| Statement of Norman P. Stein, Professor, University of Alabama School of Law, on behalf of the Pension Rights Center Testimony Before the Full Committee
of the House Committee on Ways and Means October 30, 2007
Mr. Chairman, Members of
the Committee, I am Norman Stein, a professor at the University of Alabama
School of Law, where I am privileged to hold the Douglas Arant Professorship.
This semester, I am a visiting professor at Catholic University’s Columbus
School of Law here in Washington, D.C. I am appearing today on behalf of the
Pension Rights Center, the nation’s only consumer organization dedicated solely
to promoting and protecting the retirement security of workers, retirees and
their families.
If someone were to look at the
discussion of 401(k) plan fees over the past decade, they may well compare it
to the weather: It is something that everyone talks about but about which no
one has done all that much. It is our hope that this hearing today will put us
on the road to improvement of both the disclosure and appropriateness of 401(k)
fees. Indeed, we were heartened to see that the topic of this hearing was not
merely the disclosure of 401(k) fees, an
issue on which the Center has commented before,[1]
but also on the appropriateness of some of those fees. Mere disclosure is
often not enough: If fees are too high or otherwise inappropriate, the proper
remedy is not disclosure but prohibition or regulation.
Our testimony today will focus on
six issues: (1) the effect of fees on retirement savings in 401(k) plans; (2)
disclosure of fees to participants; (3) disclosure of fees to fiduciaries; (4)
the inappropriateness of charging plan administration fees to participant
accounts; (5) the inappropriateness of a Department of Labor field assistance
bulletin that allows a plan to charge extraordinary fees to the accounts of
individual participants; and (6) the desirability of a government-sponsored,
low-fee 401(k)-type service provider, which could provide an alternative to
smaller businesses that often lack sufficient bargaining power to negotiate low-fee
arrangements with third-party administrators.
1. The Effect of Fees on
Retirement Savings
In recent years, think-tanks,
commentators, the Government Accountability Office (GAO), and the Department of
Labor have developed models and simple illustrations of the dramatic effect of
fees on retirement savings. From the standpoint of entities that provide
various services to 401(k) plans in the market, a small additional fee can
result in substantial profits, because that fee is typically multiplied by the
number of participant accounts served. In many cases, a small percentage
difference in the cost of a product or service is not particularly meaningful
to the consumer, because it is a one-time cost and is not compounded over
time. But in the area of 401(k) plans, the fee is charged periodically, and
sometimes as often as monthly, over an employee’s working life, and the time
value of money can turn a nominally insignificant fee into a significant loss
in retirement savings. The GAO, for example, has shown how a one percentage
point in fees for an investment with a seven percent before-fee rate of return
can reduce retirement savings by 17 percent over a 20-year period of
participation. Fees matter.
Although fees matter for all
investments, they matter even more for 401(k) plans. That is because the very
nature of these plans, where employee contributions flow into the plan each pay
period, can conceal the impact of fees. Participants, unaware of how much they
are paying in fees, see their accounts grow and assume they are earning
significant returns.
2. Participant
Disclosure
Disclosure of fees is keenly important to participants. They need this
information to determine whether they are getting their money's worth for their
401(k) investments, and to plan realistically for retirement. In
addition, participants cannot adequately choose among investment
options without relevant fee information. Finally, there is the fact that
financially sophisticated participants may be in a position to influence
plan decision-makers choice of investment options when the plan’s current
investment options have high fees.
In our view, automatic participant disclosure should be simple and direct. Too
much information can overwhelm an unsophisticated participant and can give even
a financially literate participant more information than they need. We
suggest that 401(k) participants be provided automatic annual fee disclosure
statements that at a minimum include the following:
;
1. A statement of why fees are important, and that they should
be considered along with return and risk characteristics in selecting
among investment options;
2. A listing for each investment option offered by the 401(k) plan,
the rate of return, net of fees, during for the preceding year;[2]
3. An individualized statement of the total dollar amount of fees charged
to a participant's 401(k) account the preceding year, including all
recordkeeping, investment, load, marketing and other fees.[3]
In addition, it would be helpful for
the annual statement to also include
1. Expense ratios for (i) aggregate investment management fees and
(ii) for administrative and advisory costs (to the extent paid by the
participant);
2. Dollar amounts per $1,000 for (i) aggregate investment management fees
and (ii) for administrative and advisory costs (to the extent paid by the
participant).
3. Transaction-oriented fees that are paid when initially purchasing
or later disposing of an investment option, with an indication of how high
these fees would be if ratably charged on annual basis for investments held for
1, 5, 10, and 15 years.
Finally, participants should be able to request more comprehensive information
about fees for particular investment options, with fees disaggregated into
uniform categories.
3. Disclosure to
Fiduciaries
Participants need fee information to help
them shape a portfolio from the investment options available under the plan. Plan
decision-makers, however, have to choose from the entire universe of available
investment vehicles those options that will be made available to plan
participants. Moreover, they need periodic information about the investment
they have chosen in order to monitor their continuing appropriateness for the
plan’s participants. Thus, plan decision-makers require detailed information
about all fees that are charged to the plan, so that they compare one
investment option to another, particularly within classes of investments. In
order for them to compare fees across various investment vehicles, the
presentation of fees should be uniform from vendor to vendor, with fees divided
into separate fees for each type of service provided by the vendor. This would
require that fees for bundled services be unbundled. Moreover, it may be
appropriate for there to be regulation that requires that each service be
available on a bundled or unbundled basis. Discounts for bundled services
should be clearly identified.
We also note that participants
should be able to request any information on fees that is submitted to the
plan.
4. Costs for
Administrative Services Should Be Borne by the Plan Sponsor
It may be time to re-evaluate whether a
plan sponsor should be able to pass administrative costs on to individual
participants or whether these costs should be considered a cost of plan
sponsorship. There are four reasons for our views:
1. The employer is the purchaser of
plan administrative services without being the actual payor for those services
(in plans that pass those costs on to the participants). This is a recipe for
market failure, since the employer does not have the maximum incentive to
bargain for the lowest possible fees and/or the most appropriate services for
the plan.
2. In some cases, particularly with
smaller plans, fees can make the cost of investing inside a plan more expensive
than investing outside a plan.
3. In defined benefit plans, the
employer bears the administrative costs of plan management, either directly if
the administrative fees are paid directly, or indirectly if the fees are
charged to the plan, since the employer bears the burden of funding the plan.
The ability to charge back fees to the participant in a defined contribution plan
creates an uneven playing field between defined benefit and defined
contribution plans. In our view, the administrative costs of plan sponsorship
should be a cost of doing business.
4. When employees decide among
employment opportunities, they will generally compare section 401(k) plans
based on the employer match and not on whether the employer bears the
administrative costs of plan sponsorship, something that even sophisticated job
seekers are unlikely to consider (or have the information to consider).
Requiring employers to bear the administrative costs as a normal cost of doing
business will increase the accuracy of employee evaluation of 401(k) plans
offered by different employers.
5. Field Assistance
Bulletin 2003-3
In 2003, the Department of Labor issued a
Field Assistance Bulletin that reversed long-standing rules on what types of
individual costs could be charged as fees to individual participants. That
Field Assistance Bulletin, which did not go through the normal regulatory
process in which a change of position is first published in the Federal
Register and comments from all stakeholders solicited and considered, adopted
positions that in our view were ill-considered and that can have unfair and, in
some cases, devastating impact on the retirement security of some plan
participants.
The most objectionable of the
holdings in this Bulletin was that the plan’s cost of a qualified domestic
relations order could be charged directly to the account of the participant.
These fees can be substantial and in some cases could reduce the value of a
modest retirement account to zero. We urge the Committee to review this
Bulletin and consider recommending that the Department of Labor withdraw it and
return to its prior interpretation of when fees can be charged solely to the
individual accounts of particular participants.
6. Low-Cost Provider
The economist Christian Weller, and
others, have proposed that legislation make available to small firms that
provide 401(k)s an option to access large, governmental third-party service
providers. This would make available the economies of scale realized by large
employers. For example, the Federal Thrift Savings Plan or the defined
contribution plans of state retirement systems might allow participation by the
employees of private employers. The availability of such an alternative might
also have ripple effects in the market, as service providers lower fees to make
their products more competitive to smaller employers.
[1] Pension Rights Center Comments in
response to U.S. Department of Labor Request for Information dated July 24, 2007
http://www.pensionrights.org/policy/regulations/401k_fees_RFI/PRC_comments_on_fee_disclosure_RFI.pdf
[2] This could be similar to the format of
the “Rates of Return” chart published by the Federal Thrift Savings Plan in its
Highlights newsletter http://www.tsp.gov/forms/highlights/high07d.pdf
[3] This type of total dollar disclosure has
recently been implemented in Australia. See Corporations Amendment Regulations
2005 (No.1), March 10, 2005 (Australia), Amendment under Corporations Act of
2001, Schedule 1, Part 3, Division 2(302), at p. 25, found at http://www.frli.gov.au/ComLaw/Legislation/LegislativeInstrument1.nsf/0/5148FBFAB97F8829CA256FC00022EC72/$file/0304600I-050307EV.pdf
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