As many retirement plan sponsors are now aware, the Department of Labor's three-pronged approach to fee disclosure for 401(k)s and other qualified plans, has brought about a series of changes that have marked the past several years. The first phase of these fee disclosures required disclosure from a plan sponsor to the regulator through Schedule C of Form 5500. This disclosure, through the tax return required to be filed by qualified plans, has been in place since January of 2009. The next two phases of the fee disclosure process will include those from service providers, such as retirement plan recordkeeping firms, third-party administrators, investment advisors, brokers and other service providers to plan sponsors, as well as disclosures that must be made from the plan sponsor to participants. Ultimately, it is the plan sponsor’s required disclosure to participants that may be the game changer for companies sponsoring retirement plans and for the industry. In this article, I will highlight the most pertinent aspects of these regulations and those issues requiring plan sponsors’ close attention. Since disclosure on the Form 5500 and its Schedule C has been in effect for several years, I will not discuss this phase of the regulatory process, except to mention that the regulators are accumulating a massive amount of information regarding fees assessed by service providers in the qualified plan arena on a national basis. It is difficult to say how this information may be used in the future. Needless to say, the regulators will have excellent information in the future to evaluate the reasonableness of fees assessed by service providers across thousands of qualified retirement plans.
It’s important to acknowledge that a change of this scale has never occurred before in the pension industry. On a national basis as many as 483,000 retirement plans and their service providers will be affected. The retirement plans impacted have nearly 72 million individual participants, collectively. Simultaneous disclosure to regulators, plan sponsors, and ultimately to plan participants, has the potential to be disruptive to the marketplace. Plan sponsors will likely be mobilized to improve their plan design and fee structure.
As referenced above, there are two sets of regulations that will impact retirement plan sponsors, service providers, and participants in a significant way in 2012. These include Regulation 408(b)(2), which covers service provider fee disclosures to retirement plan sponsors, and Regulation 404(a)(5), which mandates both an annual and a quarterly disclosure to participants of fees which impact their account performance. The service provider fee disclosure regulation, or Regulation 408(b)(2), will go into effect on July 2, 2012 and Regulation 404(a)(5) goes into effect on August 30, 2012.
Service Provider Fee Disclosure/Regulation 408(b)(2)
Regulation 408(b)(2) provides guidance regarding compliance with ERISA and the Internal Revenue Code prohibited transaction exemptions that permit reasonable contracts between retirement plans and their service providers. For a contract to be considered exempt under these prohibited transaction rules, the compensation paid to the service provider must be deemed reasonable based on the regulation’s detailed requirements.
This regulation requires that specific terms of the arrangement be disclosed to retirement plan sponsors. If all of the appropriate items are disclosed, the plan sponsor should theoretically have the information necessary to determine whether the arrangement is exempt from prohibited transaction restrictions. Interestingly, if a service provider does not provide the plan with the required disclosure by the deadlines stated in the regulation, the plan and its service provider will be deemed to have engaged in a prohibited transaction. This prohibited transaction may result in excise taxes under the code and a requirement to correct the violation. These corrective procedures could obviously be quite costly. Therefore, it is critical that, at a minimum, plan sponsors know who their service providers are and collect a 408(b)(2) disclosure by the deadline stated in the regulation.
The service provider fee disclosure rules apply to all ERISA governed plans other than SEP IRAs and SIMPLE IRAs. Therefore, plans such as 401(k)s, 403(b)s, defined benefit pension plans, and profit-sharing plans are all covered by these regulations.
Service providers responsible to provide these disclosures are broadly identified as "covered service providers who reasonably expect to receive $1,000 or more in direct or indirect compensation over the life of the contract that provides covered services." Examples of covered service providers include registered representatives of broker-dealers, advisory representatives of registered investment advisors, third party administrators, recordkeeping firms, and platform providers.
The regulations provide a great deal of specificity regarding how the disclosures are to be structured for delivery to plan sponsors. In subsequent articles, I will provide a more detailed overview of how these disclosures will be structured and the types of information which will be disclosed to plan sponsors.
Participant Disclosure/Regulation 404(a)(5)
These regulations have the potential to be a true game changer for the defined contribution industry. They require that every one of 72 million defined contribution plan participants on a national basis are informed how much they pay each quarter for costs associated with administering their retirement plan. The fees disclosed will not simply be presented using a formula. They will also be disclosed in actual dollars and cents on the participants’ quarterly statements. Under Regulation 404(a)(5), there are two categories of disclosure requirements that plan sponsors will be required to meet – quarterly and annual disclosures.
Quarterly Participant Disclosures/Regulation 404(a)(5)
The quarterly disclosures which must be made directly to participants under Regulation 404(a)(5) will in most cases appear on the participants’ quarterly statements. These disclosures must detail the dollar amount of fees or expenses charged to the participant’s account for services during the preceding quarter. These quarterly disclosures must also include a brief description of services to which charges relate -- plan administration, recordkeeping, accounting, etc. A separate statement will be required if any of the plan's administrative expenses for the preceding quarter were paid from the total operating expenses of one or more of the plan’s designated investment alternatives.
In some cases, fees for individual services for participants, such as loan processing fees or distribution fees are also assessed against their account balance. In these cases, the dollar amount charged during the preceding quarter for fees and expenses must be disclosed.
Annual Participant Fee Disclosure/Regulation 404(a)(5)
In addition to participants receiving quarterly fee disclosures, a new annual fee disclosure is also required under Regulation 404(a)(5). In addition to investment and plan expense information, as you might expect, these annual participant disclosures must include a variety of additional information.
The required additional information that must appear in the new annual participant disclosure includes plan related information such as how participants may provide investment direction for their personal participant accounts and a summary of any limitations on instructions for providing this investment direction. The annual disclosure must also provide a summary of any designated investment alternatives offered under the plan along with a description of any brokerage windows, self-directed brokerage accounts or similar programs that allow participants to select investments beyond those designated by the plan.
Under Regulation 404(a)(5), annual participant disclosures must also provide fee and expense information for general plan services which may be charged by the plan to the individual participant accounts that are not reflected in the total annual operating expense of any particular investment alternative available in the plan. This annual participant disclosure must also describe fees and expenses that may be charged against individual participant accounts, including fees for loan processing, investment advice, brokerage windows, etc.
In addition to general plan provisions and plan expense information, a variety of investment related information must be provided to participants in the annual participant disclosures. This includes the name of each investment alternative in the plan along with the investment category for that particular investment. For each investment alternative, a variety of performance related information must be provided, including the average annual return of each investment over 1, 5 and 10 year periods, along with a "past performance is not indicative of future performance" disclaimer. Importantly, each investment options’ performance must also be compared to an appropriate broad-based benchmark over the same 1, 5 and 10 year periods.
The investment related information required under the annual participant disclosure must also include the amount and description of shareholder type fees for each designated investment alternative including commissions, sales loads, sales charges, deferred sales charges, and redemption fees. It must also include the total annual operating expenses expressed as a percentage for each designated investment alternative.
In a future article, I will provide a more detailed overview of Regulation 404(a)(5) and drill further into the specifics of the quarterly and annual disclosure requirements. Suffice it to say that these disclosures will provide much more information to participants on a systematic and ongoing basis than most participants have ever received regarding plan investments and the cost of plan services passed on to them.
In closing, what is the correct strategy for plan sponsors over the next several months? HBKS Wealth Advisors is recommending that retirement plan sponsors take a multi-faceted approach to preparing for the coming fee disclosure rules.
Understand what services are currently provided by service providers and why - Build a list of all of the service providers associated with your company's ERISA qualified retirement plan. Service providers might include recordkeeping firms, third-party administrators, investment advisors, etc. After identifying your service providers, determine the associated cost for the services and consider a fee benchmarking study to determine whether or not those fees are reasonable relative to other retirement plans comparable to yours.
Learn what lower-cost alternatives are available without changing vendors. Working with your current service providers, make certain that you have the most cost-effective solution. Concurrently, consider taking a broader look at other service providers to determine if your current cost is competitive.
Get participant buy-in and participation in the decisions related to what service providers to keep and what service providers to change. Consider encouraging employee participation on selection committees for service providers. Share the results of any reviews with your employee population.
Consider informing participants of the pending disclosure notices ahead of time. Remember, participants will receive annual standalone notices as well as notices embedded in their quarterly statements. You may want to consider training in a group setting and distributing an explanatory guide for these notices. Make certain that you are prepared to respond to concerns that may be expressed by your employees and retirement plan participants.
As you can see, the Department of Labor's three-pronged approach to fee disclosure is coming full circle in 2012. These disclosures have the potential to be game changers for retirement plan sponsors and industry players, as well as retirement plan participants. These rules also have the potential to play a significant role in enhancing retirement plan design and administration as plan sponsors review disclosures and work with participants to reduce cost and enhance service.
Dean Piccirillo offers insurance products through HBK Sorce Insurance LLC. Investment advisory services are offered through HBK Sorce Advisory LLC d/b/a HBKS Wealth Advisors. Mr. Piccirillo is not able to transact business in a state that he is not licensed or registered.
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