Hearing of the Senate Special Committee on Aging - Hidden 401(K) Fees: How Disclosure Can Increase Retirement Security
SEN. KOHL: (In progress) -- Although these plans have only been around since the 1980s, they now cover over 50 million people and exceed $2.5 trillion in total assets. Out of private sector workers who have any type of retirement benefit, two-thirds have only their 401(k) savings to secure their financial well being into their retirement.
Although 401(k)s have become the primary pension fund for most Americans, there are few requirements for fund managers to tell participants how much they're paying in fees. Most fees are either absent or obscured in participants' statements and investment reports.
Not surprisingly, we'll hear today that fewer than one in five participants know the fees that they're paying. Unfortunately, the lack of disclosure and the lack of understanding can have serious consequences for an individual's retirement savings. The slightest different in fees can translate into a staggering depletion in savings, greatly affecting one's ability to build a secure retirement.
According to the Congressional Research Service, families who save their retirement funds in high fee accounts could have one quarter less in retirement than those who work for employers who offer low fee accounts. For couples who save their entire lifetime, the CRS study found that an annual fee of 2 percent could reduce savings by nearly $130,000 compared to a more reasonable fee of 0.4 percent.
Investigations by this committee have found that fees at 2 percent or higher are not uncommon. One small business owner we talked to with contract fees around 2 percent and most of the plan assets in a money market account had a net return that was almost a negative 1 percent a year. The small business owner was distressed when he finally discovered the high charges and was ready to cancel his 401(k) plan altogether.
Giving small business owners all the facts in an easy to understand manner will help them find lower cost options and make it more likely that they will offer retirement saving plans to their employees.
Fees are not the only factor that 401(k) participants should consider when deciding how to invest their savings. A wise investor should diversify portfolio and consider a funds risk in return. But while returns are unpredictable and will fluctuate from year to year, fees are something that are fixed, are known in advance, and could be easily controlled by plan enrollees.
Furthermore, we believe that there's a basic right for consumers to clearly know how much products and services are costing them. This week, Senators Harkin and myself are introducing the Defined Contribution Fee Disclosure Act of 2007. This bill will help shed some light on these fees by requiring complete transparency to both employers and participants. This will allow employers to be able to negotiate with pension fund managers in order to get the lowest possible fees for their employees.
Participants will be able to make informed choices between investment options and potentially increase their retirement savings by thousands of dollars. Ultimately, this legislation will help to lower costs for everyone by fostering competition among pension managers.
So we welcome our witnesses as we discuss the importance of fee disclosure to employers and plan participants and consider its impact on the retirement savings of older Americans. We turn now to my able ranking member and my friend, Gordon Smith, from Oregon.
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SEN. KOHL: Ms. Bovbjerg, what would you say is the best way to provide 401(k) participants with information about the fees they're paying, so that they can make wise investments?
MS. BOVBJERG: Clearly, comprehensively, but simply, and that, of course, is the trek. We've had difficulties in doing this in even things like our Social Security statements. We've had difficulties with the disclosures that we make to credit card holders, for example.
I think that the trek in these efforts is to focus on providing information and improving understanding and not simply meeting a legal requirement. We reported last year, with regard to credit card disclosures, that it was the tiny typeface problem. It was too much information. It was prepared in a way to meet a legal requirement rather than actually explain something to individuals who vary tremendously in their ability to understand these things.
SEN. KOHL: I've heard employers say that it's impossible to determine all the fees that individual participants pay. While I do understand that some fees are assessed plan wide and difficult to calculate to the penny, what is your understanding of the ability of plans to reasonably estimate the actual fees that are paid by participants?
MS. BOVBJERG: I think that this is their fiduciary duty to know what fees the plans are charging for participants, whether it's directly assessed to the participant or whether it's being assessed to the sponsor.
SEN. KOHL: Mr. Campbell, the Department of Labor has been talking about fee disclosure, as you know, since back in the 90s. So on what date can we expect the Department of Labor to have regulations that would require clear disclosure of fees to all employers and to all plan participants?
MR. CAMPBELL: Well yes sir, as I indicated, the first of our three initiatives will be final regulation within the next several weeks. That's to go into the Form 5500 disclosures to the public and the government. The second regulatory initiative, service provider disclosures to plan fiduciaries, will be proposed within the next several months, and we will be issuing a proposed regulation governing disclosures to participants by plans this winter. So these are moving along very well.
I think I would say, with respect to the previous initiatives you're referring to in the 90s, those were in the same area, but they're not these initiatives. These initiatives were begun last year. We're making very good progress by the standards of regulatory time, recognizing that it is a deliberative process and does have to follow the legal requirements of the process.
SEN. KOHL: Current ERISA law dictates that the plan sponsor should ensure that all 401(k) fees are reasonable.
How has the Department of Labor been defining "reasonable;" how has the Department of Labor been enforcing this requirement, and how many cases have been brought specifically on this issue?
MR. CAMPBELL: The requirement in the statute, as you say, is that these fees must reasonable, and plan fiduciaries bear the duty of ensuring that. The determination is on a facts and circumstances basis. The fiduciaries are responsible for looking at each service provider, the services they're providing, the cost of those services, doing due diligence and comparing them to other service providers to ensure that they are following -- again, to use the same word -- a reasonable process in gathering the information necessary to make that determination.
The Labor Department does review, when we do investigations, the fees and expenses that are being paid. Over the last several years we've brought I believe on the order of 350 or so cases that involve fee and expense issues. This is part of the reason we concluded that rather than piecemeal enforcement a regulatory effort was necessary to help globally address this. And one of the more significant regulations with respect to the reasonableness of fees is ensuring that fiduciaries have the information they need to assess whether they are reasonable.
And one of those considerations, for example, would be indirect payments coming to service providers from third parties. Fiduciaries need to be aware of those so they can factor that in to whether they're paying a reasonable amount, and how the assets of the plan are being used in connection with the financial services industry. And providing that disclosure will help ensure that those fees are reasonable.
SEN. KOHL: Thank you, Mr. Campbell. We turn now to Senator Smith.
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SEN. KOHL: Thank you. Mr. Chambers, you warn in your testimony, as you just said, that participants could be confused by an overly complicated disclosure of fees. My bill along with Senator Harkin would give one number to participants on their quarterly statement with the option for them to request further information. Do you think that giving participants a single fee number quarterly and allowing those that want to get further information is too complicated?
MR. CHAMBERS: I think, senator, the complication may be in coming up with one number for each participant. Clearly, from their perspective if you give them one number, that's fine. It may be misleading for those people. It's not going to be comparative, as some of the other folks on this panel have suggested. And I would be concerned that it would be giving them information in a vacuum. Admittedly, clean, crisp, simple, but I'm not sure that it's the information that they would need.
SEN. KOHL: Mr. Bullard, do you think giving participants a single number to represent their fees on their quarterly statement with the option for more information would be overly confusing, or would you recommend that?
MR. BULLARD: I'd recommend it strongly, and I've heard arguments before that it might be misleading, which is always the argument that industry makes after having argued that we can't provide them with too much information because it'll be too complex. Once we winnow it down to some essential simple information, it becomes misleading.
There is going to be a trade-off, as Senator Smith suggested, and that trade-off is going to be between comprehensive information and clear, simple information. And a dollar disclosure of what they actually paid in fees or a very close estimate of that amount will only have the effect, even if it is not a perfect representation of what they paid, of making them think harder about their fees. It begins to get the ball rolling, although I think I agree with Mr. Chambers about -- which is that more price transparency puts downward pressure on fees. And I am a firm believer that that particular disclosure would do more to reduce the costs of investing in 401(k) plans than any other proposal that this committee might adopt.
SEN. KOHL: Do you think that Mr. Chambers is representing interests that -- want to have higher fees?
MR. BULLARD: I think Mr. Chambers is representing an industry that has already expended large sums in compliance, and unfortunately the debate is always about new regulations rather than looking at old ones in which the people he's represented have already invested a fair amount of capital. I think the DOL should always be looking at how to reduce costs and eliminating rules that are no longer important. At the same time, they're thinking about coming up with new rules.
But as far as the cost of quarterly statements goes and the pay- offs the industry has argued -- and I think I quoted in my testimony that the mutual fund industry said that it would be breathtakingly high within a year, and investment management announced that it was going to be providing the same quarterly statement disclosure that the industry insisted was completely unaffordable.
So here's one provider that not only finds it affordable, but apparently believes it's profitable. And I think that we need to move on and think about the behavioral effect it would have on people if you give them what I describe as the $225 versus $37 disclosure. I have no doubt that even for the least sophisticated investor that would put enormous downward pressure on fees.
SEN. KOHL: To all the members of the panel, would you agree that it's really important that people enrolled in 401(k) plans know what the fee is, how we get there, whether it's difficult or easy, but it's very, very important that they know their fee. Anybody disagree with that?
MR.: I agree with that statement.
SEN. KOHL: Mr. Bullard, Mr. Love?
MR.: Certainly agree with that.
MR. BULLARD: I guess I would probably say if the test is whether they can name the expense ratio, their investment option charges, probably not, but what they really -- I think what we're getting at here is that they're conscious of their fees and the impact that it has on their bottom line.
SEN. KOHL: Right.
MR. BULLARD: And, in fact, the expense ratio does not convey that. If you ask your average person, particularly one who's not that sensitive to fees, when they get into the checkout line and instead of them saying that'll be $12.50, they say that'll be .2 percent of what you've got in your wallet, they'll have no idea what you're talking about. What we want people to understand is a dollar number so they can see they're getting this heavy hit on their balance quarter in and quarter out, and it should represent a meaningful decision on the part of the plan to pay that amount of expense.
And Mr. Chambers is absolutely right. Sometimes that $225 versus $37 will be explained by the fact -- it's a small plan, few participants, low balances, and the desire to have (high cost active funds ?). But the fact is that having those numbers would drive that inquiry and put a lot of pressure in places where the market is not efficient.
SEN. KOHL: Mr. Love, why is it that so few people do know what their fee is?
MR. LOVE: I'm afraid it's probably a matter of not having information available to them. It's a larger issue of financial literacy. Financial literacy is a problem in this country. People need to know more about how they invest, how they save for retirement. If it were clearer to them, if there were charts, if they were seeing the numbers, if there were dollar amounts, they would be much more likely to understand what the fees would -- the consequences of the fees for their retirement. Right now it is not clear. It's not that they're being hidden. They're simply not clear.
SEN. KOHL: Well, being as the fee differential can eventually mean so much in terms of the return on their 401(k), why is it that those people who administer the 401(k) plans don't make it more clear what the fee is?
MR. LOVE: I'm not sure what the answer to that -- (we are being simply called for that ?). The actual plan participant who's asked is this important to your consideration of your plan always says yes. They'd like to know what fees are when making decisions about investments. I'm not sure why they're not clearer on statements.
SEN. KOHL: Do you think that most people don't have an awareness of what the differential can mean in terms of return on their investment if the fee is two percent versus one percent versus a half a percent? They don't really understand that?
MR. LOVE: They really don't understand that. If you ask someone clearly a comparative math problem -- is one and a half percent more than half a percent -- most people can tell you yes, that's the case. But in our survey a lot of people could not -- but on the other hand, if you say to a participant, alright, here is the fund which charges 50 basis points a year and here's the fund that charges 75 basis points a year, I think that most participants are going to understand one is more expensive than the other. But that's not the final analysis. The final analysis is historically how is this fund charging fewer basis points done compared to that fund which charges more?
And to go back to Mr. Love's point about financial education, I think that that's the crux. I think that what we're dealing with here in connection with plan fees is -- if you'll pardon the expression the low hanging fruit of the equation -- I think that the bigger issue facing this country and, frankly, in my view facing Congress -- 'cause this is where you really join the foray here -- is to try to figure out ways to help the Department of Labor to help employers to focus on how they can provide better financial education to their participants.
Frankly, throwing more pieces of paper or more emails at different folks with a lot more information isn't going to get us over that hump. What's going to get us over that hump is more work similar to what the Department of Labor has done in the past, perhaps some tax opportunities for employees to get better financial information, which will then enable them to take the information that we are talking about today and put it to better use.
MR.: If I could just respond to points -- (I think -- ?) I would observe that using percentages, as Mr. Chambers just used, will simply not communicate the same information to those who are used to thinking about dollars. Second, no one has suggested that it is the final -- the idea is to get an impetus for the market to work where we think it is not working efficiently.
And then third -- the ultimate question is not really performance when you get right down to it. Virtually every study has shown that there's minimal if any repetition, that is, on persistence of performance among investment options. And if you think about what Congress's concerns should be, it should be looking at Americans as a whole. And the fact is if you look at all Americans investing in all stock funds, the return of that group is going to be the market's return. No matter how you cut it, if there's one fund that's doing better by buying good stocks that another fund shouldn't be selling, they're buying the stocks from a fund that's going to do worse than the market.
So the bottom line is America is going to get the market return regardless of all the emphasis that some would like to put on performance. The only question I think for this committee is how much of that market return is going to be given up to service providers and Wall Street?
MR.: Mr. Kohl, if I may, a couple of direct concerns that I would have. Within the industry I would offer that practically speaking the way that small plans are sold and scrutinized -- there's generally someone within the mix who has an interest in all of the facts of the plan. So while we cannot get the attention of all 20 employees and get them to invest in the knowledge, those 20 employees and a small employer generally have a high degree of trust of someone in the equation -- generally one of their coworkers -- who really does scrutinize the vendor material quite closely.
So in that regard, by paying attention to that person that they find to be influential, they take an interest in the plan. I would submit that as an industry initially -- (inaudible) -- a full, fair, level playing field on disclosure, on fees, will drive up interest in the area of concern, drive up interest and the fees. It will create downward pressure. And in the end it will take away an argument that we hear time and time again. If we do not disclose fees and if we don't do a good job with it -- and the market will fine tune that as time goes by -- there is a tendency on behalf of some people to assume the worst. So they will avoid getting into their 401(k) plan if they don't see what they see to be a very full, fair disclosure process.
So by engaging a full, fair disclosure process over time we'll bring ourselves more customers in this industry, which is what we're after.
SEN. KOHL: Is there much disagreement on what we're hearing here today? Mr. Chambers, are you in any particular disagreement with the thrust of what the other three have said this morning?
MR. CHAMBERS: I suspect that we agree on more than we disagree on, which is helpful and fully surprising on panels of this sort. I think that certainly my focus and the focus of the folks who I represent -- who I would, by the way, point out are -- many employers, not just service providers, and therefore are not in it to maximize fees. But I think that the focus that we're looking at is, as I mentioned, cost. There is significant additional cost in coming up with specific dollar amounts on a per participant basis annually, quarterly, whatever the frequency is to be. And whether that cost along with all the other costs that are associated with this -- as I mentioned before, are actually going to wind up resulting in a net loss compared to where we would've been.
So we are interested in transparency. We are interested in providing additional information. I agree completely that employees if provided with information and with education on how to use it -- that they will do a better job and they're more likely to participate to a greater extent. I'm not sure that I agree that the only way to do this is on dollars. I'm not sure that I agree with some of the other things that we've said. But the positive note is that all four of us I think agree on more than we otherwise disagree on.
SEN. KOHL: Any other comments, gentlemen? It's been a good hearing I think on an important subject, and this committee's going to continue to pursue improvements in the information that people who hold 401(k)'s get with respect to fees and other charges. And so we appreciate you being here this morning, and you can expect to hear from us.
MR.: Thank you.
MR.: Thank you, sir. (Appreciate it ?).
SEN. KOHL: Thank you so much, and thank you all for coming.
MR.: Thank you, chairman.