New fee disclosure rules apply to retirement plans that allow participants to select the investments of their accounts. By August 30, 2012, administrators of such retirement plans must provide participants the first of annual disclosures describing the fees charged against their accounts. The fee disclosure requirement gives employers an opportunity to review the reasonableness of the fees charged to the 401(k), 403(b) and other defined contribution retirement plans that they sponsor. To the extent plan fees (including charges on investments) are excessive, employers (and other fiduciaries) are obligated under law to negotiate lower plan fees. The failure to do so can subject the plan fiduciaries to excise taxes on prohibited transactions and open the door to participant challenges.
Overview of required disclosures
Fee disclosures to plan participants must generally describe the following:
- The cost of plan administrative services that may be charged against individual accounts. Such services include accounting, recordkeeping and legal fees.
- An explanation of whether administrative fees will be allocated on a pro rata or per capita basis among participants (or whether the employer will pay the administrative costs directly).
- The cost of processing loans to a plan participant.
- The cost of processing a qualified domestic relations order for a participant.
- The cost of investment advice.
- Fees for setting up a brokerage window.
- Front end- or back end-loaded sales charges.
- Redemption fees.
- Transfer fees.
- Optional rider charges in annuity contracts.
- Describe Methods of Charging Fees
In disclosing administrative expenses charged against participants’ accounts, the plan administrator must clearly identify the service involved (such as recordkeeping) and its cost (such as 12 basis points of a participant’s account or $25 per participant) and the plan’s allocation method for charging participants’ accounts (for example, pro rata or per capita).
- Fees That Cannot Be Quantified Prospectively
For fees that may or may not be charged, the plan administrator must state how such expenses will be paid if they are incurred. For example, if a plan administrator expects the plan to incur legal fees in the coming year, but does not know the precise amount of those fees when the disclosure is made, it is sufficient to identify the services and how the plan will allocate the cost among plan participants’ accounts.
- Disclosure of Revenue Sharing Covering All Plan Expenses
If the fees generated from mutual fund investments are applied against plan expenses the arrangement is referred to as “revenue sharing.” Revenue sharing may also include certain rebates to the plan from a service provider. Even if revenue sharing pays all plan expenses without charging participants’ accounts, a plan administrator must advise participants of the revenue sharing itself. However, if all plan administrative expenses are paid from revenue sharing, the administrative expenses need not be itemized and the funds paying the expenses need not be identified.
- When Revenue Sharing Does Not Pay for All Expenses
If revenue sharing does not cover all plan expenses, the fee disclosure must state specifically how expenses are paid. For example, if record keeping costs are shared proportionately among the account balances of plan participants, but reduced by revenue sharing payments that the plan receives from investment options, that fact should be explained. If the plan does not pay recordkeeping costs because the fees collected on the investment options cover those costs, the disclosure must state that fact. It is acceptable to state, for example, “The plan incurs monthly recordkeeping expenses of up to 0.02% of the plan’s assets. These expenses are typically deducted from your account on a pro rata basis. However, revenue sharing payments that the plan receives from plan investment options may pay these expenses in whole or in part. In the past, these payments have completely paid for the recordkeeping expenses. If revenues sharing payments are received, the plan will pay less than the 0.02% fee per month, and only those expenses not offset by the revenue sharing will be deducted from your account.”
- Describe Fees
Some plans offer participant-directed brokerage accounts providing a wide array of investment options in addition to the designated mutual funds that the plan fiduciaries have chosen for the plan. If the plan offers participants brokerage service, the plan administrator must explain any fees that may be charged against a participant’s account to set up the brokerage arrangement, and any ongoing fees and commissions. A general statement that such fees exist and may be charged against an individual’s account using a brokerage option is sufficient to put the participant on notice as long as the disclosure tells a participant how to obtain more information about fees.
- Quarterly Statement Showing Fees
The plan administrator must also provide participants with a quarterly statement showing the dollar amount of fees and expenses that were actually charged against the participant’s plan account individually.
- Other Information
In addition, the plan administrator must provide participants with directions for brokerage trading, any account balance requirements and trading restrictions, and how the brokerage account option differs from the designated investment funds of the plan.
Other disclosure requirements
The recent DOL guidance also covers:
- Disclosure of returns and benchmarks on plan investment options.
- Disclosure of investment-related web site addresses.
- Sample glossaries for investment terms.
- Disclosure of annual operating expenses for “fund of funds” investment options.
- Annual disclosure of charts comparing investment alternatives.
- A disclosure exemption for 403(b) plans • established before 2009 if the employer makes no contributions (including any employee salary reduction contributions).
Employer action needed
Employers should make sure that by August 30, 2012 fee disclosures are given to plan participants who must select investments for their retirement accounts. Plan administrators should expect to receive information for the fee disclosures from covered service providers by July 1, 2012. The first quarterly accounting of fees actually charged to participants' accounts are due by November 14, 2012.
Compliance with this new guidance is particularly important in light of a recent case brought in the federal district court of Missouri, Tussey v. ABB Inc., in which plan participants successfully challenged plan fiduciaries for overpaying costs. The court ordered the fiduciaries to restore over $13 million of losses suffered by the plan as a result. In particular, the court looked at the reasonableness of the plan’s per participant recordkeeping charge, the revenue sharing arrangement between the plan investments and the employer, and the employer’s failure to negotiate the cheapest class of shares made available for investment. In addition, the court found the vendor in breach of its fiduciary duty for keeping the float on the amounts contributed to the plan.
Accordingly, besides providing proper fee disclosure on plan investments to plan participants, employers must be vigilant in monitoring the reasonableness of recordkeeping costs, especially if those costs are paid through revenue sharing. In addition, employers should negotiate rebates or cheaper share options in mutual funds, as failure to do so may be evidence of a fiduciary breach. Plainly, it has become more important to watch plan expenses, negotiate cheaper fees, make proper disclosures to plan participants and reevaluate, where necessary, plan design to keep costs down.