Revealing Excessive 401(k) Fees
You may not realize this, but your 401(k) or other workplace retirement plan is not free.
Sure, you may have looked at the expenses on the mutual funds you own. But there are other costs as well for record-keeping and assorted other administrative costs. And because they generally don't show up on your quarterly statement, you probably don't know they are there.
But they are there, and they are large enough to have attracted the attention of both the Labor Department and plaintiffs lawyers. The Labor Department, in fact, has approved new rules for fee disclosure for retirement plans that are supposed to go into effect starting sometime next year.
Meanwhile, experts in the field are keeping a close eye on a federal lawsuit in Kansas City, Mo. The suit, filed by employees of a company called ABB who assert that their 401(k) plan was mismanaged and too costly, has already gone to trial. And it began on an unsettling note, when one of the plaintiffs killed his supervisor and two colleagues at work one morning before turning a gun on himself. The trial went ahead as scheduled, but 16 months have now gone by without a decision.
The delay probably has something to do with how much is at stake. For many millions of Americans who do not work for themselves, the sum of what they save in 401(k) and similar plans could be their biggest asset, by far, come retirement time. So it's crucial that employers have clear rules about proper disclosure of the fees in such plans and a definitive understanding of when those fees are excessive.
WHY FEES MATTER How much might an improvement be worth to someone who can persuade an employer to make one.
Here's how the Labor Department puts it. Let's say you have 35 years until retirement and a balance of $25,000. You put no more money in and earn a 7 percent return annually. If fees and plan expenses reduce those returns by 0.5 percent a year, your balance will grow to $227,000 in those 35 years. If those fees total 1.5 percent, however, you'll end up with just $163,000, 28 percent less.
An annual total of 0.5 percent isn't reality for most workers, alas. According to BrightScope, a company that gathers data about retirement plans and gives some of that data to individuals while selling more information to employers, the all-in fees, including those mutual fund investments you may already know about, average 1.08 percent for plans with balances of more than $100 million, 1.36 percent for those with $10 million to $100 million and a whopping 1.90 percent for plans with under $10 million.
So fees matter. And the younger you are, the more you have to gain over decades of compounding by working for an employer who understands just how much of a difference these costs can make.
DEFINING EXCESSIVE FEES So when are retirement plan fees unconscionable.
Employers are supposed to act as a fiduciary when running a retirement plan, which is a legal way of saying that they are supposed to put your interests first. But in the context of fees, they must only keep them reasonable.
And there aren't many specific definitions of what is unreasonable, for a couple of reasons. Benchmarking against other plans has traditionally been difficult, given that employers themselves often don't know exactly what their plan costs. If you don't know what everyone else is paying, there is no way to know what is reasonable, says Mike Alfred, BrightScope's co-founder and chief executive, whose team has gathered information on 47,000 plans so far and sorted it by peer group.
Then there are the judges, who are often reluctant to issue opinions that dictate a specific figure. Also, lawyers are hesitant to sue, given the enormous amount of time required to prepare excessive fee cases. Then there's the uncertain legal terrain; the ABB case is the first of its kind to actually go to trial, according to Jerome Schlichter, of Schlichter Bogard & Denton in St. Louis, the lead plaintiff's lawyer. And there is still no verdict, well over a year after closing arguments.
I know they are working on it and working on it very hard, said Fran Smith, judicial assistant to Judge Nanette K. Laughrey, of Federal District Court, who presided over the trial. It's just a very difficult case.
DISCLOSING FEES Thankfully, the basic question of what fees you're paying in your 401(k) or 403(b) is about to become easier to answer. Starting in 2012, according to new Labor Department guidelines, investment and other companies like Fidelity, which is a party to the ABB lawsuit, will need to be more clear with employers about how they are charging them.
Employers, in turn, will have to itemize more information on plan fees and expenses on account statements. In addition, they will need to display the costs of each mutual fund or other investment in a way that makes it easier for employees to compare their choices.
While it's not yet clear how all of this will work in practice, there is real potential here for employers, especially executives at smaller ones for whom managing the retirement plan is one of dozens of duties, to get a harsh wake-up call about the size of their annual bill. And even if they don't, their employees may see a menu of high-cost funds staring them in the face and begin to ask for a better plan.
LOWER FEES Until your new and improved account statement arrives, you can check to see if BrightScope has graded your 401(k) or 403(b) plan. If its total plan cost is among the highest in its peer group, you ought to ask for an explanation. Ditto if you run one of BrightScope's personal fee reports on the funds you've selected yourself in your retirement plan and find that you're paying well over 1 percent in total costs.
If you are investing in actively managed mutual funds (perhaps because your employer hasn't seen the light and given you a lineup of low-cost index or exchange-traded funds as an option), keep in mind that those fund companies may be handing some of their investment fees back to your plan's record keeper to pay for administrative costs. Ask about this and inquire whether that's the only reason your employer continues to do business with any high-fee, actively managed funds.
Try not to get too indignant about this, at least at first. At a small employer in uncertain economic times, having a retirement plan in the first place isn't a given. Let your colleagues in human resources or finance know that they, too, will benefit personally if you can find a way to strip out some costs.
Injecting a little emotion into the proceedings may help, too, though threats will probably not be constructive, especially given what happened at ABB. (The gunman there left no note, though he had told friends of troubles at work.)
Again, just a quarter of a percentage point in annual savings now can mean tens of thousands of dollars more come retirement time. Try visualizing it this way, by imagining it as the difference between one vacation each year or two at age 75, or one plane ticket, or several, for the grandchildren to come see you annually. Make sure to remind everyone you talk to of that.
And if it's confusing or even frightening to confront data like this initially, given its importance. Don't throw up your hands or just cross your fingers, as many of your colleagues will do. Instead, find other like-minded people to help you decipher the numbers and start an improvement movement.
I think 10 to 15 percent of people will always get value out of increased disclosure, Mr. Alfred said. Most of the time, they are the most influential people at the company, and they're the most likely to tell other people about it.