537 Fax: (202)
512-6061

To Report Fraud, Waste, and Abuse in Federal Programs

Contact:

Web site: www.gao.gov/fraudnet/fraudnet.htm E-mail:
[email protected] Automated answering system: (800) 424-5454 or (202)
512-7470

Congressional Relations

Gloria Jarmon, Managing Director, [email protected] (202) 512-4400 U.S.
Government Accountability Office, 441 G Street NW, Room 7125 Washington,
D.C. 20548

Public Affairs

Paul Anderson, Managing Director, [email protected] (202) 512-4800
U.S. Government Accountability Office, 441 G Street NW, Room 7149
Washington, D.C. 20548

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
[email protected].

Highlights of [24]GAO-07-530T , a testimony before the Committe on
Education and Labor, House of Representatives

March 6, 2007

PRIVATE PENSIONS

Increased Reliance on 401(k) Plans Calls for Better Information on Fees

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.

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.

Comparison of Defined Benefit Plans with Defined Contribution Plans, 1985
and 2005.

References

Visible links
  24. http://www.gao.gov/cgi-bin/getrpt?GAO-07-530T
*** End of document. ***