Over the past few years, the 401(k) industry has seen several sweeping changes take place, each of which has altered the core dynamics of how employees' retirement plans are managed. New government regulations have modified how the industry is monitored for betterment of employees. Here are five of the biggest changes that have affected the responsibility, litigation strategies, fees and overall practices for providers.
Effects of the Department of Labor's fiduciary rule
On June 9, 2017, the long-awaited Department of Labor Fiduciary Rule (or "Best Interests Rule") was rolled out, and the primary components of the rule were implemented on January 1, 2018. For 401(k) plan sponsors and their administrators, the new rule means that:
- All financial professionals who give guidance on retirement plans are considered to be fiduciaries and may only provide strictly educational advice to plan participants.
- Employer plan administrators are responsible for ensuring vendors act with the clients' best interests in mind.
- Health Savings Accounts, Medical Savings Accounts and 401(k)s are covered by the rule.
A major impact of this rule affects brokers who previously worked on commissions. As brokers are now considered as fiduciaries, they cannot prioritize their own financial benefits over the best interest for the client. The one exemption in the rule (effective July 2019) is termed the Best Interest Contract Exemption (BICE)- but it must be agreed upon by the client first.
Shifting lawsuit environment
In recent years, 401(k)-related litigation has increased substantially, and all signs indicate that lawsuits are likely going to continue to increase. After a decade of legal activity, a landmark Supreme Court decision in August 2017 made it easier for 401(k) participants to sue administrators.
This is not just the big players - small and middle market providers are vulnerable to lawsuits as well; smaller outfits have the same fiduciary responsibilities and must abide by the same rules as large ones. While not as common as lawsuits against corporations, the number of lawsuits against smaller companies is rising.
Required fee disclosures
Another Department of Labor rule, this one implemented in 2012, closed a large loophole in plan fee disclosures. Before the new rule, regulations allowed plan providers to generate fees from plan assets without disclosure. This means third-party administrators could pocket fees without ever informing the 401(k) contributors as to how much they were getting. Thanks to the new rules, there is a far higher level of transparency of how much revenue is generated from fees, which has led to a narrowing of the industry.
Increase in plan audits
Over the past decade, the Department of Labor rigorously ensured that plan sponsors are following the letter of the law set by ERISA. The federal agency is steadily enforcing its rules through increased plan audits to determine if plan sponsors are in compliance with the rules related to retirement plans. They may ask to see plan provider contracts, fiduciary meeting minutes, educational material provided to investors and investment policy statements.
Revenue sharing phase out
While revenue sharing has been a common practice in the past, it is quickly becoming taboo in the 401(k) industry. It used to be that plan sponsors chose funds, and the fund would give back money to the third-party administrator - much like a kickback. Many plan sponsors / employers did not realize what was going on as they were given the impression that their administrative fees would be lowered. What they also did not see was how this practice detrimentally influenced the plans that were chosen for retirees. While the practice is still legal, its use is increasingly avoided as the New DOL rule makes it a “prohibited transaction” unless specific exemption action is taken (BICE).
Although change might happen slowly in the 401(k) industry, the effects are typically lasting. The government has taken substantial steps in monitoring industry practices more carefully than they have in the past, and we should expect to see more changes to come. As we have seen with recent changes, the focus in the future will likely be to increase the transparency further for the benefit of plan participants.
Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This information is not intended as authoritative guidance or tax or legal advice. You should consult your attorney or tax advisor for guidance on your specific situation.
