By Kathleen M. McBride, Sept 5, 2013
This may be the questions more employers who sponsor 401(k) pension plans ask in the coming months after some 6,000 of them received letters advising them that the plans they sponsor appear to have higher-than-average costs. Higher costs can drag down the amount of savings that is left for the investor after fees are paid.
Over a lifetime of retirement savings, higher costs can deduct hundreds of thousands of dollars from the investor and put them in the pocket of individuals and firms that provide services to the plan.
Alarming? Sure. Important? You bet. The hope for a dignified retirement for millions of Americans hangs in the balance.
Recently, Yale Law Prof. Ian Ayres sent letters to 6,000 pension plans, alerting them that their plan’s fees and expenses register higher than average in a study. University of Virginia School of Law Prof Quinn Curtis, and Prof Ayers conducted the study, entitled “Measuring Fiduciary and Investor Losses in 401 k Plans.”
The study measures what the professors call “fiduciary losses” and “investor losses.”
Fiduciary losses relate to the plan’s expenses, and the limited menu of investments that employees who participate in the 401(k) can choose from (often a selection of mutual funds). These are under the control of the employer who sponsors the plan (the fiduciary).
Investor losses relate to how plan participants – investors – choose the investments from the limited menu that is offered in the plan.
Many investor advocates are concerned about high fees in 401(k)s, which started as a way of subsidizing traditional pensions, and now have become the centerpiece of American’s retirement system.
The firms, brokers and advisors who provide services to 401(k) plans say the higher fees are justified because of the services that are provided.
But why do some plans have costs that are many times higher than others? Are services that different?
Lack of Transparency
Until recently there it was nearly impossible to get a clear, detailed understanding of the costs 401(k) plans and participating investors pay for investments, recordkeeping, administration and other services. The Department of Labor has been changing that, with new requirements that mandate disclosure of fees to plan sponsors – and participants in the plans.
Plan sponsors are fiduciaries and must “act prudently and loyally to participants,” says Jeffrey Turner, Deputy Director, Regulations and Interpretations, EBSA, Department of Labor.
On a call to discuss “401K Fees And Expenses And Plan Sponsor Fiduciary Duties,” hosted by the Institute for the Fiduciary Standard, Turner noted that plan sponsors must act solely in the best interest of plan participants when selecting investment options, service providers and monitoring their choices regularly – and documenting the choices they make and how they arrived at those choices, as fiduciaries.
ERISA “forbids overpayments from plan assets,” Turner says. Plan fiduciaries should pay “not more than reasonable fees” to the service providers they select. They must also obtain “information sufficient to enable informed decisions,” including information on costs.
But how do plan sponsors know whether the fees they pay are “reasonable?” Is there a way for participants to compare 401(k) plan costs?
John Rekenthaler, Vice President of Research at Morningstar says, “It took years for investors to change their buying habits for mutual funds,” once they started to see information on costs and performance from data gathered by Morningstar. It’s more complex to gather the fee information from 401(k) plans, he But he’s optimistic – “it’s going to be done – it’s difficult to get all the information from the outside” of the plans.
Benchmarking 401(k) Plans
Benchmarking is one resource that’s widely used and has an important role, but it can be tricky. Edward Lynch, Founder & CEO of Fiduciary Plan Governance, LLC, works with pension plan sponsors and notes that for some clients they will “use three benchmarking services and get three different results,” because each benchmarking firms may use different data sets. Sometimes clients “need more than benchmarking.” When that’s the case, putting the plan’s service providers – and advisor(s) – out for competitive bid may be the best way to see what fees are reasonable.
This is done with a “Request for Information” or “Request for Proposal” which basically puts the different services – advisory, administration, record keeping, custody of assets, investment managers and perhaps more, on notice to sharpen their pencils and provide their best bid to get the job providing the services. The RFIs go to many potential providers and the process, like a reverse auction, introduces the plan sponsor to new providers who outline the services to be provided and the costs for the services. Current providers may also bid. Lynch says that this is “so impactful” that he has seen plan costs drop by two-thirds in some cases. That leaves more in plan investor participant’s retirement accounts.
The light that is shining on 401(k) plans, the prudence with which they are managed, their costs to investors, has been bubbling up for some time, but came to a high boil with the release of the Ayers letters. Time reporter Christopher Matthews says in an article entitled America Can’t Afford Wall Street’s Terrible Investment Advice: “With a retirement-savings gap that’s been estimated to be as much as $14 trillion, and Washington fighting over how much we need to cut Social Security, the American retirement system simply can’t afford to support an investment industry that makes billions from deliberately confusing its clients and steering them toward expensive products that shrink retirement accounts over time. The fact that the industry admits that it would have to drop the business of lower-income folks if forced to act in their best interest should tell you all you need to know about the value of its advice.”
In an article about the Ayers letters in Forbes, 401(k) Letters Could Expose The Worst Retirement Plans, John Wasik quotes Morningstar’s Rekenthaler: “It’s understandable that the 401(k) marketplace dislikes the letter’s implicit threat. However, such annoyances are part of the deal. The 401(k) plan has given fund companies nearly $3 trillion in incremental assets–$15 billion in annual revenues, assuming an average fund expense ratio of 0.50%. It has permitted corporations to shed the burden of guaranteeing pensions. Those benefits for fund companies and plan sponsors don’t come for nothing. They come with a spotlight. Get used to the glare, people. It will only get brighter.”