September 1, 2008

The Cost of Knowledge

I recently received a question from a reader about one of my articles concerning disclosure of expenses to participants. I thought you might like to see his question and my answer. Taken together, they provide a good overview of some of the most important issues about fee disclosures to participants.

The reader wrote: I have been following the fee and expense disclosure issues closely for some time now. In one of your articles, you talk of the libertarian and paternalistic views, but you don't explain any compromise between the two. I fully agree with the necessity of fee reporting to the DOL through the 5500 Schedule C, as well as disclosures to the fiduciaries by the providers. What I am struggling to understand is the necessity to disclose in such detail the fees and expenses for individual participants. Please don't misunderstand; I believe the information should be available, if the participant should want to have that much detail, but do you believe the yearly reporting to the participants should be mandatory? I understand your idea "forewarned is forearmed," but do you think that much detail could be overwhelming to the majority of participants if sent out unsolicited on a yearly basis? Working on the provider side, I can only imagine some of the recordkeeping dilemmas as well as software issues that will arise if the yearly reporting to the participants becomes mandatory.

My response focuses primarily on two issues. The first is that there is a way to disclose that is both meaningful and understandable. The second is that there is no "universal" participant; that is, the 401(k) world is made up of participants of all sizes and shapes.

My belief is that participants should, on an annual basis, be given the total costs that are charged to them by the plan and its investments, expressed as a dollar amount. For example, my understanding is that, for a participant with a $50,000 account balance, the cost is usually somewhere between $550 and $750, depending on the expense structure of the plan and the investments. I believe that, if participants were given that information, together with an explanation of why those costs were charged, they would be much better informed and would be able to ask important questions about the investments and the plan.

While many in the 401(k) industry have an image of partic­ipants as being easily confused and unsophisticated, I challenge that assumption. I believe that many people who are partic­ipants in 401(k) plans are very knowledgeable.

Furthermore, I believe that, for the 401(k) system to work, we need to ­educate partic­ipants on these issues. From a practical perspective, I believe that the next step will probably be to provide the most ­important information directly to the participants, and then to give them access to the balance of the information through, e.g., the Web site.

One of my concerns that the article is intended to express is that the 401(k) industry is, in some ways, being inconsistent in its approach. That is, the industry by and large supports the ­concepts that participants should fund their own benefits through deferrals and should make investment decisions in an intelligent way. In other words, in taking those positions, the 401(k) industry effectively assumes that participants are ­sophisticated, self-motivated, and capable. On the other hand, when it comes to disclosures about fees, expenses, and other infor­mation, the 401(k) industry seems to take the opposite tack. That is, the industry seems to base its conclusions on the notion that partic­ipants are passive, easily confused, and ­generally unable to make intelligent, informed decisions. While I am not asserting that one view is more correct than the other (even though I have my opinion), people need to have a consistent view and base their opinions and conclusions on that view.

As the discussion suggests, there is no easy answer. Instead, the system needs to be flexible enough to fulfill the needs of a wide range of participants. After all, the 401(k) accounts belong to participants, and not to employers or providers.

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