401(k) Fee-Asco


A Yale professor is providing a perfect follow up to this year’s PBS episode of Frontline called "The Retirement Gamble." That program detailed America's retirement crisis and the financial services industry’s feasting on high fees inside of many employer-sponsored plans. Professor Ian Ayres has recently completed an exhaustive analysis of company-sponsored 401 (k) plans and found that many charge excessive fees. But Ayres has taken the research to a new level by sending about 6,000 letters to companies, saying he would disseminate the results of his study next spring and would specifically identify and expose those companies with high-cost plans.

The concept of reeling in retirement plan fees gained a bit more momentum last year, when the Department of Labor put new rules into effect, which required 401 (k) sponsors to disclose fees and performance data to plan participants. The first round of the more detailed information was sent in November 2012 and, despite all of the media hype, those disclosures did not make much of an impact.

According to the EBRI 2013 Retirement Confidence Survey, about half (53 percent) of defined contribution plan participants reported having noticed these new disclosures, and only 14 percent of those who noticed (7 percent of all plan participants) said they made changes to their investments as a result.

This data gibes with findings from consulting firm LIMRA, which found that half of plan participants do not know how much they pay in plan fees and expenses. In fact, about a fifth of all participants think they pay nothing for their retirement plans.

To review, there are a bunch of fees that participants pay, including administrative, trustee and investment fees. The average plan costs about 1.5 percent, with larger company plans coming in at closer to 1 percent and small to medium sized ones sometimes costing in excess of 2 percent.

You may think that a half of a percent does not seem like a big difference, but that fraction could cost you hundreds of thousands of dollars over time. As a baseline, if you were to start with $100,000 and invest it over 50 years at a 7 percent return (compounded monthly) with no fees, you would end up with approximately $3.2 million.

If you apply the average plan fee of 1.5 percent, the future amount is more than halved to just over $1.5 million. But if you are in an expensive plan and the fee is 2 percent, your future value drops to $1.2 million at the end. That’s $300,000 that could be falling to your bottom line! 

What should you do if your retirement plan is more expensive than the average? One benefit to the disclosure rules is that plan participants can be empowered to effect change. The first step is to review the disclosure that was sent. If your plan costs more than the average of 1.5 percent, gather as many co-workers as possible and lobby your boss for a cheaper plan. It may surprise the boss to learn that he or she could find cheaper alternatives. But it is notoriously difficult for smaller companies to get the best plans. The reason is that the financial services industry likes scale. It takes a lot of money to provide all of the services necessary to operate a retirement plan, so financial companies like to land the big fish.

If you hit a brick wall on a new plan, then at the very least, try to have cheaper investment options added to the current plan. Index funds, which carry much lower fees, can make a big difference. I recently helped a radio caller navigate her 401 (k) plan investment options. By shifting from costlier actively managed funds to index funds, her cost of investing dropped from over 1 percent to just 0.25 percent.

It can feel burdensome to stay on top of all of these issues, but hopefully the long-term benefit outweighs the short-term work involved.