Between worries about the future solvency of Social Security and traditional pension plans that have gone the way of the drive-in movie, the 401(k) account has taken on much greater significance for those planning for retirement. While you may think you are well-versed on the ins and outs of your 401(k), a recent New York Times article, “Revealing Excessive 401(k) Fees,” by Ron Lieber points out what may be a startling revelation for many participants: The plans are not free.
As Lieber writes,“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.”
If you’re thinking something should be done about this to protect investors, the U.S. Labor Department is one step ahead of you. New rules on fee disclosure for retirement plans have been approved and are scheduled to go into effect by January 2012.
Starting in 2012, according to the new Labor Department guidelines, investment companies will need to be clear and forthcoming with employers about their fees. Employers will then be required to clearly itemize these administrative fees on employees’ account statements. Additionally, employers will need to clearly display costs for each mutual fund or investment so employees can easily compare the costs of their choices.
In my view, providing employees with all the information about the cost of their 401(k) plan is in line with the Employee Retirement Income Security Act’s (ERISA) requirement of plan fiduciaries who select and monitor service providers and plan investments. The ERISA requirement states that fiduciaries “act prudently and solely in the interest of the plan’s participants and beneficiaries.” Further, according to ERISA, plan fiduciaries also “must ensure that arrangements with their service providers are reasonable and that only reasonable compensation is paid for services.”
The organization Independent Fiduciary Consultants interprets this requirement a bit more fully, noting that financial advisors serving as plan fiduciaries for a plan should “identify, document and understand the true cost of plan services and the costs borne by the employer, plan, and participant and benchmark plan costs against fellow employers in comparable peer groups.”
Interestingly, however, these ERISA rules require only that plan fees be “reasonable,” not necessarily the lowest. So, while your employer must take “reasonable” measures to evaluate costs, he has no legal duty to shop for the best deal. Employees are turning to the courts to help make this gray area more black and white. For example, in the past, Lockheed Martin and Wal-Mart have faced class action lawsuits by employees who were dissatisfied with their 401(k) plans and fees. Currently, a federal lawsuit has gone to trial in Kansas City, MO that was filed by employees of ABB who assert that their 401(k) plan was mismanaged.
So, how high is too high for 401(k) fees? According to BrightScope, a company that gathers and tracks data on more than 55,000 retirement plans, the “all-in fees,” which include mutual fund fees you likely 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 1.90 percent for plans with under $10 million. BrightScope’s co-founder and CEO Mike Alfred says plan participants should be satisfied with fees of about 1 percent. However, he’s seen fees that range from 3 to 5 percent of assets for smaller businesses.
If you’re thinking a percentage point or two doesn’t make much of an impact, think again. The Department of Labor offers this example: “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.” That’s significant.
Of course, the issue of high fees is only one factor in the larger question of whether your employer has acted in a fiduciary capacity regarding your 401(k) plan. Ideally, your 401(k) plan should offer investment choices in every asset class, including stocks, bonds, commodities, and real estate, from a variety of mutual fund companies. What’s more, you might expect your employer to offer you some educational programs so you can make informed choices among the funds offered. In this area, your employer can decide to hire an investment advisor who operates as a fiduciary and accepts the responsibility to act in the best interests of plan participants. Alternatively, an employer may hire someone to provide only very general financial information. In this case, there is no fiduciary duty.
Just as it’s important for you to understand whether the person educating you is acting in a fiduciary role, you need to understand the legal responsibilities of any individuals advising the sponsor of your plan. Here, there is an important distinction between the two types of fiduciaries described in ERISA: the 3(38) fiduciaries and the 3(21) fiduciaries.
Simply put, ERISA provides that a plan sponsor can delegate the responsibility of selecting, monitoring, and replacing of investments to a 3(38) investment manager/fiduciary. A 3(38) fiduciary is defined as a bank, an insurance company, or a registered investment adviser (RIA) subject to the Investment Advisers Act of 1940. Named by the plan sponsor to make all investment decisions, the 3(38) fiduciary assumes legal responsibility and liability for all plan decisions. Notably, however, the plan sponsor remains responsible for the prudent selection of the 3(38) investment manager and must monitor the 3(38) investment manager’s decisions.
Conversely, an ERISA section 3(21) fiduciary is not granted discretion over the plan by the plan sponsor. Therefore, a 3(21) fiduciary may make investment recommendations without shouldering any legal responsibility or liability. In this case, the plan sponsor retains complete fiduciary duty and responsibility for plan decisions.
There’s no question that plummeting 401(k) account values during the recession and investors’ desire for greater transparency after the credit crisis have put the focus squarely on 401(k) fees. I support the efforts of the Labor Department to ensure that every investor has the information necessary to make good decisions with his or her retirement savings. Furthermore, I look forward to the day when anyone advising an investor is held to the fiduciary standard of acting 100 percent in that investor’s best interests.