Guest Article

(From the December 18, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

401(k) Fees in the Spot Light of Both the GAO and the Investment Company Institute

"Congress should consider amending ERISA to require sponsors to disclose fee information on each 401(k) investment option in the plan to participants and to require that 401(k) service providers disclose to plan sponsors the compensation providers receive from other service providers," according to a November 16 report by the U.S. Government Accountability Office. When Congressman George Miller (D-CA) asked the GAO to conduct a study of 401(k) fees, he was in the minority in a House of Representatives that was fairly strictly controlled by the Republicans. By the time he received the report, he was still in the minority party, but that will change in early January 2007. At that time Congressman Miller will be in a much more powerful position to act on the GAO's recommendation, as the expected Chair of the committee with jurisdiction over ERISA and many 401(k) plan issues. As the new Chair of the Committee on Education and the Workforce, he will be setting the agenda, although it is to be hoped, he will consult with his fellow committee members.

In addition, the GAO Report, "Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees," (GAO-07-21) recommends that the DOL require plan sponsors to report a summary of all fees paid out of plan assets or by participants. The DOL generally agreed with the findings and conclusions of the report.

About the same time, The Investment Company Institute also released a study, "The Economics of Providing 401(k) Plans: Services, Fees, and Expenses," published in its periodical, Research Fundamental, November 2006. (The Investment Company Institute (ICI) is the national association of U.S. investment companies. Founded in 1940, its membership as of December 1, 2006 included 8,792 mutual funds, 662 closed-end funds, 269 exchange-traded funds, and four sponsors of unit investment trusts.)

Together these two documents offer some valuable insight into what is sure to become a growing debate regarding 401(k) plan fees. This debate will be fueled in part by the pending class action suits alleging fiduciary breaches stemming from failure to monitor plan fees and in part by policy makers' panic over retirement income security for the baby boomers and those following them who are likely to be heavily reliant on 401(k) plan accounts.

GAO Findings

The first page of the GAO report gets right to the heart of the issue by graphically illustrating the effect on account balances over 20 years of fees that differ by just 1 percent. The GAO chart shows an account of just $20,000, earning seven percent over those twenty years, will be worth $70,500 if the account's fees are 0.5%, but worth only $58,400 if the fees are 1.5%.

In the GAO's view:

The GAO report also notes that investment fees are charged regardless of whether the mutual fund or other investment is part of a 401(k) plan or purchased by individual investors in the retail market. GAO is not suggesting 401(k) participants are being unfairly charged for the same investment fees applicable to all fund holders. But the report does note that "the fees are usually different for each investment option available to participants in a 401(k) plan." Obviously, this difference in fees can make comparisons difficult for participants in plans that offer numerous funds. The report also notes that in very small plans -- those with 25 or fewer employees -- the fees may be very high, because many plan administration costs are fixed. When those fixed fees must be shared among a smaller number of accounts, the small plan participant will bear proportionately larger costs than individual participants in plans with more participants. But the report also notes that many plan sponsors pay the cost of plan administration.

ICI's Fee Data

The ICI releases a number of periodic reports and studies throughout the year and the November 2006 study is not designed to be a direct response to the GAO report. Rather the ICI study describes the various services and fees that might apply to mutual funds held by 401(k) and provides data on 401(k) mutual fund investors' expense ratios as compared with industry average expense ratios. The ICI data show that over the last decade the average 401(k) plan expense ratio tended to be lower than the industry average expense ratio. For example, from 1996 through 2005, stock mutual funds had an "industry average expense ratio" of ranging from 0.91 percent to 1.02 percent. By contrast the average 401(k) expense ratio ranged from a low of 0.74 percent to a high of 0.98 percent, lower than individual mutual fund holders' expenses.

ICI also reports that among the 830 sponsors of 401(k) plans surveyed in 2005, 37 percent of 401(k) plans surveyed reported plan sponsors paid the annual recordkeeping/administrative fees; in 55 percent of the plans, plan participants paid, mostly through investment fees and expenses; and in four percent of plans both the participant and the plan sponsor paid fees.

ICI's Key Findings

ICI's views are summarized in its list of key findings, outlined as follows.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Laura Morrison 202.879.5653, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955. Copyright 2006, Deloitte.