Defined contribution plans in for significant changes

by Jay Kessler
August 31, 2007

The year 2007 will likely mark the beginning of a significant restructuring in the defined-contribution retirement-plan industry as plan providers are forced to become more transparent about the way they make money.

The resulting changes may be good news to employees, who are likely to see less of their retirement money going to pay fees. But the restructuring -- triggered by a series of recent lawsuits challenging the bundled-fee system of compensation -- may also push plan providers to seek other sources of revenue.

And that could have far-reaching implications for the future of defined contribution plans, which now hold more than $2.5 trillion of the country's retirement assets.

The lawsuits, which challenge buried management fees that erode investor returns, have led to a broader investigation of the role of fees in defined contribution plans. This spring, the House Committee on Education and Labor held hearings on hidden 401(k) fees. Now the U.S. Department of Labor is in the process of drawing up new regulations requiring increased fee disclosure. There is every reason to believe that there will be little wiggle room when it comes to revealing all fees.

Fees are important. A 1 percent difference in fees over a 20-year period could result in a 17 percent difference in a retirement account balance, according to the U.S. Government Accountability Office. Yet participants trying to calculate those fees can find it an impossible task. Not only are there investment fees charged for selecting and managing securities, but there are also fees for record keeping and other administrative duties. Separate vendors hired by plan sponsors may each charge their own fee. Or a single company may bundle all those services together, sharing the fees it collects among other vendors through so-called "revenue sharing" arrangements.

Often referred to as "kickbacks" by critics, these revenue-sharing arrangements are now under pressure and will likely to be replaced by clearly stated fees charged in the form of hard dollars. This increased visibility will put the spotlight not only on the size and purpose of those fees, but also who pays them. Under the old system, it is typically the employees who pick up the tab, even though they may not know it. Once the fees are fully disclosed, however, employees may start to push back.

Already it is clear that employers are going to have to pay closer attention not only to how their plans are structured, but also to the type and cost of the investment products used. No longer can employers meet their fiduciary responsibilities by simply outsourcing their retirement plans. Plan sponsors will have to provide better oversight, and they will have to pay more attention to the information provided in their communications with employees.

Fee disclosure will almost certainly put downward pressure on fees paid at all levels. This in turn will put pressure on margins, affecting a variety of business decisions including the kind of enhancements that service providers are willing to offer. As service providers shift from a "bundled" approach to fee for service, some may decide that they no longer want the responsibility of providing plan administration services. Or they may leave the business entirely.

Anticipating that the DOL will impose new requirements before year-end, many major employers are already hard at work revising the information that they provide to participants on plan management and fees. Small companies should be following right behind, reviewing the investments offered by their plan, revising their communications to employees and making sure that employees are told exactly how much the fees on their retirement accounts are costing them.

Jay Kessler a partner of Samet & Co., a certified public accounting firm based in Chestnut Hill.