The Exchange

The 401(k) Fee Puzzle: We’re All in the Dark

Last year Bank of America (BAC) planned to charge its debit-card users a monthly $5 fee as other big banks, including Wells Fargo (WFC) and JP Morgan Chase (JPM), followed suit with similar revenue-raising strategies. The fees outraged customers and helped fuel the Occupy Wall Street movement; before long the banks scrapped their plans.

When nearly every financial transaction brings another expense with it — ATM fees, airline baggage fees, credit card late-payment fees, foreign currency exchange fees, hotel fees, etc. —  this was considered a small victory for the little guy.

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But when it comes to expenses in our retirement accounts — namely, 401(k) plans — we're clueless. For example, a study published by AARP in February found that "71% are not aware that they pay fees to their 401(k) plan provider to maintain their account."

And it's not just us. A recent report by the Government Accountability Office (GAO) found that even plan sponsors — employers — aren't as clued into the fees they're paying and passing onto their employees as one might think. A somewhat surprising finding: About half of plan sponsors didn't know if they or their participants paid investment management fees or believed these fees were waived.

How Much Cash Are You Giving Up?

We all know that 401(k) fees — including marketing and distribution fees, transaction costs and investment management fees — can eat into your nest egg's returns. But how many folks  find out exactly how much cash they're forgoing through fee expenses?

Perhaps they'd pay more attention if they knew just how much money — at least according to one group — they're giving up to fees. A report released last week by left-leaning think tank Demos said that a median-income, two-earner household will fork over nearly $155,000 (or nearly one-third of their investment returns) over the course of their lifetime in 401(k) fees. Sixty-five percent of retirement savers don't know they're paying administrative, investment management and trading fees, according to the report.

The findings were criticized by some, including the American Society of Pension Professionals and Actuaries (ASPPA). The group issued a response taking issue with how Demos arrived at that  number. Their fee calculation assumes participants invest equally in a mutual fund that invests primarily in bonds and a fund which focuses on stocks, and carry the mean expense ratio for their asset class — which, according to the Investment Company Institute, is 0.72% for bond mutual funds and 0.95% for stock mutual funds. ASPPA argues that Demos should have used expense ratios for index funds, which tend to carry lower overall fees than traditional mutual funds.

The Investment Company Institute (ICI) also found fault with the Demos report, calling the lifetime amount paid in fees "implausible." ICI cites a study it conducted with Deloitte which found the median participant-weighted "all-in" fee for plans was 0.78%, or about $248 for 2011 per participant.

All this complicated fee business is still over the average 401(k) investor's head. Hey, as long as we're contributing to our employer's plan and getting a match, the rest is out of our control.

Fee Transparency Lies Ahead

Well, get ready for some 401(k) fee illumination.

Beginning July 1, financial institutions that administer these plans will be required to disclose the fees and administrative costs they charge in a user-friendly format. The rules are meant to help participants get a better handle on fees associated with their plans and encourage sponsors to shop around for administrators and compare costs.

The beneficiaries of the new rules will mainly be participants in smaller 401(k) plans (where fees are usually higher than fees at larger plans), says David Wray, president of the Plan Sponsor Council of America, a non-profit group that supports employer-sponsored retirement plans. Two-thirds of 401(k) participants work at companies with 1,000 or more employees and those companies already offer plans with low fees, Wray says. "They have the expertise and the scale," he says, and fees are already well understood. The opportunity for savings and reduction in fees is going to be with the smaller-plan sponsors, especially those that haven't shopped around, he says. Indeed, fees hit smaller plans harder than their larger counterparts: The average amount sponsors of small plans reported paying for recordkeeping and administrative services was 1.33% of assets annually, compared with 0.15% paid by sponsors of large plans, the GAO report found.

At the end of last year, Americans held $4.5 trillion in all employer-based defined contribution retirement plans, of which $3.1 trillion was held in 401(k) plans, according to the ICI.

A few more interesting tidbits from the GAO report:

  • Representatives of a retirement industry organization said it may be difficult for sponsors of small plans to negotiate for lower fees, because assets in these plans are modest. Example: The respondent in the survey that paid the highest amount — 37.26% of plan assets — for recordkeeping and administrative fees started the plan in 2009 and had less than $1,350 in assets at the end of calendar year 2010.
  • More than an estimated 90% of sponsors either did not know about or have not used the Department of Labor's educational resources to compare and assess plan fees.
  • One relatively large plan underestimated recordkeeping fees by more than $58,000, because the sponsor did not include the fees charged to participants' accounts under its revenue sharing arrangement.
  • Over half of sponsors did not ask their service providers about five different types of fees, including marketing and distribution fees (used to pay commissions to brokers and other salespersons); Sub-TA fees, which are typically used to reimburse a plan's record keeper for shareholder services; trading/transaction costs; and wrap fees, which are generally associated with annuities.

How much do you think the fees in your 401(k) plan are damaging your returns?

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