Private Pensions: Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees
Published: 2006-11-16T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: American workers are increasingly relying on 401(k) plans, which allow pre-tax contributions to individual accounts, for their retirement income. As workers accrue earnings on their investments, they also pay a number of fees that may significantly decrease their retirement savings. Because of concerns about the effects of fees on participants' retirement savings, GAO examined (1) the types of fees associated with 401(k) plans and who pays these fees, (2) how information on fees is disclosed to plan participants, and (3) how the Department of Labor (Labor) oversees plan fees and certain business arrangements. GAO reviewed industry surveys on fees and interviewed Labor officials and pension professionals about disclosure and reporting practices.
section_title: What GAO Found
paragraphs: Investment fees, which are charged by companies managing mutual funds and other investment products for all services related to operating the fund, comprise the majority of fees in 401(k) plans and are typically borne by participants. Plan record-keeping fees generally account for the next largest portion of plan fees. These fees cover the cost of various administrative activities carried out to maintain participant accounts. Although plan sponsors often pay for record-keeping fees, participants bear them in a growing number of plans. The information on fees that 401(k) plan sponsors are required by law to disclose is limited and does not provide for an easy comparison among investment options. The Employee Retirement Income Security Act of 1974 (ERISA) requires that plan sponsors provide participants with certain disclosure documents, but these documents are not required to contain information on fees borne by individual participants. Additional fee disclosures are required for certain--but not all--plans in which participants direct their investments. These disclosures are provided to participants in a piecemeal fashion and do not provide a simple way for participants to compare plan investment options and their fees. Labor has authority under ERISA to oversee 401(k) plan fees and certain types of business arrangements that could affect fees, but lacks the information it needs to provide effective oversight. Labor collects information on fees from plan sponsors, investigates participants' complaints or referrals from other agencies on questionable 401(k) plan practices, and conducts outreach to educate plan sponsors about their responsibilities. However, the information reported to Labor does not include all fees charged to 401(k) plans and therefore has limited use for effective oversight and for identifying undisclosed business arrangements among service providers. Without disclosing these arrangements, service providers may steer plan sponsors toward investment products or services that may not be in the best interest of participants and may cause them to pay higher fees. Labor has several initiatives underway to improve the information it has on fees and the various business arrangements among service providers.

section_title: Letter
paragraphs: American workers are increasingly relying on 401(k) plans for their  retirement incomes. Named after section 401(k) of the Internal Revenue  Code, 401(k) plans are private pension plans that allow workers to save  for retirement by diverting a portion of their pre-tax income into an  investment account that can grow tax-free until withdrawn in retirement.  Participation in 401(k) plans rose from fewer than 8 million participants in  the mid-1980s to about 47 million participants in 2005, and assets in these  plans increased by more than twenty fold during the same period, from  less than $100 billion to more than $2 trillion. As workers accrue earnings  on their investments, they also pay a number of fees, including expenses,  commissions, or other charges associated with operating a 401(k) plan.
Fees are one of many factors—such as the historical performance and  investment risk for each plan option—participants should consider when  investing in a 401(k) plan because fees can significantly decrease  retirement savings over the course of a career. Even a small fee deducted  from a worker’s assets today could represent a large amount of money  years later had it remained in the account to be reinvested. Concerns have  been raised that employers sponsoring the plans and plan participants may  not be aware of all of the fees being charged to them or whether  companies providing services to the plan have undisclosed business  arrangements with other service providers that could negatively affect  participants. In light of the potential effects of fees on plan participants’  retirement savings, the Ranking Member of the House Committee on  Education and the Workforce asked GAO to examine  the types of fees associated with 401(k) plans and who pays these  fees, how information on fees is disclosed to plan participants, and how the Department of Labor (Labor) oversees plan fees and  certain types of business arrangements.
To identify the fees associated with 401(k) plans and how they are charged  to plan sponsors and plan participants, we interviewed officials from  Labor, the Federal Deposit Insurance Corporation (FDIC), the Federal  Reserve Board (FRB), the Securities and Exchange Commission (SEC),  and the Treasury Department’s Office of the Comptroller of the Currency  (OCC); met with service providers and other industry professionals; and  collected information about the range of fees and how they are charged to  plan sponsors and participants. We also reviewed several industry surveys  of 401(k) sponsors. To examine how well fees are disclosed to  participants, we identified the legal and regulatory disclosure  requirements; met with 401(k) plan practitioners; and reviewed sample  disclosure documents. To examine Labor’s role in overseeing plan fees  and any undisclosed business arrangements among service providers, we  reviewed Labor’s and other agencies’ legal and regulatory authority and  Labor’s procedures for assuring that plans are meeting overall legal  requirements, including the reporting of information on the form plan  sponsors are required to submit to Labor, Form 5500. We also interviewed  officials from four of Labor’s field offices and reviewed Labor’s current  initiatives related to 401(k) plans. We conducted our review from January  2006 through October 2006 in accordance with generally accepted  government auditing standards. See appendix I for more detail regarding  our scope and methodology.
subsections: section_title: Background
paragraphs: Roughly half of all workers participate in an employer-sponsored  retirement, or pension, plan. Private sector pension plans are classified  either as defined benefit or as defined contribution plans. Defined benefit  plans promise to provide, generally, a fixed level of monthly retirement  income that is based on salary, years of service, and age at retirement  regardless of how the plan’s investments perform. In contrast, benefits  from defined contribution plans are based on the contributions to and the  performance of the investments in individual accounts, which may  fluctuate in value. Examples of defined contribution plans include 401(k)  plans, employee stock ownership plans, and profit-sharing plans.
Over the past two decades, there has been a noticeable shift by employers  away from defined benefit plans to defined contribution plans. The most  dominant and fastest growing defined contribution plans are 401(k) plans,  which allow workers to choose to contribute a portion of their pre-tax  compensation to the plan under section 401(k) of the Internal Revenue  Code. The use of 401(k) plans accelerated in the 1980s after the Treasury  issued a ruling clarifying a new section of the tax code that allowed  employers and employees to make pre-tax contributions, up to certain  limits, to employees’ individual accounts.
According to the most recent data from Labor, most 401(k) plans are  participant-directed, meaning that a participant makes investment  decisions about his or her own retirement plan contributions. About   87 percent of all 401(k) plans—covering 92 percent of all 401(k) plan  participants and 91 percent of all 401(k) plan assets—generally allow  participants to choose how much to invest, within federal limits, and to  select from a menu of diversified investment options selected by the  employer sponsoring the plan, such as an assortment of mutual funds that  include a mix of stocks, bonds, or money market investments.
Equity funds accounted for nearly half of the 401(k) plan assets at the  close of 2005. Equity funds are investment options that invest primarily in  stocks, such as mutual funds, bank collective funds, life insurance  separate accounts, and certain pooled investment products (see fig. 1).  Other plan assets were invested in company stock; stable value funds,  including guaranteed investment contracts; balanced funds; bond funds;  and money funds.
As participants accrue earnings on their investments, they also pay a  number of fees, including expenses, commissions, or other charges  associated with operating a 401(k) plan. Over the course of the employee’s  career, fees may significantly decrease retirement savings. For example, a  1-percentage point difference in fees can significantly reduce the amount  of money saved for retirement. Assume an employee of 45 years of age  with 20 years until retirement changes employers and leaves $20,000 in a  401(k) account until retirement. If the average annual net return is   6.5 percent—a 7 percent investment return minus a 0.5 percent charge   for fees—the $20,000 will grow to about $70,500 at retirement. However, if  fees are instead 1.5 percent annually, the average net return is reduced to  5.5 percent, and the $20,000 will grow to only about $58,400. The  additional 1 percent annual charge for fees would reduce the account  balance at retirement by about 17 percent.
Fees are charged by the various outside companies that the plan  sponsor—often the employer offering the 401(k) plan—hires to provide a  number of services necessary to operate the plan. Services can include  investment management (i.e., selecting and managing the securities  included in a mutual fund); consulting and providing financial advice   (i.e., selecting vendors for investment options or other services); record  keeping (i.e., tracking individual account contributions); custodial or  trustee services for plan assets (i.e., holding the plan assets in a bank); and  telephone or Web-based customer services for participants. As shown in  figures 2 and 3, generally there are two ways to provide services:  “bundled” (the sponsor hires one company that provides the full range of  services directly or through subcontracts) and “unbundled” (the sponsor  uses a combination of service providers).
Labor’s Employee Benefits Security Administration (EBSA) oversees  401(k) plans—including the fees associated with running the plans— because they are considered employee benefit plans under ERISA.  Enacted before 401(k) plans came into wide use, ERISA establishes the  responsibilities of employee benefit plan decision makers and the  requirements for disclosing and reporting plan fees. Typically, the plan  sponsor is a fiduciary. A plan fiduciary includes a person who has  discretionary control or authority over the management or administration  of the plan, including the plan’s assets. ERISA requires that plan sponsors  responsible for managing employee benefit plans carry out their  responsibilities prudently and do so solely in the interest of the plan’s  participants and beneficiaries.
The law also provides Labor with oversight authority of pension plans.  However, the specific investment products commonly contained in  pension plans—such as company stock, mutual funds, collective  investment funds, and group annuity contracts—fall under the authority of  the applicable securities, banking, or insurance regulators.
The SEC, among other responsibilities, regulates registered  securities including company stock and mutual funds under  securities law.
The federal agencies charged with oversight of banks—primarily  FRB, OCC, and FDIC—regulate bank investment products, such as  collective investment funds.
State agencies generally regulate insurance products, such as  variable annuity contracts. Such investment products may also  include one or more insurance elements, which are not present in  other investment options. Generally, these elements include an  annuity feature, interest and expense guarantees, and any death  benefit provided during the term of the contract.
An investment company, bank, or insurance company that is a service  provider to a 401(k) plan may offer any or all of these types of investment  products as plan options.
section_title: Investment Fees Account for Most 401(k) Plan Fees and Are Usually Borne by Plan Participants
paragraphs: Investment fees—which are charged by companies that manage mutual  funds or other investment products for all services related to operating the  fund—comprise the majority of fees in 401(k) plans and are typically  borne by participants. Plan record-keeping fees generally account for the  next largest portion of plan fees. These fees cover the cost of various  administrative activities carried out to maintain participant accounts.  Participants typically pay for investment fees, which are usually based on  assets in their accounts. Although plan sponsors often pay for record- keeping fees, participants bear them in an increasing number of plans.
subsections: section_title: Investment Fees and Plan Record-Keeping Fees Together Account for Nearly All of Plan Fees
paragraphs: Investment fees and plan record-keeping fees comprise the vast majority  of total plan fees. Investment fees are, for example, fees charged by  companies that manage a mutual fund for all services related to operating  the fund. These fees pay for: selecting a mutual fund’s portfolio of  securities and managing the fund; marketing the fund and compensating  brokers who sell the fund; and providing other shareholder services, such  as distributing the fund prospectus. These fees are charged regardless of  whether the mutual fund or other investment product, such as collective  investment funds or group annuity contracts, is part of a 401(k) plan or  purchased by individual investors in the retail market. As such, the fees  are usually different for each investment option available to participants in  a 401(k) plan.
Investment fees account for the majority of 401(k) plan fees regardless of  plan size. For example, as figure 4 illustrates, a 2005 industry survey  estimated that investment fees accounted for 84.5 percent of total fees in  plans with 25 members and for 98.6 percent of total fees in plans with  2,000 participants.
Since investment fees account for the bulk of plan fees, several investment  consultants we interviewed encourage 401(k) plan sponsors to offer  options such as institutional funds to lower fees. Institutional mutual  funds resemble funds available in the retail market, but are typically only  available to 401(k) plans with assets above a certain threshold, such as   $1 million. Similarly, indexed funds have lower management fees than  actively managed funds. These funds closely track a market performance  indicator, such as the Standard & Poor’s 500, which largely eliminates  expenditures associated with research, investment selection, and buying  and selling.
Plan record-keeping fees, which cover individual account maintenance for  plan participants, generally constitute the second-largest portion of plan  fees. Unlike investment fees, plan record-keeping fees apply to the entire  401(k) plan rather than the individual investment options. Plan record- keeping fees are usually charged by the service provider to set up and  maintain the 401(k) plan. These fees cover a variety of activities such as  enrolling plan participants, processing participant fund selections,  preparing and mailing account statements, and other related  administration activities.
A 2005 industry survey of service providers estimated that plan record- keeping fees constituted 12 percent of total plan fees for plans with   25 participants. As shown in figure 5, these fees make up a smaller  proportion of total plan fees in larger plans, indicating economies of scale.
In addition to investment and record-keeping fees, there are a number of  other fees charged to administer the plan as a whole, including  trustee fees that are charged by an individual, bank, or trust  company to securely maintain plan assets;    audit fees that are imposed by a service provider in connection  with the annual audit that is required of ERISA-covered plans with  more than 100 participants;  legal fees that are charged by an attorney or law firm to provide  legal support for administrative activities, such as ensuring the  plan is in compliance with ERISA or representing the plan in a  divorce settlement;  investment consulting fees that are charged by an advisor, often a  pension consultant, hired to help the plan sponsor select funds for  the plan and to monitor investments; and  communication fees that cover the cost of educating participants  about the plan. Communication services may include a meeting led  by a service provider to introduce the plan to participants.  Communication services may also include providing participants  with access to toll-free phone services, Internet service, and  ongoing educational seminars.
These fees generally comprise a much smaller percentage of total plan  fees than investment and plan record-keeping fees.
section_title: Participants Bear Most Investment Fees and an Increasing Number of Participants Bear Plan Record-Keeping Fees
paragraphs: Participants pay for the majority of investment fees and a greater number  bear plan record-keeping fees. As shown in table 1, a 2005 industry survey  of 401(k) plan sponsors found that plan participants paid investment fees  in almost 62 percent of plans with 5,000 members or fewer. This  arrangement was even more common in plans with over 5,000 members  where participants bear investment fees in about 71 percent of all plans.  For both size plans, plan sponsors and participants shared investment fees  in about 10 percent to 12 percent of plans. Another industry survey of plan  sponsors with 1,000 employees or more also found that plan participants  paid investment fees in the majority of plans in 2005.
Participants generally pay investment fees indirectly. The investment  returns that participants receive reflect their share of the fund’s assets  after investment fees and other expenses have been subtracted.  Investment fees are reported as a percentage of the fund’s overall assets,  also known as the expense ratio.
The 2005 survey of plan sponsors also found that participants bear a plan’s  record-keeping fees in about 50 percent of plans with 5,000 participants or  more. Plan sponsors paid record-keeping fees in about 35 percent of these  plans and share fees with participants in about 15 percent. The opposite is  true for plans with fewer than 5,000 participants, where plan sponsors paid  record-keeping fees in 58 percent of cases. However, many of the industry  professionals whom we spoke with said plan participants bear a greater  portion of these fees than they did in the past. According to these  professionals, record-keeping fees have shifted to participants because  companies changed the way they charge record-keeping fees and many  plan sponsors wanted to reduce their share of plan fees. Originally, record- keeping fees were explicit fees billed to the plan sponsor. When the use of  mutual funds in 401(k) plans started to grow, some funds were marketed  to sponsors as having no record-keeping fees. In these cases, record  keepers were compensated out of the investment funds’ operating  expenses for their services, such as maintaining individual account  records for its retail investors and consolidating participant requests to  buy or sell shares. Some sponsors may have been unaware that record- keeping fees were taken out of participant assets. Others were aware that  the fees were passed on to participants.
Record-keeping fees may be charged as a percentage of assets, or based  on the number of transactions or the number of participants in the plan.  Some industry professionals told us that fees charged as a percentage of  assets may not reflect actual costs to the service provider since the fees  grow regardless of the level of service provided. The professionals said  service providers may charge record-keeping fees to participants as a flat  fee and as an asset-based fee in plans with low assets. An asset-based fee  would not generate enough revenue to cover record-keeping fees in these  plans, so a flat fee is added. As plan assets grow, the revenue generated by  asset-based fees eventually covers plan record-keeping fees, and the flat  fee may be dropped. Other industry professionals said record-keeping fees  may vary if they are offered by insurance companies or banks that can use  fee structures unique to their industry.
section_title: Required Disclosures Provide Limited Fee Information to Assist Participants in Comparing Investment Options
paragraphs: The fee information that ERISA requires 401(k) plan sponsors to disclose  is limited and does not provide participants with an easy comparison of  investment options. All 401(k) plans are required to provide disclosures on  plan operations, participant accounts, and the plan’s financial status.  Although they often contain some information on fees, these documents  are not required to disclose the fees borne by individual participants.  Additional fee disclosures are required for certain—but not all—plans in  which participants direct their investments. These disclosures are  provided to participants in a piecemeal fashion and do not provide a  simple way for participants to compare plan investment options and their  fees.
subsections: section_title: Disclosures Provide Limited Information on Fees to Participants in a Piecemeal Way
paragraphs: ERISA requires that plan sponsors provide all participants with a summary  plan description, account statements, and the summary annual report, but  these documents are not required to disclose information on fees borne by  individual participants. Table 2 provides an overview of each of these  disclosure documents, and the type of fee information that they may  contain.
These required documents apply to all 401(k) plans, including plans in  which participants have no control over investment decisions. Additional  fee disclosures are required for certain—but not all—plans in which  participants direct their investments. ERISA requires disclosure of fee  information to participants where plan sponsors seek liability protection  from investment losses resulting from participants’ investment decisions.  Such plans—known as 404(c) plans—are required to provide participants  with, among other information, a description of the investment risk and  historical performance of each investment option available in the plan and  any associated transaction fees for buying or selling shares in these  options. Upon request, 404(c) plans must also provide participants with,  among other information, the expense ratio for each investment option. To  meet certain 404(c) requirements, such plans distribute prospectuses or  fund profiles. The prospectuses and fund profiles are not meant to be  comprehensive for the entire 401(k) plan, but rather are relevant for  individual investment options in the plan.
According to the most recent Form 5500 data, 54 percent of 401(k) plans— representing 64 percent of 401(k) participants—classify themselves as  404(c). However, the data also show that 87 percent of 401(k) plans— representing 92 percent of 401(k) participants—direct their 401(k)  investments. These data suggest that some participant-directed plans are  not 404(c) and, thus, not required to disclose to participants certain fee  information such as the expense ratio of each investment option.
Plan sponsors may voluntarily provide participants with more information  on fees than ERISA requires, according to plan practitioners. For example,  plan sponsors that do not elect to be 404(c) often distribute prospectuses  or fund profiles when employees become eligible for the plan, just as  404(c) sponsors do. Also, according to plan practitioners, plan sponsors  are not required to provide record-keeping or other fee information in  their account statements, although many do so. In addition, plan sponsors  are not required to provide the investment fees for the investment options  in the summary plan document, but they may provide this information as  well. Still, absent requirements to do so, some plan sponsors may not  identify all the fees participants pay.
Participants may not be aware of the different fees that they pay, yet are  responsible for directing their investments within the plan. According to  industry professionals, participants can be unaware that they pay any fees  for their 401(k) investments and are particularly unaware of investment  fees that are typically not quantified on account statements. In a  nationwide survey, more than 80 percent of 401(k) participants report not  knowing how much they pay in fees. Some industry professionals said  that making participants who direct their investments more aware of fees  would help them make more informed investment decisions.
Information on fees is disclosed to participants in a piecemeal way. In  order to get a more complete picture of fees, participants must collect  various documents over time. As shown in table 3, disclosure documents  with fee information are generally provided to participants at different  times.
Some documents that contain fee information are provided to participants  automatically, whereas others, such as prospectuses or fund profiles, may  require that participants seek them out. According to industry  professionals, participants may not know to seek such documents out.
section_title: Participants Cannot Easily Compare Investment Options Based on Fee Information Provided
paragraphs: ERISA does not require that plan sponsors provide participants who are  responsible for directing their investments with fee information that could  assist them in comparing the plan’s investment options. To identify the fee  information for comparing investment options, participants must sift  through multiple documents that are not always disclosed to them  automatically. For example, to piece together certain fees associated with  a plan’s investment options, a participant often must collect multiple  prospectuses or fund profiles. Furthermore, because ERISA does not  require that these documents be provided automatically to all participants,  some participants may need to request them but may not know to do so.  According to industry professionals, some participants may be able to  make comparisons across investment options by piecing together the fees  that they pay, but doing so requires an awareness of fees that most  participants do not have. Assessing fees across investment options can be  difficult for participants because the data are typically not presented in a  single document which facilitates comparison.
Participants can use fees along with other information, such as risk and  historical performance, to compare different investment options. In some  cases, differences in fees across products can be explained by their  investment focus or other features. For example, mutual funds with shares  in international stock generally charge higher fees than mutual funds with  shares in domestic stock because international funds generally incur  additional investment management costs. Higher costs can also arise if an  investment option has additional features. For example, a provider may  charge an additional fee to include certain benefit features, such as  providing the participant with an option to convert a 401(k) account  balance into a retirement annuity. Industry associations have considered  different ways to present comparative information about a plan’s  investment options to participants in a single document, but the industry  does not have a standard way of doing so. These associations have  generally suggested annually providing key information—such as the  investment objective, fees, and other key features—associated with each  plan’s investment options in a table to help participants compare among  them.
Industry professionals suggested that comparing the expense ratio—  a fund’s operating fees as a percentage of its assets—across investment  options is the most effective way to compare options’ fees. The expense  ratio can be used to compare investment options because it includes  investment fees that account for most of the fees borne by participants  and is generally the only fee measure that varies by option. Fund options  with relatively high fees, such as actively managed funds, tend to have  larger expense ratios than funds which are not actively managed. Also,  fund options that are only available to institutional investors tend to have  lower expense ratios than other types of funds.
Most 401(k) investment options have expense ratios that can be  compared, but this information is not always provided to participants.  According to industry data, at least 69 percent of 401(k) assets are  invested in options, such as mutual funds, that are generally required to  present the expense ratio in a prospectus. Participants who do not belong  to 404(c) plans are not required to receive prospectuses and therefore may  not receive the expense ratio information. In addition, investment options  besides mutual funds, such as guaranteed annuity contracts, may not be  required to produce prospectuses that include expense ratios, but  according to industry professionals, such options have expense ratio  equivalents that investment industry professionals can identify. However,  participants who do not receive this information cannot compare the  investment options’ expense ratios.
Because differences in fees can have large impacts on returns over time,  industry professionals recommend considering expense ratios when  making investment decisions. However, they point out that expense ratios  should not be considered in isolation; rather, they should be considered in  light of other important investment factors, such as risk and historical  performance.
section_title: Labor Has Authority over 401(k) Plan Fees and Certain Types of Business Arrangements, but Lacks Information for Effective Oversight
paragraphs: Labor has authority under ERISA to oversee 401(k) plan fees and certain  types of business arrangements involving service providers, but lacks the  information it needs to provide effective oversight. Labor collects  information on fees from plan sponsors, investigates participants’  complaints or referrals from other agencies on questionable 401(k) plan  practices, and conducts outreach to educate plan sponsors about their  responsibilities. However, the information reported to Labor does not  identify all fees charged to 401(k) plans and therefore has limited use for  effectively overseeing fees and identifying undisclosed business  arrangements among consultants or other service providers. Certain  business arrangements that are undisclosed may lead to participants  paying higher fees for products or services that do not offer any additional  value or benefit than other lower cost alternatives. Labor has several  initiatives underway to improve the information it has on fees and the  various business arrangements among service providers.
subsections: section_title: Labor Collects Information on Fees, Investigates Complaints and Referrals, and Conducts Outreach to Educate Plan Sponsors
paragraphs: Under ERISA, Labor is responsible for enforcing the requirements that  plan sponsors (1) ensure that fees paid with plan assets are reasonable and  for necessary services, (2) diversify the plan’s investments or provide a  broad range of investment choices for participants, and (3) report  information known on certain business arrangements involving service  providers. Labor does this in a number of ways, including collecting  information on fees from plan sponsors, investigating participants’  complaints or referrals from other agencies on questionable 401(k) plan  practices, and conducting outreach to educate plan sponsors about their  responsibilities.
subsections: section_title: Information on Fees
paragraphs: Labor collects information on fees charged to 401(k) plans primarily  through the Form 5500. The form includes information on the plan’s  sponsor, the features of the plan, and the number of participants. The form  also provides more specific information, such as plan assets, liabilities,  insurance, and financial transactions. Filing this form satisfies the  requirement for the plan administrator to file annual reports concerning,  among other things, the financial condition and operation of plans. Labor  uses this form as a tool to monitor and enforce plan sponsors’  responsibilities under ERISA. The reporting form is not routinely  provided to participants, but ERISA requires that it be made available  upon request.
Generally, information on 401(k) fees is reported on two sections of the  Form 5500, Schedule A and Schedule C. Schedule A is used to report fees  and commissions paid to brokers and sales agents for selling insurance  products. Schedule C includes information on the fees paid directly or  indirectly to service providers for all other investment products. Schedule  C also identifies service providers with fees in excess of $5,000 by name.
section_title: Investigations
paragraphs: Labor officials told us that complaints from plan participants provide the  most effective leads on plan sponsors’ violations of ERISA, but that Labor  receives very few complaints related to excessive 401(k) plan fees. In  fiscal year 2005, Labor received only 10 inquiries or complaints related to  401(k) fees. A Labor official told us that most plan participants likely do  not understand much about plan fees and are thus unlikely to complain  about them. In addition to responding to complaints, Labor also receives  referrals from various entities, such as other federal agencies. For  example, federal banking regulators like the Federal Reserve Board will  review bank operations as part of their oversight and may uncover  instances where a bank that provides services to a 401(k) plan is violating  ERISA requirements. Several federal banking regulators have a written  agreement to refer such cases to Labor, but Labor receives fewer than   100 referrals per year from these and other entities, such as state  insurance and securities agencies. A Labor official told us that only one of  the referrals that the agency has closed over the past 5 years was directly  related to fees.
Labor uses the Form 5500 in its investigations, but according to agency  officials, this effort does not find many fee violations because it is difficult  to identify unreasonable fees. Officials stated that they conduct few  investigations based solely on the 401(k) fee information provided on  Form 5500 but may review the fees charged to the plan as a part of  investigations into other problems, such as not depositing participants’  contributions into their accounts in a timely manner. In addition, Labor  may audit the Form 5500 to ensure that appropriate fees are disclosed.
Labor officials told us that it is difficult to discern whether a fee is  reasonable or not on its face, and therefore, investigators rarely initiate an  investigation into a fee’s reasonableness. Plan fees can vary widely based  on the types of services offered, and a “boutique” plan may have high fees  but offer many services that a plan sponsor has determined are in the  interest of the plan’s participants. In the rare instance that a fee appears  egregious, Labor will generally enlist the services of a “fee expert” to make  that determination, because according to one official, Labor is unable to  do so itself. A fee expert will conduct a benchmarking study or request  estimates from other service providers to get a sense of the market rate for  certain services.
Labor’s most recent in-depth review of fees identified some plans with  high fees but determined that they were not unreasonable or in violation  of ERISA. Labor last undertook a comprehensive review of 401(k) fees in  1997, in response to media, industry, and government concern that  participants were potentially being charged excessive fees. According to a  Labor official, 50 401(k) plans were investigated to analyze plans’  compliance with certain ERISA requirements related to fees, such as  ensuring that fees charged to the plan are reasonable. The plans were  selected based on various factors including anecdotal evidence of high  fees and a listing in an industry journal of plans that had recently  contracted with service providers. Labor found that the plan sponsors had  complied with these ERISA requirements. In some cases, Labor did  determine that participants were paying high fees. It referred these  cases—which included insurance products and international equity  funds—to a fee expert from academia for further analysis to determine if  the fees were unreasonably high. The expert determined that the fees were  high, but not unreasonable. Labor uncovered some violations unrelated to  fees and notified the plans of needed corrective actions.
In fiscal year 2006, seven of Labor’s regional offices had ongoing  enforcement projects related to fees, but none were exclusive to 401(k)  plans. We spoke with four offices about their specific projects, the reasons  for their initiation, and their findings to date. According to agency officials,  most of the investigations under these projects were initiated due to  allegations related to defined benefit plans. The projects focused on  specific areas, such as bank trust department investigations, settlor fees,  or intermediary investment fees and practices.
section_title: Outreach
paragraphs: Labor has launched a nationwide campaign to improve workers’ health  and retirement security by educating employers and service providers  about their fiduciary responsibilities under ERISA. Its fiduciary education  program includes nationwide educational seminars with fees among the  topics covered. Labor’s campaign also includes several educational  publications on topics such as understanding fees and selecting service  providers. For example, one of the publications, Understanding  Retirement Plan Fees and Expenses, is designed to help plan sponsors  better understand and evaluate their plans’ fees and expenses. Another,   A Look at 401(k) Plan Fees for Employees, highlights the most common  fees that may be paid by plans and is geared toward plan participants.
section_title: Limited Information on Fees Paid by Plans Hinders Labor’s Ability to Effectively Oversee Fees
paragraphs: The information reported to Labor on the Form 5500 has limited use for  effectively overseeing fees paid by 401(k) plans because it does not  explicitly list all of the fees paid from plan assets. For example, plan  sponsors are not required to report mutual fund investment fees to Labor,  even though they receive this information for each of the mutual funds  they offer in the 401(k) plan in the form of a prospectus. In addition to  disclosing this information to sponsors of 401(k) plans, mutual fund  companies are required to file this information with the SEC, which  regulates mutual funds. While prospectuses are provided to SEC on a  fund-by-fund basis, neither SEC nor Labor have readily available  information to be able to link individual fund information to the various  401(k) plans to which the funds may be offered as investment options.  Furthermore, prospectuses provide fees as an expense ratio, which is  deducted from plan assets when investment returns are calculated, and as  such are not explicitly stated. Without information on all of the fees  charged directly or indirectly to 401(k) plans, Labor is limited in its ability  to identify fees that may be questionable.
Industry experts told us that additional information could be reported on  the Form 5500 to give Labor a more precise idea of the cost of  administering a defined contribution plan and 401(k) plan fees. The ERISA  Advisory Council Working Group reported that the Form 5500, as  currently structured, does not reflect the way that the defined contribution  plan fee structure works, because only those fees that are billed explicitly  and are paid from plan assets are deemed reportable. Many of the fees are  associated with the individual investment options in the 401(k) plan, such  as a mutual fund; they are deducted from investment returns and not  reported to plan sponsors or on the Form 5500. The Advisory Council  concluded that Form 5500s filed by defined contribution plans are of little  use to policy makers, government enforcement personnel, plan sponsors,  and participants in terms of understanding the cost of a plan. The Advisory  Council recommended that Labor modify the Form 5500 and the  accompanying schedules so that all fees incurred either directly or  indirectly by these plans can be reported or estimated. This information  then could be used to compare fees for research or regulatory purposes.
section_title: Labor and Plan Sponsors Lack Information on the Various Business Arrangements among Service Providers
paragraphs: Many opportunities exist for business arrangements to go undisclosed,  given the various parties involved in today’s 401(k) arena. Problems may  occur when pension consultants or other companies providing services to  a plan also receive compensation from other service providers. Without  disclosing these arrangements, service providers may be steering plan  sponsors toward investment products or services that may not be in the  best interest of participants. In addition, plan sponsors, being unaware, are  often unable to report information about these arrangements to Labor on  Form 5500 Schedule C.
SEC recently identified certain undisclosed arrangements in the business  practices of pension consultants that the agency referred to as conflicts of  interest. Plan sponsors pay pension consultants to give them advice on  matters such as selecting investment options for the plan and monitoring  their performance and selecting other service providers, such as  custodians, administrators, and broker-dealers. The SEC released a report  in May 2005 that raised questions about whether some pension consultants  are fully disclosing potential conflicts of interest that may affect the  objectivity of the advice. For example, the report revealed that more than  half of the pension consultants examined had compensation arrangements  with brokers who sell mutual funds. The report highlighted concerns that  these arrangements may provide incentives for pension consultants to  recommend certain mutual funds to a 401(k) plan sponsor and create  conflicts of interest that are not adequately disclosed to plan sponsors.  Plan sponsors may not be aware of these arrangements and thus could  select mutual funds recommended by the pension consultant over lower- cost alternatives. As a result, participants may have more limited  investment options and may pay higher fees for these options than they  otherwise would.
In addition, specific fees that are considered to be “hidden” may mask the  existence of a conflict of interest. Hidden fees are usually related to  business arrangements where one service provider to a 401(k) plan pays a  third-party provider for services, such as record keeping, but does not  disclose this compensation to the plan sponsor. For example, a mutual  fund normally provides record-keeping services for its retail investors, i.e.,  those who invest outside of a 401(k) plan. The same mutual fund, when  associated with a plan, might compensate the plan’s record keeper for  performing the services that it would otherwise perform, such as  maintaining individual participants’ account records and consolidating  their requests to buy or sell shares.
The problem with hidden fees is not how much is being paid to the service  provider, but with knowing what entity is receiving the compensation and  whether or not the compensation fairly represents the value of the service  being rendered. Labor’s position is that plan sponsors must know about  these fees in order to fulfill their fiduciary responsibilities. However, if the  plan sponsors do not know that a third party is receiving these fees, they  cannot monitor them, evaluate the worthiness of the compensation in view  of services rendered, and take action as needed.
section_title: Labor Has New Initiatives to Improve Information on Fees
paragraphs: Labor officials told us about three initiatives currently underway to  improve the disclosure of fee information by plan sponsors to participants  and to avoid conflicts of interest. For one initiative, Labor is considering  the development of a proposed rule regarding the fee information required  to be furnished to participants under its section 404(c) regulation.  According to Labor officials, they are attempting to define the critical  information on fees that plan sponsors should disclose to participants and  the best way to do so. They are deliberating on what fee information  should be provided to participants and in what format to enable  participants to easily compare the fees across the plan’s various  investment options.
The second initiative proposes changes to the Form 5500 Schedule A and  instructions to improve the disclosure of insurance fees and commissions  and identify insurers who fail to supply information to plan sponsors.  According to a 2004 ERISA Advisory Council Report, many employers  have difficulty obtaining timely Schedule A information from insurers.  Labor proposes to add a checkbox to the form to permit plan sponsors to  identify situations in which the insurance company has failed to provide  Schedule A information. The form would also have space to indicate the  type of information that was not provided. Because plan sponsors must  submit a separate Schedule A for each insurance contract, Labor would be  able to identify which insurance companies are failing to satisfy their  disclosure obligations under ERISA and its regulations.
The second initiative also proposes changes requiring plan sponsors to  report additional information on fees on Schedule C of Form 5500.  Consistent with recommendations made by the ERISA Advisory Council  Working Groups and GAO, Labor issued a proposed rule on July 21, 2006,  to revise the Schedule C and accompanying instructions to clarify that the  plan sponsor must report any direct and indirect compensation (i.e.,  money or anything else of value) it pays to a service provider during the  plan year. Also, a new section would be added requiring that the source  and nature of compensation in excess of $1,000 received from parties  other than the plan or the plan sponsor, such as record-keepers, be  disclosed for certain key service providers, including, among others,  investment managers, consultants, brokers, and trustees as well as all  other fiduciaries. Labor officials told us that the revision aims to improve  the information plan sponsors receive from service providers. The officials  acknowledge, however, that this requirement may be difficult for plan  sponsors to fulfill without an explicit requirement in ERISA for service  providers to give plan sponsors information on the fees they pay to other  providers.
The third initiative involves amending Labor’s regulations under section  408(b)(2) of ERISA to define the information plan sponsors need in  deciding whether to select or retain a service provider. According to  Labor, plan sponsors need information to assess the reasonableness of the  fees being paid by the plan for services rendered and to assess potential  conflicts of interest that might affect the objectivity with which the service  provider provides its services to the plan. The proposed change to the  regulation is intended to make clear what plan sponsors need to know  and, accordingly, what service providers need to provide to plan sponsors.
In addition to these three initiatives, Labor has a model fee disclosure  worksheet available on its Web site. The worksheet was developed to help  plan sponsors analyze and compare fees during their negotiations with  service providers. Labor worked with several industry groups to develop  this worksheet as a result of the problems it identified during its 1997  investigations on 401(k) fees. Labor officials told us that this worksheet or  a similar tool could be used to facilitate plan sponsors attainment and  analysis of fee information and that plan service providers could also use  the worksheet to disclose their fee arrangements when soliciting potential  clients.
section_title: Conclusions
paragraphs: As American workers take increasing responsibility for the adequacy of  their retirement savings through 401(k) plans, they need to be more aware  of the fees that they pay. ERISA does not explicitly require plan sponsors  to disclose comprehensive information on fees to participants, yet even  small fees can significantly affect retirement savings over the course of a  career. Information about investment options’ historical performance is  useful, but alone does not provide participants with enough information  for making informed investment decisions. Giving participants key  information on fees for each of the plan’s investment options in a simple  format—including fees, historical performance, and risk—will help  participants make informed investment decisions within their 401(k) plan.  In choosing between investment options with similar performance and  risk profiles but different fee structures, the additional provision of  expense ratio data may help participants build their retirement savings  over time by avoiding investments with relatively high fees.
Amending ERISA and updating regulations to better reflect the impact of  fees and undisclosed business arrangements among service providers will  help Labor provide more effective oversight of 401(k) plan fees. Without  such changes, Labor will continue to lack comprehensive information on  all fees being charged directly or indirectly to 401(k) plans. In addition,  some conflicts of interest that affect the fees that participants pay may  continue to go unnoticed because service providers are not required to  inform plan sponsors of the compensation they receive from other service  providers. As a result, Labor may not be able to identify instances in which  service providers might be steering plan sponsors to overpriced  investment options or services that are not in the best interest of plan  participants. Further, requiring plan sponsors to report more complete  information to Labor on fees—those paid out of plan assets or by  participants—would put the agency in a better position to effectively  oversee 401(k) plans and, in doing so, to protect an increasing number of  participants.
section_title: Matters for Congressional Consideration
paragraphs: To ensure that participants have a tool to make informed comparisons and  decisions among plan investment options, Congress should consider  amending ERISA to require all sponsors of participant-directed plans to  disclose fee information of 401(k) investment options to participants in a  way that facilitates comparison among the options. This information could  be provided via expense ratios and be communicated annually in a single  document alongside other key information about the investment options  such as historical performance and risk. Providing such a disclosure to  participants who are responsible for directing their 401(k) investments  would ensure that they have another important tool to make informed  comparisons and investment decisions among the plan’s options.
To allow plan sponsors, and ultimately Labor, to provide better oversight  of fees and certain business arrangements among service providers,  Congress should consider amending ERISA to explicitly require that  401(k) service providers disclose to plan sponsors the compensation that  providers receive from other service providers.
section_title: Recommendation for Executive Action
paragraphs: To better enable the agency to effectively oversee 401(k) plan fees, the  Secretary of Labor should require plan sponsors to report a summary of all  fees that are paid out of plan assets or by participants. This summary  should list fees by type, particularly investment fees that are being  indirectly incurred by participants.
section_title: Agency Comments
paragraphs: We provided a draft of this report to Labor and SEC. Labor provided  written comments, which appear in appendix II.  Labor’s comments  generally agree with the findings and conclusions of our report.  Specifically, Labor stated that it will give careful consideration to GAO’s  recommendation that plans be required to provide a summary of all fees  that are paid out of plan assets or by participants. Labor and SEC also  provided technical comments on the draft, which we incorporated as  appropriate.
Labor described a number of details related to its ongoing regulatory  initiatives and outreach activities, many of which we also cited in the  section of our report on Labor’s authority and oversight. In its written  comments, Labor also suggested an additional technical change on legal  fees for plan design, which we have made to the final report.
Unless you publicly announce its contents earlier, we plan no further  distribution until 30 days after the date of this report. At that time, we will  send copies of this report to the Secretary of Labor, the Chairman of the  SEC; appropriate congressional committees; and other interested parties.  In addition, the report will be available at no charge on GAO’s Web site at  http//:www.gao.gov.
If you or your staff have any questions about this report, please contact me  at (202) 512-7215 or bovbjergb@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this report. GAO staff who have made major contributions to this report  are listed in appendix III.
section_title: Appendix I: Scope and Methodology
paragraphs: To identify the major fees associated with 401(k) plans and how they are  charged to plan sponsors and plan participants, we interviewed officials  from Labor, the Federal Deposit Insurance Corporation (FDIC), the  Federal Reserve Board (FRB), the Securities and Exchange Commission  (SEC), and the Treasury Department’s Office of the Comptroller of the  Currency (OCC); met with service providers and other industry  professionals; and collected information about the range of fees and how  they are charged to plan sponsors and participants. We also reviewed  several major 2005 industry surveys of 401(k) sponsors including surveys  by HR Investment Consultants, the Profit Sharing and 401(k) Council of  America (PSCA), and Hewitt Associates. Since the survey response rates  are low, the data may not be generalizable. To assess reliability of the  survey data, we contacted the authors of each survey and collected  information on the methodology that was used to complete it.
The results of HR Investment Consultants’ survey are based on  responses from 125 vendors that service 401(k) plans. This  response represents about 85 percent of the assets invested in  401(k) plans. Company officials said they survey vendors because  they are generally more knowledgeable than employers about plan  fees. The survey was e-mailed to respondents as an attachment in  2004 and the results were updated in 2005. The authors were not  able to provide a response rate, but said the survey was completed  by most respondents. HR Investment Consultants provides a range  of services to employers offering participant-directed retirement  plans.
PSCA’s survey results are based on responses from 1,106 plan  sponsors that have profit-sharing plans, 401(k) plans, or a  combination of both and represent 1 to 5,000-plus employees. The  survey was mailed or faxed to respondents and conducted from  March 2006 to May 2006. The survey provides a snapshot as of the  end of 2005. The survey response rate was 21 percent. PSCA  officials were able to provide us with data that excluded profit- sharing plans only. PSCA is a national, nonprofit association of  1,200 companies and their 6 million plan participants. According to  PSCA, it represents the interests of its members to federal policy  makers and offers assistance with profit sharing and 401(k) plan  design, administration, investment, compliance, and  communication.
Hewitt Associates’ survey results are based on responses from   458 employers with 1,000 employees or more. Nineteen percent of  the respondents represented Fortune 500 companies. The survey  was conducted from mid-March through April 2005. The survey and  a link to a Web site were e-mailed to respondents whose email  addresses were available so they could complete the survey on the  Web or on paper. The other surveys were mailed with a stamped  and addressed enveloped. The survey had a 9 percent response  rate. Hewitt Associates is a human resource outsourcing and  consulting firm.
To assess how fees are disclosed to plan participants, we reviewed  relevant laws and regulations, spoke with agency and industry officials,  and reviewed sample disclosure documents. To understand requirements  to disclose information about fees to participants, we reviewed ERISA and  relevant regulation sections such as 404(c) and spoke with agency officials  described above.
To identify the content and frequency of fee-related disclosures typically  made to 401(k) plan participants, we spoke with plan practitioners and  reviewed documents including sample disclosure documents. Specifically,  we interviewed an array of service providers that serve plans of varying  sizes including members of the American Bankers Association, American  Benefits Council, American Council of Life Insurers, American Society of  Pension Professionals & Actuaries, Securities Industry Association,  Society of Professional Administrators and Record Keepers, as well as  several plan consultants. We also interviewed officials from three plan  sponsors. However, because we could not readily obtain a representative  sample of service providers or plan sponsors, the information obtained  does not represent the views of all service providers or plan sponsors. In  addition, we reviewed a limited number of sample disclosure documents  made to participants. Because the documents do not reflect a  representative sample, we supplemented the information with Labor  documents, including those from the 2004 ERISA Advisory Council’s  Working Group on Fee and Related Disclosures to Participants, to  determine the type of disclosures typically made to participants.
To understand participants’ awareness of fees and related disclosures, we  spoke with the American Association of Retired Persons (AARP) in  addition to the agency and other industry professionals listed above. We  also reviewed AARP’s nationwide survey of plan participants regarding  plan fees and assessed its methodology. The survey reached plan  participants aged 25 or older during November and December 2003. The  total sample of over 1,200 respondents was stratified by age and  geographic region and then weighted by age, region, and gender to create  a representative sample of the total population.
To assess Labor’s role in overseeing plan fees and certain types of  business arrangements, we reviewed Labor’s and other agencies’ legal and  regulatory authority and Labor’s procedures for assuring that plans meet  overall legal requirements. We reviewed the information required to be  reported on the Form 5500, and several reports produced by federal  agencies, trade associations, participant groups, and industry experts,  regarding retirement plan fees and business arrangements among service  providers. In addition to interviewing Labor officials in the national office  about the their enforcement and outreach efforts, we also interviewed  officials from Labor’s regional offices located in Atlanta, Georgia;  Philadelphia, Pennsylvania; San Francisco, California; and Chicago, Illinois  about their ongoing enforcement projects related to fees. We spoke with  officials from the four offices about their specific projects, the reasons for  their initiation, and the findings to date. Finally, we inquired about Labor’s  past initiative specific to 401(k) fees and reviewed Labor’s current  initiatives related to 401(k) plans.
section_title: Appendix II: Comments from the Department of Labor
section_title: Appendix III: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Tamara Cross, Assistant Director,  Daniel Alspaugh, Monika Gomez, Joel Green, Susan Pachikara,   Dayna Shah, Roger Thomas, Rachael Valliere, and Walter Vance made  important contributions to this report.