Participants and 401(k) Expenses

By Fred Reish and Stephanie Bennett

As you undoubtedly know ... because of all the newspaper headlines, the House Education and Labor Committee is conducting hearings about the information that is given—and should be given—to plan sponsors and participants.

One of the most controversial issues involves fees and expenses. On one side, some experts are taking a libertarian approach and urging that legislation require that providers give participants complete information related to their 401(k) investments and the plan, including information on fees and expenses. On the other side, some experts—primarily from the financial services industry—are taking a paternalistic approach and arguing that the information should be limited.

The libertarian approach seems to be based on a belief that participants can, or will at some point in the future, be able to digest the information about fees and expenses—and make intelligent decisions. The paternalistic approach counters that participants are confused and have a hard time making decisions about participating in 401(k) plans—and that, if they are provided much more information, they will be overwhelmed.

There is some support for both sides of the argument. Many participants are able to handle all of the information about 401(k) investments and expenses. However, other participants may not be interested or may not have a good foundation of knowledge to evaluate the information. If my understanding is correct, the issue boils down to ... do we adopt the libertarian approach and give all of the information to all the participants, knowing that some will handle it, but others won’t, or do we adopt the paternalistic approach and limit the information to all participants?

Regardless of the outcome of that argument, I believe that, in due course, participants will be given one of the most important items of information that they need—and that it will be done without confusing them.

That one item is ... a statement of the annual cost of the plan that is charged to their account. For example, if the combined investment expenses and expenses for operating the plan are 1.50% per year, and if a participant has a $50,000 account balance, at the end of the year the participant would receive a notice (probably as a part of the annual benefit statement) that his account was charged a total of $750 for the year (that is, 1.50% of $50,000).

There are several reasons why a participant should know that information. The first is that the money in the account belongs to the participant. If the participant’s money is going to be charged for management of the investments and administration of the plan, the participant should be told so in the most direct way. I cannot imagine a more simple, yet impactful, way of doing that.

Of course, if participants have not been told that they are bearing the costs of the plan (except, for the employer contributions), that disclosure could result in confusion and upset.

So, forewarned is forearmed. If plan sponsors have not been clearly communicating with employees about who is bearing the costs of the plan, now is the time to start that dialogue.

In my experience, many plan sponsors have not communicated as clearly as possible on that issue. On the other hand, participants are given information about the expense ratios charged to their investments—and, by and large, those expenses have been reasonable. So, the issue is not one of wrongdoing; instead, it is one of better communication.

Furthermore, in the past a dialogue about the cost of a 401(k) plan was not one of the higher priorities. However, now it is. This is the time for plan sponsors to address this issue, in an open and complete manner, with their employees.

The failure to openly, accurately and completely communicate on those issues could lead to litigation and possibly to fiduciary liability. A number of class action lawsuits have been filed in recent years concerning fees, expenses and revenue sharing. In some of those cases, there are allegations that the fiduciaries failed to inform the participants about those matters. While it is too early to tell if those claims have traction, we now know that they have been asserted. As a matter of risk management, now is time to communicate with your employees about these matters.

© 2007 Reish Luftman Reicher & Cohen. All rights reserved. The REPORT TO PLAN SPONSORS is published as a general informational source. Articles are general in nature and are not intended to constitute legal advice in any particular matter. Transmission of this report does not create an attorney-client relationship. Reish Luftman Reicher & Cohen does not warrant and is not responsible for errors or omissions in the content of this report.

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