Personal Finance

The Curtain Opens on 401K Fees

Gretchen Morgenson
Comstock | Getty Images

If market gyrations have taken a bite out of your 401(k), get ready for more discomfort. You’re about to learn how much you’re paying just to maintain that account.

New Labor Department rules will require fuller disclosure about the fees charged on 401(k)’s. Fees, of course, can be an enormous drain on retirement savings — but they are often obscured, giving many Americans the impression that the accounts are somehow cost-free.

A survey published last February by AARP, for example, found that 71 percent of those polled believed that they did not pay fees on their 401(k)’s. Six percent said they did not know whether fees were levied.

So the coming disclosures, scheduled to show up on third-quarter statements this fall, may come as a shock. Still, it’s better to know than to be in the dark.

There are an estimated 483,000 individual retirement account plans, covering 72 million participants, the Labor Department says. These accounts hold roughly $3 trillion in assets. Greater transparency couldn’t be more important.

The new rules are intended to ensure that the fees in 401(k) plans are reasonable. The Labor Department says it hopes that the disclosures will help investors compare various investment offerings and see how costs eat away at account balances.

Two main fees are extracted from 401(k) plans: investment management fees and administrative costs. Under the new rules, companies administering 401(k)’s — often mutual fund concerns — must provide employers who sponsor the plans with details of all fees associated with running the accounts. For example, fees for general plan administrative services, like legal work, accounting and recordkeeping, will have to be disclosed.

Plan sponsors are supposed to use this information to analyze whether the fees in their plans are too high. But they won’t have to pass along all of this data to participants. Instead, the sponsors will be required to calculate expense ratios for the investments offered in a plan, showing participants the charges per $1,000 invested.

According to a Deloitte/Investment Company Institute study released last November, the median 401(k) expense ratio was 0.78 percent. But the range of ratios is wide, the report noted: from 0.28 percent to 1.38 percent.

Expense ratios on 401(k) plans are supposed to be lower than those on investments offered to individuals. That’s because the combined assets in many retirement plans should be large enough to qualify for lower-cost institutional funds. In general, the greater the assets held in a plan, the lower the fees.

Brent L. Glading, founder of the Glading Group, a consulting firm that analyzes 401(k)’s, says he welcomes the disclosure requirements but fears that the new rules will confuse plan participants. Employers will have to work much harder to educate participants about costs and benefits of various fund offerings, he says.

Unfortunately, he adds, employers are not up to the task. “The disclosure is going to make index funds look better in some cases, and that’s fine,” he says. “But you will find many active managers with fees that are justifiable because their performance outperforms the index. It is clearly going to be the responsibility of the plan sponsor to help participants understand what it all means, and I am not sure they are prepared for it.”

If plan sponsors are to help their employees use the disclosures to make better investment choices, they have a lot of boning up to do. A study issued by the Government Accountability Office in April found that half of the 1,000 sponsors surveyed either did not know if they or their participants paid investment management fees or believed, incorrectly, that such fees were waived by service providers.

Investment management fees are a rather large cost to be unsure about. According to the Deloitte/I.C.I. study, these fees make up 84 percent of total 401(k) expenses.

Such ignorance might be understandable for sponsors of small plans, but large plan overseers can also be clueless. According to the G.A.O. study, 31 percent of large plan sponsors didn’t know whether they or their participants paid investment management fees.

The report also said 29 percent of plan sponsors did not know if their plans paid for trustee, legal or audit services.

If plan sponsors don’t even know that fees are levied, they are surely not putting any effort into aggressively managing the costs that their employees are paying in their 401(k)’s. The G.A.O. study confirms that.

Glading Group   
Brent L. Glading

While almost half the plans surveyed by the G.A.O. reported that they did not know if they or their participants paid transaction costs, 95 percent of those said they had not even asked their service providers for information regarding these costs.

When sponsors do receive an accounting of various costs, they rarely use it to push for lower fees, the G.A.O. found. For example, the Labor Department requires sponsors to identify individuals receiving at least $5,000 in compensation for services rendered to a 401(k) plan. But the G.A.O. noted that 89 percent of the sponsors surveyed said they did not use the information to compare fees with those charged by other companies. And 83 percent said they didn’t use the data to negotiate lower fees from current providers.

“The reality is, most of the fiduciaries of these plans don’t want to do what they are supposed to do,” Mr. Glading said. “They say, ‘It doesn’t save money for the company, so why do I care?’ There has to be a groundswell from the employees.”

PERHAPS that will be the main benefit of the new disclosures. It may just be that when workers begin to see how investment fees and administrative costs are ravaging their retirement savings, they’ll start prodding the managers overseeing these plans to behave like the fiduciaries they are.

The fact is, fund companies and other providers of 401(k)s are getting rich off these plans. And in this zero-sum game, future retirees are definitely the poorer for it.