As a fiduciary of your company’s retirement plan, do you know how much you are being charged from plan assets by your service providers? Do you focus on the checks your company writes to service providers and not on the true cost that includes charges against plan assets?
Consider 2 situations: (1) A 401(k) plan has $2,000,000 of assets. The service provider charges $2,500 per year performing its duties. The service provider does not receive any fees from plan assets. (2) Same 401(k) plan except the service provider charges the company $1,000 per year and also charges plan assets 10 basis points (0.10% or .001 of assets).
In situation 1 the service provider receives $2,500 per year. In situation 2, the service provider receives $1,000 from the company and $2,000 from plan assets for a total of $3,000. The provider receives greater compensation in situation 2. However, many plan trustees and other fiduciaries would not aware of the total compensation paid to their service providers. The fact that a service provider receives more compensation in situation 2 might be perfectly reasonable. For example, the provider might perform more services than the provider in situation 1; the provider might have better and more timely service; or the plan sponsor might like the idea that the employees “pitch in” for the cost of plan service and be willing to pay extra for it.
Disclosure is the key to the new rules. The Department of Labor (DOL) is not regulating how much providers are allowed to charge, a client. Instead, the DOL is requiring that the provider disclose how much it receives as compensation so the plan fiduciaries can make an informed decision about choosing service providers.
These disclosures apply to brokerage firms and investment advisors. Fees that are paid out of plan assets as service fees (12b-1 fees), or advisory fees, must be disclosed. Plan trustees can now see how much compensation a broker receives and compare it to the level of service provided.
These disclosures also apply to “indirect” compensation. These are amounts that are subsidies paid by third parties to the service provider. Consider the $2,000,000 plan in the example above. Let’s say the investment funds are provided and recordkeeping performed by the XYZ insurance company. The government forms and calculations are done by the ABC administration firm. XYZ pays ABC 5 bp or .0005 times assets. This equals $1,000. This amount does not come from plan assets. It comes from the pockets of XYZ. In other words, the charges to plan assets would be the same whether or not XYZ paid ABC $1,000.
Service providers that act as a fiduciary of the plan must also include this statement in their disclosures. Expect to see these disclosures soon. They must be completed by April 1, 2012. Plan fiduciaries should always be aware of the true cost for maintaining a 401(k) plan. These regulations will make that job a little easier and level the playing field.
The failure to follow these rules could result in an excise tax for the service provider and possibly rescission of the contract to provide services.
If there are any changes to the compensation, or when a new agreement is made between the plan and the service provider, then a new disclosure must be made. There is no automatic requirement to make periodic (such as annual) disclosures.