If you’re already losing sleep over potential legal challenges from the members of your DC pension plan, here’s another item to add to the sobering list of reasons to be concerned—fee disclosure.
Plan sponsors are required to provide members with a description of the fees they pay. That’s been the case since 2005 when the Guidelines for Capital Accumulation Plans (CAP Guidelines) went into effect. But there’s a huge difference between disclosing investment management fees and helping members understand the impact of those fees.
When it comes to investment management fees—and their long-term impact on savings—the reality is that many plan sponsors are no more enlightened then their members. For this reason, and the lack of any clear direction in the CAP Guidelines as to how fees should be disclosed, fee disclosure tends to be treated as just one more item on the CAP compliance checklist. The result? An administrative solution to what should be an important learning opportunity for members.
For most plan sponsors, fee disclosure simply means adding a column to their fund return table. Often, it’s not clear whether the seemingly inconsequential amounts shown under the obscure heading of “IMF” are quarterly or annual, or whether the investment returns shown are before or after fees have been deducted.
Given the long-term impact of fees on savings, it’s too bad they aren’t better explained. In most cases, the fees that members pay in a group savings plan are lower—as much as 1.5% lower depending on the plan and the fund—than they’d pay in an individual plan obtained through the retail market. That can make a big difference to a member’s long-term savings. For example, if a member has a $100,000 portfolio, a 1% lower investment management fee will save them about $1,000 in the first year—and even more in the years that follow. In fact, assuming a net return of 6% a year, it will result in savings of about $17,600 over a 10-year period.
How do we know that members don’t understand the importance or impact of fees? By the investment choices they make. If they truly understood investment management fees:
- members would be more likely to take fees into account when making investment selections within their group savings plan (fees typically vary from one fund to another—even within a plan);
- they’d be more inclined to increase contributions to their group savings plan and less likely divert savings to more costly retail arrangements. In fact, they’d probably be flocking to plans like the revamped Saskatchewan Pension Plan—a voluntary DC plan with competitive returns and investment fees that average 1% or less per year—that allows annual contributions of up to $2,500 from out-of-province taxpayers with available contribution room; and
- they’d be more selective about where they move their money when they leave their group savings plan. Too often the money is transferred to a retail institution based on factors such as location and convenience, without a second thought for front end loads, deferred sales charges and other fees.
- To help members understand the advantages of belonging to a group savings plan that offers lower fees, some DC providers offer tools that members can use to calculate the additional savings generated by lower fees.
That’s a good start, but probably isn’t enough, especially when you consider the low levels of tool usage experienced by most DC plan sponsors.
U.S. going one better
The U.S. has taken fee disclosure a step further. Granted, it may have taken a crisis of confidence in their financial institutions and a series of class-action lawsuits against companies with retirement plans that charged members excessive, undisclosed fees to make this happen but the U.S. Department of Labor is introducing new rules around fee disclosure.
Starting Jan.1, 2012, new members of 401(k) plans must receive an explanation of costs when they set up their account.
What makes the new regulations truly meaningful is that fees must be expressed as both a percentage of assets and a dollar amount. They also require that 401(k) participants be given enough information to compare the cost of fees for different investment options and have access to a website with additional details.
The goal of the new rules, says Assistant Secretary of Labor, Phyllis Borzi, is to ensure participants “understand the dramatic effect fees play in the returns that they get.”
This is a goal worth pursuing on both sides of the border.