Private Pensions: Information That Sponsors and Participants Need
to Understand 401(k) Plan Fees (30-OCT-07, GAO-08-222T).
Employers are increasingly moving away from traditional pension
plans to what has become the most dominant and fastest growing
type of plan, the 401(k). For 401(k) plan sponsors, understanding
the fees being charged helps fulfill their fiduciary
responsibility to act in the best interest of plan participants.
Participants should consider fees as well as the historical
performance and investment risk for each plan option when
investing in a 401(k) plan because fees can significantly
decrease retirement savings over the course of a career. GAO's
prior work found that information on 401(k) fees is limited. GAO
previously made recommendations to both Congress and the
Department of Labor (Labor) on ways to improve the disclosure of
fee information to plan participants and sponsors and reporting
of fee information by sponsors to Labor. Both Labor and Congress
now have efforts under way to ensure that both participants and
sponsors receive the necessary fee information to make informed
decisions. These efforts on the subject have generated
significant debate. This testimony provides information on 401(k)
plan fees that (1) sponsors need to carry out their
responsibilities to the plan and (2) plan participants need to
make informed investment decisions. To complete this statement,
GAO relied on previous work and additional information from Labor
and industry professionals regarding information about plan fees.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-08-222T
ACCNO: A77792
TITLE: Private Pensions: Information That Sponsors and
Participants Need to Understand 401(k) Plan Fees
DATE: 10/30/2007
SUBJECT: Fees
Government information dissemination
Information disclosure
Information management
Investment planning
Pension plan cost control
Pensions
Retirement income
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GAO-08-222T
* [1]Background
* [2]Sponsors Must Consider a Broad Range of Information to Fulfi
* [3]Sponsors Need Information to Evaluate Fees and Expenses Asso
* [4]Plan Sponsors Need to Collect and Evaluate Meaningful Inform
* [5]Labor's Initiatives Related to 401(k) Plan Sponsors
* [6]Basic Fee Information Is Important for Participants to Make
* [7]Participants May Not Be Aware of the Fee Information Needed
* [8]Participants Need Information on Investment Fees
* [9]Participants Also Need Information on Other Fees That Affect
* [10]Labor's Initiatives Related to 401(k) Plan Participants
* [11]Conclusions
* [12]Contacts and Acknowledgements
* [13]GAO's Mission
* [14]Obtaining Copies of GAO Reports and Testimony
* [15]Order by Mail or Phone
* [16]To Report Fraud, Waste, and Abuse in Federal Programs
* [17]Congressional Relations
* [18]Public Affairs
* [19]PDF6-Ordering Information-Young-10-25-07.pdf
* [20]GAO's Mission
* [21]Obtaining Copies of GAO Reports and Testimony
* [22]Order by Mail or Phone
* [23]To Report Fraud, Waste, and Abuse in Federal Programs
* [24]Congressional Relations
* [25]Public Affairs
Testimony before the Committee on Ways and Means, House of Representatives
United States Government Accountability Office
GAO
For Release on Delivery
Expected at 10:00 a.m. EDT
Tuesday, October 30, 2007
PRIVATE PENSIONS
Information That Sponsors and Participants Need to Understand 401(k) Plan
Fees
Statement of Barbara D. Bovbjerg, Director
Education, Workforce, and Income Security Issues
GAO-08-222T
Mr. Chairman and Members of the Committee:
I am pleased to discuss the information that sponsors and participants
need to better understand the fees associated with their 401(k) plans.
Named after section 401(k) of the Internal Revenue Code, 401(k) plans are
private sector pension plans that typically allow workers to save for
retirement by diverting a portion of their pretax income into an
investment account that can grow tax-free until withdrawn in retirement.
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 workers accrue earnings on their investments, they also pay a
number of fees, including expenses, commissions, or other charges
associated with a 401(k) plan.
For plan sponsors, understanding their expenses helps fulfill their
fiduciary responsibility to act in the best interest of plan participants.
Given this responsibility and the potentially large impact on an
individual's account balance over time, it is important that both plan
sponsors, typically the employer, and participants, as investors, receive
and understand the fee information necessary to make informed decisions.
Even a small fee deducted from a worker's assets today could represent a
large amount of money years later had it remained in the account to be
reinvested. The Department of Labor (Labor) is currently finalizing
regulations on the disclosure of fees to participants, and several bills
have been introduced to improve such disclosure. These efforts have
generated debate about the type of fee information sponsors and
participants may need, and the amount and format of fee information that
should be disclosed. As Congress considers these issues, you asked us to
describe information sponsors and participants need about fees. My remarks
today will focus on the information on fees that (1) sponsors need to
carry out their responsibilities to the plan and (2) plan participants
need to make informed investment decisions.
^1 Defined benefit plans, sometimes referred to as traditional pension
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.
To describe the fee information needed by 401(k) plan sponsors and
participants, we relied on our previous work that examined the types of
fees associated with 401(k) plans and who pays these fees, how information
is disclosed to sponsors and participants, and Labor's oversight of
fees.^2 We also used information from Labor and from industry
professionals on the subject of fee disclosure to plan sponsors. We
conducted our review in October 2007 in accordance with generally accepted
government auditing standards.
In summary, plan sponsors need to understand a broad range of information
on expenses associated with their 401(k) plans to fulfill their fiduciary
responsibilities. For example, sponsors need information on expenses
associated with the investment options that they offer to participants and
the providers they hire to perform plan services. Such information would
help them meet their fiduciary duty to determine if expenses are
reasonable for the services provided. In addition, sponsors need to
understand the implication of certain business arrangements between
service providers, such as revenue sharing. While industry professionals
might agree about some of the information that sponsors need, they
disagree about how much information is needed about individual expense
components when a package of plan services, known as a "bundled"
arrangement, is sold to a sponsor for a single price. Despite this
disagreement, industry professionals have made various suggestions to help
plan sponsors collect meaningful information on expenses. Labor has also
undertaken a number of activities related to the information on plan
expenses that sponsors should consider.
Participants need fee information to make informed decisions about their
investments--primarily, whether to contribute to the plan and how to
allocate their contributions among the investment options the plan sponsor
has selected. To make informed decisions, participants need to be made
aware of an investment option's relative risk, its historic performance,
and the fees they pay. However, many participants are not aware that they
pay any fees, and of those who are, most may not know how much they are
paying. Most industry professionals agree that information about
investment fees, such as the expense ratio--a fund's operating fees as a
percentage of its assets--is fundamental for plan participants. Some
industry professionals also believe that other fees that are also charged
to participants should be understood so that participants can clearly see
the effect these fees can have on their account balances.
^2 GAO, Private Pensions: Changes Needed to Provide 401(k) Plan
Participants and the Department of Labor Better Information on Fees,
[26]GAO-07-21 (Washington, D.C.: Nov. 16, 2006).
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.
The Employee Retirement Income Security Act of 1974 (ERISA) ^3 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.^4 A plan fiduciary includes a person who has
discretionary authority or control over plan management or any authority
or control over the management or disposition of plan assets.^5 ERISA
requires that plan sponsors responsible for managing employee benefit
plans carry out their plan responsibilities prudently and solely in the
interest of the plan's participants and beneficiaries. Plan sponsors, as
fiduciaries, are required to act on behalf of plan participants and their
beneficiaries. These responsibilities include
o selecting and monitoring service providers to the plan,
o reporting plan information to the government and to
participants,
o adhering to the plan's investment policy statement and other
plan documents (unless inconsistent with ERISA),
o identifying parties-in-interest to the plan and taking steps to
monitor transactions with them,
o selecting investment options the plan will offer and
diversifying plan investments, and
o ensuring that the services provided to their plan are necessary
and that the cost of those services is reasonable.
^3 29 U.S.C. SS 1001-1461.
^4 Any person who makes investment decisions with respect to a qualified
employee benefit plan's assets is generally a fiduciary. The duties the
person performs for the plan rather than their title or office determines
whether that person is a plan fiduciary. 29 U.S.C. S 1002(21)(A).
^5 29 U.S.C. S 1002(21).
Plan sponsors may receive some information on an investment option's
expenses that includes management fees, distribution and/or service fees,
and certain other fees, such as accounting and legal fees. These fees are
usually disclosed in the fund's prospectus or fund profile. To better
enable the agency to effectively oversee 401(k) plan fees, we recommended
in November 2006 that the Secretary of Labor should require plan sponsors
to report to Labor a summary of all fees that are paid out of plan assets
or by participants. This summary should list fees by type, particularly
investment fees that are being indirectly incurred by participants.
In addition to receiving information about investment fees, sponsors may
receive information about expenses for administration and other aspects of
plan operations. Sponsors can also have providers fill out the Form 5500,
which ultimately gets filed with Labor,^6 and includes information about
the financial condition and operation of their plans. Generally,
information on 401(k) expenses is reported on two sections of the Form
5500, Schedule A and Schedule C.^7 However, our November 2006 study
reported that the form is of little use to plan sponsors and others in
terms of understanding the cost of a plan.^8
While plan sponsors may receive information on investment and other fees,
they may not be receiving information on certain relevant business
arrangements. In November 2006, we reported that several opportunities
exist for such business arrangements to go undisclosed, given the various
parties involved in creating and administering 401(k) plans. Problems may
occur when pension consultants or other companies providing services to a
plan also receive compensation from other service providers. Service
providers may be steering plan sponsors toward investment products or
services in which they have a direct business interest themselves without
disclosing such arrangements. In addition, plan sponsors, being unaware,
are often unable to report information about these arrangements to Labor
on Form 5500 Schedule C. Our November 2006 report also recommended that
Congress consider amending ERISA to require that service providers
disclose to plan sponsors the compensation that providers receive from
other service providers.
^6 The Form 5500 includes information on the plan's sponsor, the features
of the plan, and the number of participants. The form also provides more
specific information, such as information about plan assets, liabilities,
insurance, and financial transactions. Filing this form satisfies the
requirement for the plan administrator to file annual reports concerning,
among other things, the financial condition and operation of plans. Labor
uses this form as a tool to monitor and enforce plan sponsors'
responsibilities under ERISA.
^7 Schedule A is used to report fees and commissions paid to brokers and
sales agents for selling insurance products. Schedule C includes
information on the fees paid directly to service providers for all other
investment products, but excludes investment fees deducted from returns.
Schedule C also identifies service providers with fees in excess of $5,000
by name.
^8 Labor's ERISA Advisory Council Working Group on Plan Fees and Reporting
on Form 5500 came to this conclusion, finding that only the fees that are
billed explicitly and are paid from plan assets are deemed reportable.
Many of the fees are associated with the individual investment options in
the 401(k) plan, such as a mutual fund, and are deducted from investment
returns and not reported to plan sponsors or on the Form 5500.
In our prior report on 401(k) fees, we found that the fee information that
ERISA requires 401(k) plan sponsors to disclose is limited and does not
provide participants with an easy way to compare investment options. All
401(k) plans are required to provide disclosures on plan operations,
participant accounts, and the plan's financial status. Although they often
contain some information on fees, these documents are not required to
disclose the fees borne by individual participants. Overall, we found that
the information currently provided to participants does not provide a
simple way for them to compare plan investment options and their fees, and
are provided to participants in a piecemeal fashion.
Additional fee disclosures are required for certain--but not all--plans in
which participants direct their investments. ERISA requires disclosure of
fee information to participants where plan sponsors seek liability
protection from investment losses resulting from participants' investment
decisions. Such plans--known as 404(c) plans--are required to provide
participants with a broad range of investment alternatives, descriptions
of the risks and historical performance of such investment alternatives,
and information about any transaction fees and expenses in connection with
buying or selling interests in such alternatives.^9 Upon request, 404(c)
plans must also provide participants with, among other information, the
expense ratio for each investment option. Plan sponsors may voluntarily
provide participants with more information on fees than ERISA requires,
according to industry professionals. For example, plan sponsors that do
not elect to be 404(c) often distribute prospectuses or fund profiles when
employees become eligible for the plan, just as 404(c) sponsors do. Still,
absent requirements to do so, some plan sponsors may not identify all the
fees participants pay.
^9 Section 404(c) of ERISA generally provides relief for plan fiduciaries
of certain individual account plans, such as 401(k) plans, from liability
for losses resulting from investment decisions made by plan participants
and beneficiaries. 29 U.S.C. S 1104(c). Implementing regulations provide
specifics for complying with section 404(c). 29 C.F.R. S 2550.404c-1
(2007).
Some participants may be able to make comparisons across investment
options by piecing together the fees that they pay, but doing so requires
an awareness of fees that most participants do not have. Assessing fees
across investment options can be difficult for participants because the
data are typically not presented in a single document that facilitates
comparison. However, most 401(k) investment options have expense ratios
that are provided in prospectuses or fund profiles and can be compared;
based on industry data, expenses for the majority of 401(k) assets, which
are in investment options such as mutual funds, can be expressed as an
expense ratio.
Sponsors Must Consider a Broad Range of Information to Fulfill Their Fiduciary
Responsibilities
Plan sponsors, as fiduciaries, must consider plan fee information related
to a broad range of functions. According to Labor, ERISA requires that
sponsors evaluate fee information associated with the investment options
offered to participants and the providers they hire to perform plan
services and consider the reasonableness of the expenses charged by the
various providers of services to the plan. In addition, the sponsor must
understand information concerning certain arrangements, such as when a
service provider receives some share of its revenue from a third party.
While industry professionals might agree about some of the information
that sponsors need, they disagree about how much information is needed
about individual expense components when a package of plan services, known
as a bundled arrangement, is sold to a sponsor for a single price. Some
pension plan associations and practitioners have made various suggestions
to help plan sponsors collect meaningful information on expenses. Labor
has also undertaken a number of activities related to the information on
plan expenses that sponsors should consider.
Sponsors Need Information to Evaluate Fees and Expenses Associated with
Investment Options and Plan Services
In order to carry out their duties, plan sponsors have an obligation under
ERISA to prudently select and monitor plan investment options made
available to the plan's participants and beneficiaries and the persons
providing services to the plan. Understanding and evaluating the fees and
expenses associated with a plan's investments and services are an
important part of a fiduciary's responsibility. Plan sponsors need to
monitor the fees and expenses associated with the plan's investment
options and the services provided by outside vendors, including any
revenue sharing arrangements, to determine whether the expenses continue
to be reasonable for the services provided.
Industry experts have suggested that plan sponsors be required to obtain
complete information about investment options before adding them to the
plan's menu and obtain information concerning arrangements where a service
provider receives some share of its revenue from a third party. A number
of associations recently put together a list of service- and fee-related
data elements they believe defined contribution plan sponsors and service
providers should discuss when entering into agreements. The data elements
include such information as payments received by plan service providers
from affiliates in connection with services to the plan, float revenue,^10
and investment-related consulting services. The list is meant as a
reference tool for plan sponsors and providers to use to determine the
extent to which a service provider receives compensation in connection
with its services to the plan from other service providers or plan
investment products (e.g., revenue sharing or finders' fees). According to
the associations that formulated this tool, the information can aid plan
sponsors to evaluate any potential conflicts of interest that may arise in
how fees are allocated among service providers.
In our prior work, we noted that plan sponsors may not have information on
arrangements among service providers that, according to Labor officials,
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 Securities and Exchange Commission (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.^11 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. 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.
^10 Float revenue is revenue earned from the short-term investment of plan
assets.
^11 U.S. Securities and Exchange Commission, Office of Compliance
Inspections and Examinations, Staff Report Concerning Examinations of
Select Pension Consultants, (Washington, D.C.: May 2005).
While there is general agreement that understanding the fees and expenses
associated with a plan's services is an important part of a fiduciary's
responsibility, pension professionals disagree about how much information
is needed about the expense components of bundled fee arrangements. One
representative speaking on behalf of five industry associations stated he
did not believe that the requirement to "unbundle" bundled services and
provide individual costs in many detailed categories was particularly
helpful because the information provided would not be very meaningful and
the costs of providing this information would ultimately be passed on to
plan participants through higher administrative fees. He also raised
concerns about how a service provider would disclose component costs for
services that are not offered outside a bundled contract. In addition, he
said that posting such information could force public disclosure of
proprietary information regarding contracts between service providers and
plan sponsors. Finally, he stated that as long as they are fully informed
of the services being provided, many plan sponsors might prefer reviewing
aggregate costs so that they can compare and evaluate whether the overall
fees are reasonable without analyzing each itemized fee.
On the other hand, a representative of another pension association
contended that it is possible with very little cost to develop an
allocation methodology to provide a reasonable breakdown of fees for plan
services. He believes that not disclosing component pricing provides a
competitive advantage, enabling bundled providers to tell plan sponsors
that they can offer certain retirement plan services for free--when fees
are deducted from investment returns--while unbundled providers are
required to disclose the fees for the same services. He further stated
that any disclosure requirements should apply uniformly to all service
providers. In his view this would allow plan fiduciaries to assess the
reasonableness of fees by comparison and thereby allow fiduciaries to
determine whether certain services are needed, which could lead to lower
fees.
Plan Sponsors Need to Collect and Evaluate Meaningful Information on Expenses
Industry professionals have suggested that, before hiring a service
provider or adding investment options to the plan's menu, plan sponsors
should obtain complete fee information, including information concerning
arrangements in which a service provider receives some share of its
revenue from a third party. Pension plan associations and practitioners
have made various suggestions to help plan sponsors collect meaningful
information on expenses.
In 2004 the ERISA Advisory Council on Employee Welfare and Pension Benefit
Plans created a Working Group to study retirement plan investment
management fees and expenses as they were currently reported to Labor.^12
In addition to issues related to annual reporting, the Working Group was
also interested in determining whether plan sponsors currently receive
adequate data from the service providers in order to both understand and
report fees. In its final report, the Working Group made the following
recommendations, among others, in an effort to further educate plan
sponsors and fiduciaries about plan fees:^13
o Plan sponsors should avoid entering transactions with vendors
who refuse to disclose the amount and sources of all fees and
compensation received in connection with plan.
o Plan sponsors should require plan providers to provide a
detailed written analysis of all fees and compensation (whether
directly or indirectly) to be received for its services to the
plan prior to retention.
o Plan sponsors should obtain all information on fees and expenses
as well as revenue sharing arrangements with each investment
option. Plan sponsors should also determine the availability of
other mutual funds or share classes within a mutual fund with
lower revenue sharing arrangements prior to selecting an
investment option.
o Plan sponsors should require vendors to provide annual written
statements with respect to all compensation, both direct and
indirect, received by the provider in connection with its services
to the plan.
o Plan sponsors need to be aware that with asset-based fees, fees
can grow just as the size of the asset pool grows, regardless of
whether any additional services are provided by the vendor, and as
a result, asset-based fees should be monitored periodically.
o Plan sponsors should calculate the total plan costs annually.
^12 Section 512 of ERISA provides for the establishment of an Advisory
Council on Employee Welfare and Pension Benefit Plans. The duties of the
council are to advise the Secretary and submit recommendations regarding
the Secretary's functions under ERISA. The council consists of 15 members
appointed by the Secretary of Labor: Three members are representatives of
employee organizations; three members are representatives of employers;
there is one representative each from the fields of insurance, corporate
trust, actuarial counseling, investment counseling, investment management,
and accounting; and three members are representatives of the general
public. 29 U.S.C. S 1142.
^13 Final Report of the 2004 ERISA Advisory Council Working Group, Health
and Welfare Form 5500 Requirements (Nov. 10, 2004).
More recently in 2007, one witness before the ERISA Advisory Council
recommended further that plan sponsors should evaluate fees associated
with three categories of services:^14
o Net investment expenses would not only include investment
expenses, such as the expense ratio of a mutual fund, but would
also subtract any fees or commissions paid to a broker,
consultant, or advisor for services in the categories below.
o Administrative expenses would include specific charges for
operational services, such as record keeping, administration,
compliance, and communication, as well as revenue sharing or other
payments from investments.
o Advisory expenses would include amounts paid directly by the
plan to consultants, advisors, or brokers, as well as indirect
payments from sources such as investments or related companies.
In addition, some industry professionals believe that plan sponsors, as
they monitor investment alternatives, should review investment alternative
results against appropriate benchmarks and compare their plans' options to
competing funds with similar investment goals.^15 A benchmark is used to
compare specific investment results with that of the market or economy.
Industry professionals also noted that although there are appropriate
benchmarks for mutual funds, benchmarks are not as readily available for
other types of investment products. According to one industry professional
that we spoke with, plan sponsors do not have good benchmarks to assess
the reasonableness of investment options' expense ratios. Only limited
information is available, and a national database of funds and their
expense ratios does not exist. He further stated that without such a
source, selecting which funds constitute a meaningful comparison set is
not an easy task, and may be open to interpretation. Disclosure encourages
price competition, but in his opinion, because of the lack of available
information, the 401(k) market is relatively ineffective at fostering
price competition.
^14 Written Comments of C. Frederick Reish, Reish Luftman Reicher & Cohen,
for Testimony before the 2007 U.S. Department of Labor Advisory Council on
Employee Welfare and Pension Benefits Plans Working Group on Fiduciary
Responsibilities Update and Revenue Sharing Practices, (Sept. 20, 2007).
^15 Although some industry professionals believe that participants should
be provided comparative benchmarks for their investment options, not all
industry professionals agreed. Most industry professionals we consulted
believed that benchmarks would be more useful for plan sponsors than for
participants. Since plan participants do not have any control over the
investment options offered in a plan, industry professionals said that
benchmarking is less useful to plan participants than plan sponsors, since
plan sponsors use benchmarks in evaluating alternatives to their plans'
investment options.
Labor's Initiatives Related to 401(k) Plan Sponsors
Labor, in its comments on our November 2006 report, stated that the agency
has proposed a number of changes to the Form 5500, including changes that
would expand the information required to be reported on the Schedule C.
The changes are intended to assist plan sponsors in assessing the
reasonableness of compensation paid for services and potential conflicts
of interest that might affect those services. According to testimony
earlier this month from the Assistant Secretary of Labor, the agency will
be issuing a final regulation requiring additional public disclosure of
fee and expense information on the Form 5500 within the next few weeks.^16
This change will be helpful to plan sponsors as they look retrospectively
at the preceding plan year. In addition, Labor was considering an
amendment to its regulation under section 408(b)(2) of ERISA, expected to
be issued this year. This amendment would help to ensure that plan
sponsors have sufficient information on the compensation to be paid to the
service provider and the revenue sharing compensation paid by the plan for
the specific services and potential conflicts of interest that may exist
on the part of the service provider.
Labor's ERISA Advisory Council currently has a working group focusing on
fiduciary responsibility and revenue sharing. One area of focus is what
service providers should be required to provide when they enter into a
revenue sharing or rebate arrangement. Labor also provides a model form on
its Web site specifically designed to assist plan fiduciaries and service
providers in exchanging complete disclosures concerning the costs involved
in service arrangements. Other associations and entities continue to
develop model fee disclosure forms for plan sponsors.
^16 Statement of Bradford P. Campbell, Assistant Secretary of Labor,
Before the Special Committee on Aging, U.S. Senate, Oct. 24, 2007.
We are currently conducting work in the area of 401(k) plan sponsor
practices, identifying how plan sponsors decide which features to include
in the plans they establish and how plan sponsors oversee plan operations.
Part of our work will consider how plan sponsors monitor the fees charged
to their plans. We expect to issue a report in 2008.
Basic Fee Information Is Important for Participants to Make Informed Decisions
Before making informed decisions about their 401(k) plan investments,
participants must first be made aware of the types of plan fees that they
pay. For example, according to one nationwide survey, some participants do
not even know that they pay plan fees. In 2006, we reported that
investment fees constitute the majority of fees in 401(k) plans and are
typically borne by participants. Most industry professionals agree that
information about investment fees--such as the expense ratio, a fund's
operating fees as a percentage of its assets--is fundamental for plan
participants. Participants also need to be aware of other types of
fees--such as record-keeping fees and redemption fees or surrender charges
imposed for changing or selling investments--to gain a more complete
understanding of all the fees that can affect their account balances.
Whether participants receive only basic expense ratio information or more
detailed information on various fees, presenting the information in a
clear, easily comparable format can help participants understand the
content of the disclosure.
Participants May Not Be Aware of the Fee Information Needed to Make Informed
Decisions
Currently, most participants are responsible for directing their
investments among the choices offered by their 401(k) plans, but may not
be aware of the different fees that they pay. According to industry
professionals, participants are often unaware that they pay any fees
associated with their 401(k) plan. In fact, studies have shown that 401(k)
participants often lack the most basic knowledge--that there are fees
associated with their plan. When asked in a recent nationwide survey
whether they pay any fees for the 401(k) plan, as figure 1 shows, 65
percent of 401(k) participants responded that they do not pay fees.^17
Seventeen percent said they do pay fees, and 18 percent stated that they
do not know. When this same group was asked how much they pay in fees, as
shown in figure 2, 83 percent reported not knowing.
Figure 1: Participants' Response to Survey Question on Awareness of Fees
^17 AARP Knowledge Management, 401(k) Participants' Understanding and
Awareness of Fees, (Washington, D.C.: July 2007). AARP commissioned a
nationally representative survey of 1,584 401(k) plan participants age 25
and older. The survey was fielded from June 8 through June 24, 2007, by
Knowledge Networks of Menlo Park, California, to members of its nationally
representative online panel. The overall sample was designed to be
nationally representative of 401(k) plan participants age 25 and older.
Figure 2: Participants' Response to Survey Question on Awareness of Fees
Participants Need Information on Investment Fees
Although it is clear that participants require fee information to make
informed decisions, it is not so clear what fee information is most
relevant. In 2006, we reported that investment fees constitute the
majority of fees in 401(k) plans and are typically borne by participants.
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.^18 These fees are charged regardless of whether the mutual
fund or other investment product, such as collective investment funds or
group annuity contracts, is part of a 401(k) plan or purchased by
individual investors in the retail market.^19 As such, the fees are
usually different for each investment option available to participants in
a 401(k) plan.
^18 Fees related to marketing and compensating brokers to sell the fund
are known as 12b-1, or distribution fees, and are limited by the Financial
Industry Regulatory Authority, the entity that succeeded the National
Association of Securities Dealers Inc., to a maximum of 1 percentage point
of the total expense ratio per year.
In our previous report, we recommended that Congress consider amending
ERISA to require all sponsors of participant-directed plans to disclose
fee information on 401(k) investment options to participants in a way that
facilitates comparison among the options, such as via expense ratios.^20
As mentioned earlier, there have been at least two bills recently
introduced in Congress on the subject. Industry professionals have also
suggested that comparing the expense ratio across investment options is
the most effective way to compare options' fees. They generally agree that
an expense ratio provides valuable information that participants need and
can be used to compare investment options because it includes investment
fees, which constitute most of the total fees borne by participants.
According to an industry official, the disclosure of expense ratios might
include a general description of how expense ratios vary depending on the
type and style of investment. For example, investment options with
relatively high fees, such as actively managed funds, tend to have larger
expense ratios than funds that are not actively managed. Also, investment
options that are only available to institutional investors tend to have
lower expense ratios than other types of funds.
Most of the investment options offered in 401(k) plans have expense ratios
that can be compared, but this information is not always provided to
participants. In addition, investment options other than mutual funds may
not be required to produce prospectuses that include expense ratios, but
according to industry professionals, most options have expense ratio
equivalents that investment industry professionals can identify.
^19 Mutual funds that use brokers to sell shares may also impose a sales
fee, or "load," when a fund is bought, transferred, or sold to compensate
the broker. SEC does not limit the size of the sales load a fund may
charge, but the Financial Industry Regulatory Authority does not permit
exceeding 8.5 percent of the purchase price. A "front-end load" is
incurred when a mutual fund is purchased and reduces the amount available
to purchase fund shares. A "back-end load" is a fee that is charged when a
mutual fund is sold or transferred. Back-end loads generally decrease over
time in steps until they are eventually eliminated.
^20 We found that it is hard for participants to make comparisons across
investment options because they have to piece together the fees that they
pay, and assessing fees across investment options can be difficult because
data are not typically presented in a single document that facilitates
comparison.
Participants Also Need Information on Other Fees That Affect Their Account
Balances
Industry professionals also believe that participants need information on
other fees that are not included in the expense ratio but still affect
their account balances. For example, annual fees or fees on a per
transaction basis that can be deducted from account balances should be
disclosed, such as administrative and record-keeping fees, participant
loan origination fees, and annual loan charges.^21
In addition, industry professionals also recommended that certain
investment-specific fees be disclosed, including
o redemption fees or sales charges--fees that may be imposed by
the provider as a result of changing investments in a given
period,
o surrender charges--fees that may be imposed as a result of
selling or withdrawing money from the investment within a given
number of years after investing, and
o wrap fees--fees that are assessed on the total assets in a
participant's account.^22
Some industry professionals recommended that plan participants be provided
information on their returns net of all fees so that they can clearly see
what their investments have earned after fees. Others recommended that
information be disclosed that explains how the investment and
administrative costs of the plan affect their investment returns and their
overall retirement savings in the plan. These officials believed that such
information would help participants understand that fees are an important
factor to consider when directing their investments.
Whether participants are provided with basic expense ratio information or
more detailed information on various fees, or both, providing the
information in a clear, easily comparable format can assist participants
in understanding the information disclosed. In our prior reports on
helping the public understand Social Security information and on more
effective disclosures for credit cards, we found that certain practices
help people understand complicated information.^23 These practices include
^21 Plan record-keeping fees cover individual account maintenance for plan
participants. They cover a variety of activities, such as enrolling
participants, processing fund selections, preparing and mailing account
statements, and other related administration activities. A loan
origination fee is charged to a participant who elects to take a loan from
the plan. The fee covers document preparation and loan processing
expenses. Annual loan charges are imposed for account maintenance.
^22 Wrap fees are for various expenses, such as sales commissions,
administrative expenses, and/or recording keeping fees. However, wrap fees
can also be assessed against specific investment options and/or at the
plan level based on total plan assets. For example, a wrap fee may be
assessed against a "low fee" investment option because the investment
provider does not contribute toward the cost of plan record-keeping and
administration.
o language--writing information in clear language,
o layout--using straightforward layout and graphics,
o length--providing a short document,
o comparability--making options easy to compare in a single
document, and
o distribution--offering a choice of paper or electronic
distribution.
Labor's Initiatives Related to 401(k) Plan Participants
In our prior work, we noted that Labor is considering the development of a
new rule regarding the fee information required to be furnished to
participants under its section 404(c) regulation. According to Labor
officials, they are attempting to identify the critical information on
fees that plan sponsors should disclose to participants of 404(c) plans
(but not all participant-directed plans) and the best way to do so. The
initiative is intended to explore what steps might be taken to ensure that
participants have the information they need about their plan and available
investment options, without imposing additional costs, given that such
costs are likely to be charged against the individual accounts of
participants and affect their retirement savings. The officials are
currently considering what fee information should be provided to
participants and what format would enable participants to easily compare
the fees across a plan's various investment options. Labor is also
currently evaluating comments received from consumer groups, plan
sponsors, service providers, and others as it develops its regulation.
Labor also has ongoing efforts designed to help participants and plan
sponsors understand the importance of plan fees and the effect of those
fees on retirement savings. Labor has developed and makes available on its
Web site a variety of educational materials specifically designed to help
plan participants understand the complexities of the various fee and
compensation arrangements involved in 401(k) plans. Its brochure titled A
Look at 401(k) Plan Fees is targeted to participants and beneficiaries of
401(k) plans who are responsible for directing their own investments.
^23 GAO, Social Security Statements: Social Security Administration Should
Better Evaluate Whether Workers Understand Their Statements,
[27]GAO-05-192 (Washington, D.C.: Apr. 1, 2005); GAO, Social Security
Administration: Longstanding Problems in SSA's Letters to the Public Need
to Be Fixed, [28]GAO/HEHS-00-179 (Washington, D.C.: Sept. 26, 2000); GAO,
Credit Cards: Increased Complexity in Rates and Fees Heightens Need for
More Effective Disclosures to Consumers, [29]GAO-06-929 (Washington, D.C.:
Sept. 12, 2006); and GAO, SSA Benefit Statements: Well Received by the
Public but Difficult to Comprehend, [30]GAO/HEHS-97-19 (Washington, D.C.:
Dec. 5, 1996).
Conclusions
Both 401(k) plan sponsors and participants need fee information in order
to make the most informed decisions. For plan sponsors, requiring that
certain information on fees be disclosed can help them understand what
services they are paying for, who is benefiting, and whether their current
arrangements are in the best interest of plan participants. Requiring plan
sponsors to report more complete information to Labor on fees--including
those paid out of plan assets by participants--would put the agency in a
better position to effectively oversee 401(k) plans and, in doing so, to
protect an increasing number of participants. The mere act of requiring
such information may actually promote competition among the entities that
provide services to plans and possibly reduce the fees service providers
charge.
For plan participants, given the voluminous amount of information that
could be disclosed, determining the relevant information that participants
most need is key. At a minimum, providing information such as expense
ratios or other investment-specific fee information could be the place to
start. Also, making sure that the information is accessible in terms of
the language, layout, length, comparability, and distribution can ensure
that participants actively utilize the information disclosed. As
participants become more sophisticated or demand more information,
decisions can then be made about the type and format of additional fee
information.
Mr. Chairman, this concludes my prepared statement. I would be happy to
respond to any questions you or other members of the committee may have at
this time.
Contacts and Acknowledgements
For further information regarding this testimony, please contact Barbara
D. Bovbjerg, Director, Education, Workforce, and Income Security Issues,
at (202) 512-7215 or [31][email protected] . Contact points for our
Offices of Congressional Relations and Public Affairs may be found on the
last page of this statement. Individuals making key contributions to this
testimony include Tamara E. Cross, Assistant Director; Daniel F. Alspaugh;
Monika R. Gomez; Matthew J. Saradjian; Susannah L. Compton; Craig H.
Winslow; and Walter K. Vance.
(130793)
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To view the full product, including the scope and methodology, click on
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For more information, contact Barbara D. Bovbjerg at (202) 512-7215 or
[email protected].
Highlights of [33]GAO-08-222T , a testimony before the Committee on Ways
and Means, House of Representatives
October 30, 2007
PRIVATE PENSIONS
Information That Sponsors and Participants Need to Understand 401(k) Plan
Fees
Employers are increasingly moving away from traditional pension plans to
what has become the most dominant and fastest growing type of plan, the
401(k). For 401(k) plan sponsors, understanding the fees being charged
helps fulfill their fiduciary responsibility to act in the best interest
of plan participants. Participants should consider fees as well as the
historical performance and investment risk for each plan option when
investing in a 401(k) plan because fees can significantly decrease
retirement savings over the course of a career.
GAO's prior work found that information on 401(k) fees is limited. GAO
previously made recommendations to both Congress and the Department of
Labor (Labor) on ways to improve the disclosure of fee information to plan
participants and sponsors and reporting of fee information by sponsors to
Labor. Both Labor and Congress now have efforts under way to ensure that
both participants and sponsors receive the necessary fee information to
make informed decisions. These efforts on the subject have generated
significant debate. This testimony provides information on 401(k) plan
fees that (1) sponsors need to carry out their responsibilities to the
plan and (2) plan participants need to make informed investment decisions.
To complete this statement, GAO relied on previous work and additional
information from Labor and industry professionals regarding information
about plan fees.
Information on 401(k) plan fee disclosure serves different functions for
plan sponsors and participants. Plan sponsors need to understand a broad
range of information on expenses associated with their plans to fulfill
their fiduciary responsibilities. Sponsors need information on expenses
associated with the investment options that they offer to participants and
the providers they hire to perform plan services. Such information would
help them meet their fiduciary duty to determine if expenses are
reasonable for the services provided. In addition, sponsors also need to
understand the implication of certain business arrangements between
service providers, such as revenue sharing. Despite some disagreements
about how much information is needed, industry professionals have made
various suggestions to help plan sponsors collect meaningful information
on expenses. Labor has also undertaken a number of activities related to
the information on plan fees that sponsors should consider.
Participants need fee information to make informed decisions about their
investments--primarily, whether to contribute to the plan and how to
allocate their contributions among the investment options the plan sponsor
has selected. However, many participants are not aware that they pay any
fees, and those who are may not know how much they are paying. Most
industry professionals agree that information about an investment option's
relative risk, its historic performance, and the associated fees is
fundamental for plan participants. Some industry professionals also
believe that other fees that are also charged to participants should be
understood, so that participants can clearly see the effect these fees can
have on their account balances.
Participants' Response to Survey Question on Awareness of Fees
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References
Visible links
26. http://www.gao.gov/cgi-bin/getrpt?GAO-07-21
27. http://www.gao.gov/cgi-bin/getrpt?GAO-05-192
28. http://www.gao.gov/cgi-bin/getrpt?GAO/HEHS-00-179
29. http://www.gao.gov/cgi-bin/getrpt?GAO-06-929
30. http://www.gao.gov/cgi-bin/getrpt?GAO/HEHS-97-19
31. mailto:[email protected]
32. http://www.gao.gov/cgi-bin/getrpt?GAO-08-222T
33. http://www.gao.gov/cgi-bin/getrpt?GAO-08-222T
34. http://www.gao.gov/
35. http://www.gao.gov/
36. http://www.gao.gov/fraudnet/fraudnet.htm
37. mailto:[email protected]
38. mailto:[email protected]
39. mailto:[email protected]
*** End of document. ***