On March 29, 2022, the U.S. House of Representatives passed the Securing a Strong Retirement Act – better known as SECURE Act 2.0 because it builds upon the Setting Every Community Up for Retirement Enhancement (SECURE) Act. I support SECURE Act 2.0 generally but am disappointed the bill doesn’t offer any 401(k) transparency reform. Today, 401(k) plans can be a black box of hidden fees and conflicts of interests. This lack of transparency can make it impossible for employers to offer their employees a cost-efficient 401(k) plan.
A cost-efficient 401(k) plan is characterized by low administration fees and ”prudent” investments – basically, funds that meet their investment objective for reasonable fees. These features can help employees retire years sooner, while protecting employers from fiduciary liability. Americans deserve no less.
Here’s a summary of the 401(k) provisions of SECURE 2.0 and the 401(k) transparency reform I believe would lead to more cost-efficient plans.
401(k) Provisions of SECURE Act 2.0
Enacted in 2019, the original SECURE Act was widely viewed as the most extensive retirement plan legislation in over a decade. The law created Pooled Employer Plans (PEPs) - a form of Multiple-Employer 401(k) Plan (MEP). Supporters claim PEPs lower 401(k) investment and administration fees through “economies of scale.” In truth, a traditional single-employer 401(k) plan with leading index funds and flat administration fees can cost much less. Don’t believe me? Shop around.
SECURE Act 2.0 won’t make 401(k) plans more cost-efficient either. Key provisions of the House bill include:
- Roth option for matching contributions – Today, matching contributions are always made by employers on a pre-tax basis. SECURE Act 2.0 would allow employers to give plan participants the option to treat their match as a Roth (i.e., after-tax) contribution.
- Match on student loan repayments - SECURE Act 2.0 would give employers the option to base matching contributions on a participant’s student loan payments - rather than their elective deferrals - beginning in 2023.
- Catch-up contributions – Today, a 401(k) plan can permit participants aged 50 and older to make catch-up contributions. For 2022, the catch-up limit is $6,500. SECURE Act 2.0 would raise the limit to $10,000 (indexed for cost-of-living) for participants aged 62 and older beginning in 2024. Additionally, all catch-up contributions must be Roth (i.e., after-tax) beginning in 2023.
- Small business tax credits – The SECURE Act 2.0 would enhance the 401(k) tax credits available to small businesses (up to 100 employees):
- Credit for startup costs - Today, the 3-year 401(k) startup credit for small businesses is 50% of administrative costs, up to $5,000 per year. SECURE Act 2.0 would increase the 50% to 100% for small businesses up to 50 employees. Joining an existing plan (e.g., a Pooled Employer Plan (PEP)) would now qualify a small business for the full 3-year credit regardless of the plan’s start date.
- Credit for employer contributions – SECURE Act 2.0 would give small businesses a tax credit for employer contributions - up to $1,000 per employee.
- Automatic enrollment mandate – New 401(k) plans would be required to automatically enroll eligible employees at 3%. The 3% default rate must then escalate by 1% annually until reaching at least 10%. Plans in existence prior to the enactment of SECURE 2.0 would be exempt from this rule. So would businesses with 10 or fewer employees.
- Required Minimum Distributions (RMDs) - The SECURE Act raised the RMD age from 70-1/2 to age 72. SECURE 2.0 would raise the RMD age to 73 in 2023, 74 in 2030, and age 75 in 2033. The bill would also reduce the IRS excise tax for certain RMD failures.
- Long-term/part-time workers - Under the SECURE Act, a 401(k) plan must allow part-time employees who work at least 500 hours each year for three consecutive years to make elective deferrals. SECURE 2.0 would change the eligibility requirement to 500 hours in two years.
In my view, cost-efficiency is the key to making retirement as affordable as possible for 401(k) plan participants. To make more 401(k) plans cost-efficient, I believe the following 401(k) transparency reform is necessary.
Reform #1 – Define a Safe Harbor 401(k) Investment Menu
ERISA imposes few investment-related 401(k) fiduciary responsibilities on employers. They boil down to picking – and maintaining - enough “prudent” investments to allow any plan participants to diversify their account “so as to minimize the risk of large losses.” ERISA does not define “prudent” but I think it’s safe to consider cost-efficient funds – basically funds that meet their investment objective for reasonable fees – to be prudent.
The problem? Most 401(k) providers have little – if any – incentive to help business owners select prudent investments. In fact, the opposite is true. They can grow their profits by steering business owners towards “imprudent” investments with excessive fees and/or inferior returns – in short, give conflicted investment advice. The worst part? It’s perfectly legal for them to do so.
To help business owners select “prudent” 401(k) investments, I would like to see Washington define a “Qualified Core Investment Alternative” menu (my invention). Qualified Default Investment Alternatives (QDIAs) offer business owners a fiduciary safe harbor for selecting a default investment today. I think a safe harbor is needed for selecting an entire investment menu.
A QCIA menu could be modeled after the Federal government’s Thrift Savings Plan (TSP). The TSP’s menu delivers market returns with index funds and professional investment advice with target-date index funds. If 401(k) fiduciaries want different funds, no problem – they could use QCIAs as performance benchmarks.
Reform #2 – Make Hidden 401(k) Fees Illegal
401(k) are NEVER free. All 401(k) providers charge fees for delivering plan administration services such as asset custody, participant recordkeeping, Third-Party Administration (TPA), and professional investment advice. Their administration fees can either “direct” or “indirect” in nature:
- Direct fees – can be paid from either 1) plan assets or 2) a corporate bank account. They are highly transparent. Their dollar amount must be explicitly reported in invoices in 408b-2 and 404a-5 fee disclosures, participant statements, and invoices.
- Indirect fees – are deducted from investment returns. Often called “hidden fees” because they lack the transparency of direct fees, indirect fees are buried in the fund expense ratios of 408b-2 and 404a-5 disclosures, and not appear at all in participant statements or invoices. The two most common forms of indirect fees are revenue sharing and variable annuity “wraps.”
I would like to see Washington make indirect fees illegal for three reasons:
- Regardless of their direct or indirect nature, all 401(k) fees paid from plan assets reduce participant returns dollar-for-dollar. These losses mean less principal earning compound interest until retirement. Given the stakes, I think all 401(k) fees paid from plan assets should be as transparent as possible. Only direct fees fit that bill.
- Indirect fees are always based on a percentage of assets. That means their dollar amount increases automatically as participant account balances grow.
- Many 401(k) providers limit their investment options to funds that pay revenue sharing. This limitation can make many – if not most – “prudent” 401(k) investments unavailable to plan participants.
Reform #3 – Standardize 408b-2 Fee Disclosures
When final 408b-2 regulations were released in 2012, they were a big step forward in improving the transparency of 401(k) provider fees – making it easier for business owners to protect the interests of their 401(k) plan participants and avoid fiduciary liability. However, these rules had a major shortcoming - they did not mandate a standard disclosure format. Many 401(k) providers have taken advantage by burying their administration fees in fund expense ratios and/or multi-page documents.
To fix this shortcoming, 408b-2 reform is necessary. I think a standard one-page summary that totals a 401(k) provider’s administration and investment fees into a single “all-in” fee would do the trick. That way, business owners can quickly learn the full cost of their 401(k) plan – not to mention, compare their current 401(k) provider’s fees to competitors on an apple-to-apples basis.
Reform #4 – Reform the Form 5500
Most 401(k) plans – except for certain owner-only (or “solo”) plans – must file a Form 5500 annually. The goal of the Form 5500 is to help the government and other stakeholders perform 401(k)-related research.
For decades, the Form 5500 has done a poor job at meeting this goal for two reasons:
- Small plan 5500 filers do not report indirect administration fees at all. while the Schedule C that large plans must file does not disclose 100% of them.
- Small plan 5500 filers are not required to report plan investments, while large plan filers report investments on paper attachments that are difficult to data mine.
These 5500 shortcomings harm both 401(k) plan fiduciaries and participants. When 401(k) market information is not readily accessible, it’s more difficult for plan fiduciaries to benchmark their plan fees vs. comparable plans – making unnecessary participant losses and fiduciary liability more likely.
I think Form 5500 reform is necessary to make 401(k) plans more comparable. Reform was proposed years ago, but it went nowhere.
You Don’t Need to Wait for a Cost-Efficient 401(k) Plan!
401(k) lawsuits have exploded in recent years. No surprise when you know how 401(k) industry hidden fees and conflicts of interests can make it impossible for employers to offer their employees a cost-efficient 401(k) plan. SECURE Act 2.0 will do nothing to solve this problem.
Four common sense 401(k) reforms from Washington can.
In the meantime, it’s still possible for any employer – regardless of size – to offer a cost-efficient 401(k) plan. They just need to hire the right 401(k) provider.