Defined Contribution / Financial Law and Regulation

Fees Matter a Lot, but They're Not All That Matters

May 07, 2012

The US Department of Labor’s new fee-disclosure rules for defined contribution (DC) plans will provide participants with much more information on plan and investment-option fees. That’s good. But there’s a real risk that it may unintentionally drive participants toward making poor investment decisions, as my colleagues Mark Fortier and Daniel Notto explain below.

New DC Participant Disclosure Rules

The 404(a)(5) regulations apply to participant-directed plans for plan years that start on, or after, November 1, 2011. Initial disclosures must be provided by August 30, 2012, and fee information must be included in quarterly statements by November 14, 2012. The information provided will include details on fees in a user-friendly format, including charges for recordkeeping, loans and qualified domestic-relations orders, as well as investment sales charges and redemption fees.

Fees are important, but they should only be one of many considerations when choosing retirement investments. In the end, what should matter to investors is their long-term return and risk after fees.

Here’s a hypothetical example that highlights the potential problem. The new rules require plans to show expenses as a dollar amount for a one-year period based on a $1,000 investment. Let’s say a participant finds that the target-date fund he’s invested in costs $8.00 per year while employer stock costs only 20 cents.

The participant might decide to reduce his investment costs by shifting 20% of his plan assets from the target-date fund to employer stock. But such a heavy concentration in a single stock would drive up the risk of his plan investments. There’s a good reason why target-date funds, not employer stocks, are qualified default investment alternatives.

This is not a far-fetched example. In response to a recent survey of more than 1,000 US DC plan sponsors that we’ll be releasing soon, only 27% said that their participants are very comfortable or comfortable with investing. The vast majority of participants are what we refer to as “Accidental” investors who are uncomfortable making investment decisions.

Participants need appropriate guidance about how to respond to the new fee information. Fortunately, our survey also found that plan sponsors are ready to provide it: 85% said that helping employees make effective investment decisions is very important or important. That help will probably be provided through sponsors’ call centers, because behavioral testing has shown that participants are more likely to pick up the phone to ask a question than read through fee disclosures.

Notes, flyers, educational materials and call-center scripts: all these tools should encourage participants to consider every relevant factornot just annual costwhen choosing an investment option. If available, an in-plan financial advisor can serve as an additional resource, providing more investment advice than plan sponsors are permitted to offer.

Under related 408(b)(2) rules, discussed in an earlier article, plan sponsors will be responsible for ensuring that investment fees are reasonable. When fees turn up in quarterly statements, participants will be better informed as to the impact of those fees. Plan sponsors can help participants consider fees in the proper context when making investment decisions.

"Target date” in a fund’s name refers to the approximate year when a participant expects to retire and begin withdrawing from his or her account. Target-date funds gradually adjust their asset allocation, lowering risk as participants near retirement. Investments in target-date funds are not guaranteed against loss of principal at any time, and account values can be more or less than the original amount invested, including at the time of the fund’s target date. Also, investing in target-date funds does not guarantee sufficient income in retirement.

Fees Matter a Lot, but They're Not All That Matters
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