Fee disclosure won’t fix your 401(k)
First, the good news: The Labor Department has published its final fiduciary disclosure regulations, which will shed much needed light on hidden fees and costs associated with 401(k) plans. By the end of the summer, 401(k) service providers must disclose heaps of information, including a clear breakdown of the compensation they are receiving for their work. And the new regulations have teeth. A fiduciary that fails to disclose will risk significant penalties for being in breach of federal law, specifically the Employee Retirement Income Security Act, or ERISA.
Now the unfortunate caveat: These new requirements will have little impact on the overall success of 401(k) plans. In fact, I predict that most small business 401(k)s will continue to fail in providing sufficient retirement income for their employees until employers learn how to evaluate their plans, which are universally underfunded.
Retirement income is the primary measuring stick for 401(k) success, period. Just imagine how America will look when the typical retiree experiences a 40 to 60 percent reduction in retirement cash flow, a future that is increasingly inevitable if current trends continue. Less income for 60 to 80 million boomers barreling toward retirement means less consumption, a smaller tax base and ultimately a weaker nation.
Today, only about half of small business employees have access to a 401(k). Of those with access, only 4 to 6 percent will retire with enough assets to replace their lost earnings from employment.
So while the new disclosure rules are a welcome change, they are unlikely to address the core problem of poorly funded plans. My admittedly bleak assessment is based on experience. Most employers I talk to in my work as a financial advisor report being happy with their plans, though when I ask them why, they have no idea. Keep in mind that these are usually senior executives who have no trouble rattling off details about profit margins and business strategy.
The problem is generally not lax attention on the part of employers, but rather the incentives that prevail in the financial services industry in general, including among 401(k) providers, which of course will never win points for transparency. Simply put, a 401(k) provider maximizes its revenue by managing as many employer-sponsored plans as possible and not by ensuring that any given plan is run well. This is problematic since the 401(k) has become the primary retirement vehicle for the majority of the U.S. population.
Since all 401(k) information is public, it's possible to scan current balances, number of employees and contribution levels for virtually all plans in existence. The stark truth is that it's rare to find a plan that is operating correctly.
Here's a typical case: A small business with 36 employees (average age of 47) and a $2 million dollar payroll might have a 401(k) plan with $2 million or $3 million in assets. To be fully funded in the next 18 years, when most of these employees will want to retire, the plan will need a balance of $20 million. In all likelihood, the plan sponsor does not have a strategy to close this gap.
Typically this is where an outside independent fiduciary can come in, analyze the situation and offer suggestions on more aggressively growing the plan's overall balance. Here are four key questions an employer can ask:
1. How much should my plan
have in assets to be on pace for minimum funding?
2. How much should my employees add each year and what amount of matching is needed?
3. Have I received full fee
disclosure and have I evaluated alternative options?
4. What don't I know that I
should know to make my plan successful?
Stories are already appearing in the financial and business press about the new rules, whose deadlines for compliance have been pushed out. (Fees must be disclosed to providers by July 1 and to participants by Aug. 30; the earlier cutoffs were April 1 and June 30, respectively.) Welcome the news, but don't assign it outsize significance.
That said, don't be too fatalistic either, an all-too-common feeling as mud season approaches in the Upper Midwest. The good news is that most plans have the basic structure to be successful. Small improvements across an array of fronts, including employee education and sound strategy from a fiduciary, can drive success over the long run. I have seen multiple plans that were stuck in the mud put a strong strategy in place for growth and then double and triple in value in relatively short order.
Mark R. Folgmann, AIF, is owner of Ark Advisors LLC, a fee-only firm that specializes in improving small business 401(k)s. He can be reached at 231-668-4118 or firstname.lastname@example.org