Have you ever wondered how much your 401(k) plan cost to run? Most investors look only at the returns, but at The Retirement Advisor we have always been concerned with the cost of investments since that impacts your bottom line.
Ever since U.S. companies started adopting 401(k) plans as a retirement savings vehicle in the early 1980s, they have grown to be the savings vehicle of choice, with the number of participants in 401(k) plans surpassing those in traditional defined benefits plans during the mid 1990s.
Many employers tack on additional fees to administer their 401(k) plan. A recent publication from the Investment Company Institute (ICI) on “The Economics of Providing 401(k) Plans” breaks down the sources of fees into the following three general groups:
1. Administration services: This includes recordkeeping, transaction processing, and trustee services.
2. Participant-focused services: This includes participant communication (such as web access or call centers), participant education, investment management, and loan processing.
3. Regulatory and compliant services: This includes creating plan documents, consulting services (assistance in selecting the “right” mutual funds), accounting and auditing services, and legal advice.
According to a report published by the U.S. Government Accountability Office (GAO), out of all the different subgroups mentioned in the ICI publication, investment fees (fees that are charged by companies managing mutual funds) and plan recordkeeping fees together account for nearly all of the fees being charged to 401(k) plans. Investment fees are typically borne by the participants in the 401(k) plan, while recordkeeping fees generally by the company (that is, the plan sponsor).
So Where is the Problem?
While mutual funds are legally required to disclose their fees and expenses to the participants, the current disclosure requirements are limited in nature and does not allow for an easy comparison across investment options or across different plans. In the GAO’s own words, ERISA “requires that plan sponsors provide participants with certain disclosure documents, but these documents are not required to contain information on fees borne by individual participants. Additional fee disclosures are required for certain – but not all – plans in which participants direct their investments. These disclosures are provided to participants in a piecemeal fashion and do not provide a simple way for participants to compare plan investment options and their fees.”
Given the opaque nature of fee arrangements, and given the sheer size of the $2.4 trillion 401(k) plan industry, there is a significant incentive for service providers to overcharge 401(k) plan participants or to mask the nature of their fee arrangements (such as arrangements that result in conflicts of interest). Make no mistake: An extra 0.5% or 1.0% charge on a midsize 401(k) plan (approximately $100 to $200 million in assets) can result from additional fees of $500,000 to $2 million on an annual basis – hardly a trivial sum. For the retiree as well, having an extra 1% annual fee deducted from his or her 401(k) plan would result in a 19% “savings shortfall” relative to his original savings (the amount which the participant would have saved if the extra 1% charge had not been implemented) if compounded over 20 years. In other words, a 19% savings shortfall is not trivial! For plan participants who are not sure how much they are being charged in their 401(k) plans, we recommend at The Retirement Advisor that you ask your employer for a full disclosure and start saving money.
To learn how to subscribe to The Retirement Advisor Newsletter, visit our web site where you can download a free issue with instructions on how to subscribe. Subscribers are able to obtain all of our back issues at no extra cost.
Ever since U.S. companies started adopting 401(k) plans as a retirement savings vehicle in the early 1980s, they have grown to be the savings vehicle of choice, with the number of participants in 401(k) plans surpassing those in traditional defined benefits plans during the mid 1990s.
Many employers tack on additional fees to administer their 401(k) plan. A recent publication from the Investment Company Institute (ICI) on “The Economics of Providing 401(k) Plans” breaks down the sources of fees into the following three general groups:
1. Administration services: This includes recordkeeping, transaction processing, and trustee services.
2. Participant-focused services: This includes participant communication (such as web access or call centers), participant education, investment management, and loan processing.
3. Regulatory and compliant services: This includes creating plan documents, consulting services (assistance in selecting the “right” mutual funds), accounting and auditing services, and legal advice.
According to a report published by the U.S. Government Accountability Office (GAO), out of all the different subgroups mentioned in the ICI publication, investment fees (fees that are charged by companies managing mutual funds) and plan recordkeeping fees together account for nearly all of the fees being charged to 401(k) plans. Investment fees are typically borne by the participants in the 401(k) plan, while recordkeeping fees generally by the company (that is, the plan sponsor).
So Where is the Problem?
While mutual funds are legally required to disclose their fees and expenses to the participants, the current disclosure requirements are limited in nature and does not allow for an easy comparison across investment options or across different plans. In the GAO’s own words, ERISA “requires that plan sponsors provide participants with certain disclosure documents, but these documents are not required to contain information on fees borne by individual participants. Additional fee disclosures are required for certain – but not all – plans in which participants direct their investments. These disclosures are provided to participants in a piecemeal fashion and do not provide a simple way for participants to compare plan investment options and their fees.”
Given the opaque nature of fee arrangements, and given the sheer size of the $2.4 trillion 401(k) plan industry, there is a significant incentive for service providers to overcharge 401(k) plan participants or to mask the nature of their fee arrangements (such as arrangements that result in conflicts of interest). Make no mistake: An extra 0.5% or 1.0% charge on a midsize 401(k) plan (approximately $100 to $200 million in assets) can result from additional fees of $500,000 to $2 million on an annual basis – hardly a trivial sum. For the retiree as well, having an extra 1% annual fee deducted from his or her 401(k) plan would result in a 19% “savings shortfall” relative to his original savings (the amount which the participant would have saved if the extra 1% charge had not been implemented) if compounded over 20 years. In other words, a 19% savings shortfall is not trivial! For plan participants who are not sure how much they are being charged in their 401(k) plans, we recommend at The Retirement Advisor that you ask your employer for a full disclosure and start saving money.
To learn how to subscribe to The Retirement Advisor Newsletter, visit our web site where you can download a free issue with instructions on how to subscribe. Subscribers are able to obtain all of our back issues at no extra cost.
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