Is the Form 5500 worthless?

Close to 700,000 retirement plans filed a Form 5500 in 2011, representing $6 trillion in assets held by more than 130 million Americans.

Given the form's role as a primary tool for enforcing the Employee Retirement Income Security Act, it's safe to say that no reporting instrument is as vital to the accounting of retirement assets. It's also safe to say that few have much respect for it.

Regulators, plan sponsors and others with a stake in the country's retirement industry have spent years complaining about it.

Disparities in how assets are classified relative to accounting standards, confusion over how to report service provider fees, and an overall lack of data detailing plan investments and their performance have led many to question the quality, and ultimate usefulness, of the Form 5500.

"You can't look at a Form 5500 and definitively say what a plan is paying in fees," says Greg Carpenter, founder and CEO of Employee Fiduciary, a Mobile, Alabama-based retirement plan service provider. "Maybe you can make an educated guess, but you can't say definitively."

Carpenter would know. His firm, which principally serves smaller firms – those with fewer than 100 participants – prepares 1,500 Form 5500s a year.

He's been wrestling with the form's complexities since 1997, and says they've only grown worse as 401(k) plans have become more standardized.

"Form 5500 was conceived before mutual funds ruled the Earth," explains Carpenter. "Previously, retirement plan options varied, and were more complex. As the 401(k) industry began to overtake the market, trading volumes went up, and fees went down. Form 5500 failed to adapt."

The Government Accountability Office (GAO) examined the problem and found wide agreement among stakeholders that much needs to be done.

The GAO offered a number of recommendations based on surveys of officials from the Department of Labor, the IRS and the Pension Benefit Guarantee Corporation — the three government entities charged with developing the form under ERISA.

It also surveyed Form 5500 stakeholders from the private sector — plan sponsors, service providers, retirement consultants, ERISA attorneys and financial researchers and academics.

Here is a breakdown of the three areas that it identified as most problematic:

Weaknesses in format

The basic format of 5500 was called into question by many of those who spoke to the GAO.

What the Government Accountability Office suggests be done to make the Form 5500 useful again.

Schedule H, Part 1 of the form allows sponsors to aggregate all trust investments together. Many plans invest assets through Master Trust Investment Accounts or Common Collective Trusts, according to the GAO report. By aggregating all of a plan's assets into trusts, and then "lumping" the trusts together, the performance of individual assets gets buried, again creating transparency issues relative to how different aspects of a plan are performing.

Also in Schedule H, plan sponsors are required to "break out" their plan assets in ways far different from how the investment industry reports the information to regulators. This means stakeholders are tasked with keeping two sets of records. It also raises the potential for divergent reporting between the two methods, and that can raise transparency issues when assessing a plan's performance. Ten out of 31 respondents reported this as a "very" or "extremely" significant challenge.

Elsewhere, the overly general asset categories in Schedule H make it difficult to understand the underlying holdings of indirect investments. The GAO says that large single-employer DB plans invested about 63 percent of their assets in four types of indirect investments in 2010. Large single-employer DC plans held, on average, 34 percent of their assets in indirect investments. Half of respondents said the resulting lack of transparency creates "very" or "extremely" significant challenges.

Challenges in finding key information

Many of those queried by the GAO also reported that vital plan information is often not collected, and when it is, it's not "easily extracted" from Form 5500 data.

One of the greatest areas of concern captured by the GAO focused on the fees paid to third-party administrators. The GAO said many stakeholders reported difficulty in determining the expenses deducted from investment returns. Almost half (45.2 percent) of respondents said this poses "very" or "significant" challenges.

In this area, too, the information provided to the administrators of plans that prepare Form 5500 is inconsistent with other industry disclosure standards, the GAO said in its report.

More than half of the respondents said the form does not sync up with ERISA's 408(b)(2) disclosure requirements. That means sponsors file two different forms to the Department of Labor, disclosing fees to service providers in two different ways, resulting in two different sets of data.

Meanwhile, small plans (those with fewer than 100 participants) aren't required to detail much about their plan's composition. Small plans account for about 85 percent of all plans in the market. The absence of data on these plans means there's no way to benchmark their performance, or assess what they pay in fees. And it calls into question if their compliance with ERISA can even be determined.

Inconsistent data

A problem repeatedly raised in the report, inconsistent data weakens from the form's purpose — to provide regulators and others with the information needed to gauge a plan's ultimate health.

Consequently, the ability to accurately compare plans is limited. Unclear definitions of service providers' roles and how different types of providers are compensated makes it difficult to determine when a plan may be paying too much in fees. Nearly half of respondents said a lack of clarity in how providers' compensation is classified ("eligible indirect compensation," "reportable indirect compensation," and "direct compensation") creates "very" or "extremely" significant challenges.

One-third of stakeholders said basic naming conventions, and even inconsistencies with how Employer Identification Numbers (EIN) and Plan Numbers (PN) are applied, are inconsistent throughout the form.

The regulatory bodies agreed wholeheartedly. Inconsistency with EINs and PNs hinders the PBGC's ability to analyze records across years, it told the GAO. The IRS keeps a repository of assigned EINs and PNs, but it doesn't share that information with other regulators or with industry.

In light of its many flaws, it's no wonder the GAO concluded that "incomplete, inconsistent and incomparable data (collected by the form) warrant immediate attention." So why hasn't anything been done to fix what so many agree are flaws in the form?

The answer rests at least in part in what the DOL, IRS and PBGC all told the GAO: that the process for making form changes is lengthy and can be complicated.