Retirement plan fees receive increased scrutiny
Mutual fund expense ratios don't reveal all of the fees associated with 401(k)s. Here's how to spot the others.
If you participate in a 401(k), 403(b), or similar employer-sponsored retirement plan, you are probably paying all or a portion of the fees that come with it.Skip to next paragraph
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Even the largest providers of 401(k) plans agree that fees are a big deal because the lower those costs are, the more you'll have to spend when you retire. For example, an information sheet from Vanguard shows a $314,023 difference between a fund that carries an expense ratio of 0.30 percent and one that charges 1.40 percent, based on 40 years of compound growth, annual contributions of $3,000, and an 8 percent return. (The expense ratio represents the percentage of the fund's assets that go toward running the fund.)
But read Vanguard's example more closely and it indicates that its calculations were made "before costs." (Hmmm ... wasn't this scenario designed to illustrate costs?)
Clearly, expense ratios do not include all of the costs associated with a 401(k), notes David Loeper, CEO of Financeware Inc., and author of the new book, "Stop the 401(k) Rip-off!" In fact, he says, there are other costs that aren't easy to find, but employees are probably paying them.
Mr. Loeper is not alone. Sen. Herb Kohl (D) of Wisconsin and Rep. George Miller (D) of California have introduced bills calling for full disclosure of 401(k) fees.
In addition, at least a dozen class-action lawsuits have been filed against such companies as International Paper Corp. and Lockheed Martin Corp., alleging violations of pension laws by allowing plan participants to be overcharged by plan managers. "One was dismissed in early February," says Pamela Hess, director of retirement research at Hewitt Associates, one of the largest retirement-plan service providers in the country. The suit linked investment losses and fees, which the judge didn't think was reasonable.
Yet all this attention means fees are receiving more scrutiny. "A GAO [Government Accountability Office] report from last November noted that 80 percent of the public doesn't know what they're paying for their 401(k) plans," says Loeper.
The GAO reported that changes were needed to give better information on fees for plan participants, noting that even a seemingly small difference in the fees can make an enormous difference in the overall size of an employee's 401(k) account balance. A 1-percentage-point difference in fees can reduce retirement benefits by 17 percent over 20 years, the report states.
Currently, some 62 million people, – active participants, former employees, and retirees – are holding $2.7 trillion in assets inside 401(k) accounts, according to the Investment Company Institute (ICI). More than half of those assets are invested in mutual funds. (See chart.)
With those funds come fees. A fund's expense ratio accounts for many of those expenses, including the investment advisory fee, administrative costs, as well as its marketing and distribution costs.
But Loeper contends that some fees aren't disclosed at all, making it next to impossible to determine if the costs associated with a 401(k) are too high. Among the frequently nondisclosed fees he lists are wrap fees, which include costs for trading and monitoring investments for which the investor could be charged as much as 2.5 to 3 percent a year.
"Charges are often clumped under administration expenses, a most-effective means of hiding extra costs," he says.
Loeper discovered all this when he got fed up with his company's 401(k) plan and switched service providers. "We were paying more than $500 a year per participant; now the administrative costs are down to only $60 a year per participant, and I was personally paying $1,500 a year for my own 401(k) and now pay just $198."
The new plan for his 25-person company costs less than 0.6 percent of assets, he says. Not only did the shift decrease costs, it increased the flexibility and number of investment choices. As a result, his employees can choose from 1,500 no-load funds instead of what had been 10 to 20 choices for no additional cost other than what each fund itself charges. "So, despite the variety available through these self-directed accounts, we can still keep the costs down."