The world of 401(k) plans is in an uproar. Finally, someone is questioning the fees that plan participants pay for the mutual fund choices within the plans, and the actual expenses of managing the plans, keeping the records and providing services.
What do most 401(k) plans charge, on average, for these services? That’s been a closely guarded secret, available only to those who dig through voluminous plan documents. But now a professor from Yale University, Ian Ayres, has undertaken that task, searching the fee structures out of the year-end form 5500s, which are required to be filed by these retirement plans. It appears that he has ranked the more than 46,000 plans by fee structure. And he has sent more than 6,000 letters to plan sponsors, giving them their rankings, “threatening” to make the name of high-fee plans known to the public via media and Twitter!
Plan participants have little choice about how to save for retirement in a company 401(k) plan. The employer or plan sponsor chooses the funds that are available within the plan, and then it’s up to the employee to decide how to allocate money among those choices. The company sets up rules for matching contributions and loans from plans, but the actual money management is left to the fund companies, and a “third party administrator” typically does the record keeping. Many companies didn’t think much about the actual costs of running the plan, since those costs are borne by plan participants. Now, at last, companies are taking a closer look, being reminded that under the Employee Retirement Income Security Act (ERISA) they have a legal responsibility to the participants. The very idea that their plan might be among the most costly has plan sponsors extremely worried, and rushing to their consultants and to the plan providers to see where they stand in the universe of plan fees. Strangely, there is no real public benchmark for what a plan should cost the participants. The data in Ayres’ study dates from year-end 2009. But since then there have been some changes. As of year-end 2012, plan sponsors require new ERISA Section 408(b) (2) disclosures of fees. Many were embarrassed into cutting fees or changing plan providers before the end of last year, to avoid disclosing outsized costs.
Some of those 401(k) costs depend on the individual’s choice of fund investments within the plan. An index fund should cost less than 25 basis points (one basis point equals one one-hundredth of a percent). But a “managed fund” will have slightly higher costs. Those costs cover the cost of research and transactions made by each fund. But there are also record-keeping costs that are passed on to plan participants.
The industry contends that fees alone are not a proper comparison tool, since they don’t reflect the value of other services provided to plan participants. Some plan providers actually credit money back to participants’ accounts from the management fees through “revenue sharing,” a process not accounted for in the professor’s study. Still, it’s hard to know where your plan stands on the scale of fees and costs. And make no mistake, those annual fees and costs can make a big impact on your retirement savings.
In 2008, I interviewed David Loeper, who wrote a provocative book called Stop the 401(k) Rip-Off! He explained that a worker would have to save an extra $800 a year to make up for the fact that the company has a retirement plan that has an extra 0.5 percent in costs each year. Five years ago, when Loeper first called attention to this issue, there were few ways that employees could complain about their high-cost plans, without worrying about being labeled a troublemaker and risking their jobs. Now that Ayres has raised the issue in such a public way, you can be sure that there will be lawyers just waiting to file class-action suits on behalf of those who are stuck in the high-cost plans. But lawsuits will just add costs to employers —costs that will be taken out of money that could go toward compensation or matching contributions.
Perhaps the better way for an employee to shake up the system would be to send an anonymous note to the HR department asking about the costs, relative to benchmarks for a company of similar size. Given all this new concern, that should be enough to get management to make some changes in high-cost plans.