Form 5500: The Form that Needs Reform

You know them by number. The 1040. The W-2. The 3-fingered salute.

I would like to introduce you to another one... the 5500. Or Form 5500, to be exact.

If you sponsor a retirement plan, you are already acquainted. “Form 5500 Annual Return/Report of Employee Benefit Plan” is a disclosure document required by the Department of Labor. Think of it as a tax return for your 401(k) plan. Once it is filed, it becomes public information, luring inquiring law professors to peruse the juicy data. More on that in a bit.

Form 5500 filings serve two purposes – one passably well and the other, well, not so much.

1. The 5500 does okay on reporting on the rate of participation, employee and employer contributions and other basic data that indicate that the plan is complying with IRS and DOL guidelines. The Federal government grants huge tax subsidies for qualified retirement plans, and the Feds want to make sure that those receiving the tax benefits are complying with the law. That’s fine. We may not like government oversight, but the Form 5500 can provide important insights regarding the effectiveness and legal compliance of a retirement plan.
2. Form 5500 falters when it comes to its other purpose - the “kinda, sorta” disclosure of retirement plan fees. The problem: not all fees paid from plan assets have to be reported. Fees paid directly from the plan must be reported, but fees paid indirectly through mutual fund expense ratios need not be reported. Both reduce returns to investors, reported or not.

Here is why it matters.

Fees paid from plan assets - either directly or indirectly - reduce investor returns. And because not all fees are disclosed, Form 5500 is not suitable for determining the true cost of the plan, much less comparing costs across plan or determining average plan costs. The data is just too incomplete to warrant precise analysis. One might be able to draw some very broad conclusions about the costs of some plans, but to draw more detailed conclusions simply will not work.

The Yale professor who recently put out a 401(k) cost study relied on these Form 5500 data and drew very detailed, pointed conclusions. Decent analysis, and I applaud the effort, but the data he used was not complete or potentially accurate.

Here’s my take: If we are going to collect the fee data and make it public, let’s do it in such a way that we can do apples-to-apples comparisons. If we did it that way, Form 5500 would probably get simpler, too. The truth is out there and available - it’s just not being reported.

Share your thoughts with me in the comment box below.