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401(k) Fees: Bad News, Good News

Alicia Munnell, the director of the Center for Retirement Research at Boston College, is a weekly contributor to “Encore.

As the role of 401(k) plans and similar defined contribution plans continues to expand in our retirement system, plan participants are paying more of the cost of financing their retirement income. The increase in individual payments takes two forms. First, in old fashion defined benefit plans, employers made all of the contributions; in 401(k) plans, employees typically contribute about 6% of their earnings and employers match 50 cents on the dollar. Second, employees pay most of the fees associated with 401(k) plans in the form of lower net returns.

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Fees fall into two categories – those associated with administration of the plan, such as record keeping, legal work, and accounting; and those associated with investment management. The investment management fees account for the bulk of the total.

Fees are extremely important. For example, if fees amount to 1% of assets, they reduce a 401(k) participant’s rate of return by about 25 percent.

The bad news on fees comes from a recent study from the Government Accountability Office (GAO). The findings of the GAO survey showed that many sponsors – particularly of small plans – had no idea how much they and their participants were being charged. Small plans were also paying very high fees for record keeping and administrative services – 1.33% of assets annually compared with 0.15 percent paid by sponsors of large plans.

The good news is that the Department of Labor has two initiatives focused on fees. Under the new rules, companies administering 401(k) plans must disclose to the sponsor all the costs associated with administering the plans. The deadline for these disclosures is July 1, 2012. Plan sponsors are supposed to use this information to ensure that the fees are reasonable. That is, they have to prudently select and monitor their service provider. But they do not have to pass this cost information along to participants.

Sponsors are responsible, however, for providing participants with expense ratios for investments offered by the plan, showing participants the charges per $1,000 invested. Initial disclosures are due August 30, 2012; quarterly disclosures are due November 14, 2012.  For many investors the fee disclosure may come as a shock, since people often have the impression that the accounts are cost-free. The goal of the fee disclosure is to enable investors to compare alternative investments and assess the extent to which fees erode their balances.

The hope is that when sponsors and participants see the fees, they will respond by moving toward low-cost options, thereby putting downward pressure on expenses. A study by my colleagues at the Center for Retirement Research at Boston College suggests that considerable savings are possible. They analyzed the trading costs and fees of the 100 largest domestic equity mutual funds held in defined-contribution pension plans for the years 2004 through 2008. The pricing of the actively managed funds in this sample cost the average plan 0.70 of a percentage point or more in annual returns. By shifting investment options from managed mutual funds to exchange-traded funds (ETFs) or commingled trusts, an average plan could reduce its administration and management fees between 0.20 and 0.40% of assets.

Some fear that the disclosing of fees will cause people to move away from actively managed funds to indexed funds. That would be wonderful, in my view. The fees and trading costs of the domestic equity funds in my colleagues’ sample are not correlated with the performance of the funds. The funds with the greatest expenses tended to divide evenly between those funds that outperformed and those that underperformed the market by the largest margins. Therefore, indexed funds are likely to give participants the biggest bang for their buck and a bigger pile of assets at retirement.

Oops, sorry to go back to bad news. All these good disclosure requirements apply only to 401(k) plans. Unfortunately, more money now has been rolled over into individual retirement accounts (IRAs) than remains in 401(k)s ($4.9 trillion versus $3.9 trillion as of the fourth quarter of 2011). So individuals will see fee information for only about 45 percent of their retirement assets.


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    • Siebert discount brokerage service is to my knowledge the most affordable in terms of account and service fees. That was based off of comparisons I did back in 2008 when looking for which firm I would set up a discount brokerage service with.

      But overall, I don’t touch the stock market. It was nice to get some financial and investing education and double my money on some stocks, and lose all my money on others, but I’d rather play Roulette with my discretionary income, and use my investment funds for real estate. A bank isn’t going to lend me money to buy stocks, insurance companies won’t cover them if they burn to the ground, many won’t beat the inflation rate let alone the bare minimum 10% net annual ROI any decent investor shoots for. And it’s hard to find any stock that produces a 1% dividend every month. If you buy $100k in stocks, that’s all you got, they might pay a fraction of a dividend every few months or once a year if you’re lucky. It’s easy to find a $100k property rented and everything that pays $1,000/mo net income after all expenses.

    • A stunning display of ignorance (or is it deception?) on the part of this “author.” Of course larger plans will pay a smaller percentage of assets for administrative services. A 100 employee million dollar plan costs as much to administer as a 100 employee billion dollar plan. I don’t need to go into further detail. This should be basic knowledge for the purported expert author. As for the investment management fees, do you think that it costs nothing to provide ongoing service and education to employees and managagement? To advise the Plan Sponsor of their fiduciary resposibilities and help keep them in compliance? To properly manage a portfolio or construct an investment policy and portfolio for a company whose employess are relying on you to provide investments and expertise that ultimately determines their standard of living in retirement? Do you think that if it weren’t for portfolio managers and financial advisors, investments would be free? By all means, opt out of your 401k and do it all by yourself. Nobody is stopping you from doing that. Just do me a favor and report a follow-up article to explain how this works out for you.

    • This is a good change. It’s been said that “sunlight is the best disinfectant” The stated goal of the DOL is issuing the 404(a)(5) disclosure regulations is to lower the fees and expenses charged to plan participants by 14.9 Billion.

      If you are a CFO or plan sponsor,the following is an orderly way to prepare for these changes:


    • @don and @counter i completely agree. as well as, where is the link for the GOA survey? where is the proof of indexed funds > mutual funds?… etf’s are rarely offered on any platform. Fees should be reduced in this bear market. but the sentiment from writers like this almost devalues the purpose of a recordkeeper/tpa/broker. borderline propaganda. the only link i see is for the writers colleagues study which is admittedly flawed by the writer.


About Encore

  • Encore examines the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities and priorities of today’s retirees. The blog also explores news that affects retirement, from the Wall Street Journal Digital Network and around the web. Lead bloggers are reporter Catey Hill and senior editor Jeremy Olshan. Other contributors include The Wall Street Journal’s retirement columnists Glenn Ruffenach and Anne Tergesen; the Director for the Center for Retirement Research at Boston College, Alicia Munnell; and the Director of Research for Pinnacle Advisory Group, Michael Kitces, CFP.