Proposal Games: Why You May Not Know What Your 401k Plan Will Cost
By Brandon Bellin, FSA, CFA, Senior Associate Actuary, Securian Retirement
The U.S. Department of Labor's 408(b)(2) regulation, which became effective July 1, 2012, requires retirement plan providers to provide detail about all the costs associated with recordkeeping and administering the plan. This means that employers who offer 401k plans as employee benefits should now have the means to fulfill their fiduciary obligation in understanding how much those plans really cost, at least with their current provider.
But what if the sponsor decides to evaluate other potential providers? Will they be able to determine and understand how much their plan will cost with another provider? Unfortunately, this can be quite difficult, as many providers have tried to gain a competitive edge by playing "proposal games."
Plan providers often receive revenue from the companies that provide the investment options within the plans. These revenues can vary among investment options, creating a conflict of interest and allowing the provider to imply to clients that it cuts costs by offering proposals with funds that generate lower revenue for the provider.
Fiduciaries who allow providers to play these proposal games without understanding the actual cost of the plan may violate their fiduciary duty to understand plan fees and determine whether they are reasonable.
Many retirement plan providers collect and retain revenue sharing from underlying investments, such as 12b-1 and sub-TA fees. The revenue may vary from fund to fund, creating an incentive for a provider to produce initial proposals for clients with investments with low revenue sharing fees to make them appear less expensive. Once past the initial proposal these providers may suggest a "better" line-up of funds that is better only in the sense that it pays pay higher fees and generates more revenue for them. The Qualified Default Investment Alternative (QDIA) is an area where revenue sharing fees often are higher and providers may encourage employers to direct participant assets into the QDIA.
Proprietary Target-Date Funds
As target-date funds grow in popularity and usage, some plan providers generate additional revenue by offering their own target-date funds from an affiliated asset manager. In these cases the investment management expenses can be unreasonably high for the underlying funds. For example, many target-date options that include passive index funds have expense ratios more typical of funds with active managers.
This additional revenue allows the provider to make its base recordkeeping pricing appear lower than it is: Because it flows through the asset management firm, the provider does not have to reveal that this revenue subsidizes recordkeeping expenses. And, while a provider may not require plan sponsors to select its proprietary target-date funds, it can safely assume a certain percentage of plan assets will end up in those funds anyway.
Some providers offer managed accounts that allow participants – for an additional fee – to obtain "professional management" of their plan assets. These fees can be substantial and may exceed the actual cost of providing managed accounts, allowing the provider to reduce base recordkeeping fees. This is why it's important for employers and advisors to understand managed account fees and how they contribute to overall plan costs.
Service providers without investment-neutral revenue and full fee transparency have an incentive to manipulate the investment array to their own advantage during the proposal process. These tactics deliberately divert scrutiny from the actual cost of the products and services offered, and in turn put plan sponsors at risk. The Department of Labor holds fiduciaries responsible for knowing about and evaluating indirect payments and providing employees with the most cost effective investment options. Those who don't breach their fiduciary responsibilities.
Products and services are provided by one or more of the following affiliates of Securian Financial Group, Inc: Minnesota Life Insurance Company, or Securian Retirement, a unit of Minnesota Life. • 400 Robert Street North, St. Paul, MN 55101-2098.
For plan sponsor use only. Not for use with participants.
401khelpcenter.com is not affiliated with the author of this article nor responsible for its content. The opinions expressed here are those of the author and do not necessarily reflect the positions of 401khelpcenter.com.