Am I really going to get sued if my 401k fees are too high?
The financial news is not often “abuzz” with stories about the 401k industry. In fact, The Department of Labor’s (“DOL”) fiduciary rule, one of the biggest pieces of landmark legislation related to qualified retirement plans, was passed in April of this year and the media’s coverage was underwhelming at best. Simply stated, it requires that by January 1, 2018, anyone giving plan advice or selling a product must now act in a fiduciary capacity – implicitly putting the best interest of the plan and the participants before their own. For some more detail on the new ruling click here to read our May 24th, 2016 Fiduciary File.
The media however, seems to like the news stories that include big names and law suits. Recently, some fairly well-known names including New York Life, Morgan Stanley, Safeway and Duke University have all found an unflattering place in the media spotlight because of lawsuits related to excessive 401k fees.
Can my employee’s really sue me for excessive fees?
We are not attorneys, nor do we provide legal advice, however the short answer is – Yes.
The simple truth is as an employer offering a 401k plan for your employees, you are held to a fiduciary standard of care. That means you must put your participants’ best interests before your own, and operate in a prudent manner exercising proper due diligence. If you fail to meet that fiduciary obligation, you are liable – personally. And that goes for all parties who are fiduciaries to the plan.
There are a myriad of ways you might breach your fiduciary obligations to your plan if you are not careful and prudent. The recent uptick in law suits specifically deal with high fees in the absence of increased performance. According to Bloomberg BNA “Workers have used litigation to challenge 401(k) fees for more than a decade, but the frequency of these lawsuits recently picked up steam. Since September 2015, more than a dozen lawsuits have been filed challenging the fees paid by 401(k) plans of large companies like Intel Corp., Anthem Inc., Verizon Communications Inc. and Chevron Corp.”
However, these suits have not been limited to just mega companies. Plans as low as $9 million in assets have made the news lately for the very same reason. Many legal experts in the field predict that over the next few years, we will see the average size of the plans brought to task on this issue drop dramatically.
How big a deal is this issue in real dollars?
The math is fairly simple on this issue. There are four main sources of fees that must be paid to various providers in a 401k plan: Fund Expenses, Custodial Expenses, Administration Expenses, and Advisor Fee / Brokerage Commissions.
Example:
Let’s use a 35-year-old employee making $40,000 per year. The employee currently pays 2% per year for all of the expenses associated with the 401k plan. However, a similar plan with the same investment choices and services is available for 1% per year. The employee starts with $1,000 in their 401k account and has a 10% salary deferral per year for 30 years earning an average rate of return of 6% before expenses. The employee will end up with about $232,000 in the plan at the 2% expense rate. However, the same employee, deferring the same amount, in the same investments, will end up with about $277,000 in the plan with a 1% expense rate. This is a $45,000 difference.
This example highlights one employee with a modest salary. Multiply this by the number of employees and you’ll see how big the dollar amount can be!
Ok, but am I really likely to get sued?
According to BNA Bloomberg “This universe is anything but small: Nearly 75,000 401(k) plans have $25 million or fewer in assets, and more than 4.2 million workers have their retirement savings in these plans, according to recent data from the Employee Benefit Research Institute. Research shows that these smaller plans typically carry higher fees than larger plans that can use their size as leverage to negotiate better deals, making them vulnerable to lawsuits claiming excessive fees.”
So the answer is, the likelihood of being sued is possibly higher in this climate than in years past; however, we don’t believe that is the big take-away here. What’s not good for the participants, in turn, it is not good for you either.
Complex issue – simple solution
It would be easy if all plans and investments were created equal – just pick one with good service at a good price and be done with it, right? Unfortunately, It’s not that easy.
“Is my plan too expensive?” The answer is … wait for it … “that depends”. The services your plan needs, the investment options, the level of assistance, the success of your participants and a laundry list of other factors come into play when determining whether or not your plan is too expensive.
Consider our example above. If the investment choices, education and advice available in the plan that costs 2% in expenses enabled the employee to earn 8% instead of the 6% in a plan that only cost 1% – so long as it is a similar level of risk, the 2% expense plan is actually a better deal by 1%.
The DOL and the Center for Fiduciary Studies suggest a benchmark analysis on retirement plans every 2 to 3 years is a best practice for plan sponsors. A detailed benchmark analysis will not only quantify all the fees you are paying and who you are paying them to, it will also measure those fees against the current services and performance of the plan. Periodic benchmarking is part of a sound, prudent process – and a clearly defined and executed process is what is defendable.
You probably don’t need the cheapest plan, though the goal should be a reasonably priced plan with great service and great performance. However, you do need clear documentation of the process you use to make plan level decisions about vendors, design changes, investment changes; combined with a paper trail proving that the process is being monitored and executed on a regular basis.
So, should you really be worried about your employees suing you because their 401k fees are too high? Maybe……but probably not. Should you be concerned that the fee’s, performance, design and utilization of your current plan are costing your employees and you a significant amount of money year after year even though your plan might not feel broken? Absolutely. If you don’t know exactly what you are paying and exactly what you are paying for, it’s time to find out. It is no doubt a complex issue, but the first step is simple – get the facts.