What They’re Taking From Your 401(k)
Obscure Retirement Plan Fees Add Up Shockingly
Like 47 million other U. S. workers, software engineer Don Sengpiehl is counting on retirement money invested in a company- sponsored 401( k) savings plan. But ask Sengpiehl how much that plan costs, and the 54- year- old Loudoun County resident — who studied math at Massachusetts Institute of Technology — won’t be able to do much more than guess. Disclosures about 401( k) fees bewilder him, and he says he doesn’t have the time or know- how to figure out what he’s being charged, much less to monitor whether his employer is pushing for the lowest possible fees.
“ I basically set it up, put it in motion and hope for the best,” he said.
Many workers share Sengpiehl’s ignorance about retirement plan fees, even as 401( k) s have become the dominant retirement savings vehicle offered by corporate America. Financial industry executives, consumer groups and federal regulators say that confusing and often fragmentary disclosures by employers and 401( k) managers make it hard for most workers to understand what they’re being charged.
Unlike traditional pension plans, in which companies make all the investment decisions and promise a set amount upon retirement, 401( k) s require employees to take more responsibility for how the money is in- vested — and therefore how much they will have at retirement. Increasingly, workers and regulators are asking how people can be expected to make wise choices without easier- to- understand, more complete information, especially about fees.
In recent months, class- action lawsuits have been filed against about a dozen big companies — including Boeing, International Paper and Bethesda- based Lockheed Martin — claiming that these employers have allowed financial managers of their 401( k) plans to charge excessive fees. In many cases, the lawsuits say, the companies simply have not fully understood which fees were being charged. Federal law requires employers that sponsor 401( k) plans to protect employees’ interests, and the lawsuits claim that the companies have failed to seek the best price possible given the services provided.
The companies dispute the charges, and even some retirement experts who favor more disclosure say the suits exaggerate the issue. Thomas Greer, a spokesman for Lockheed Martin, said, “ We believe the suit to be without merit. We intend to defend against it vigorously. We do not feel our fees are excessive or out of whack, and we believe that the investment management and administrative expenses associated with the company 401( k) plans are appropriate, fair, reasonable and in line with other major companies’.”
The lawsuits have helped focus public attention on the fee issue, as have recent congressional hearings. But the impetus behind both is the large and growing number of people affected. There are more than two workers invested in a 401( k) for every one covered by a traditional pension, the mirroropposite of 35 years ago, and the Pension Protection Act enacted last summer is expected to accelerate the trend. Designed to encourage Americans to save more for retirement, the new law allows employers to automatically enroll new hires in 401( k) s.
At a hearing before the House Education and Labor Committee last month, several retirement consultants testified that workers are being overcharged billions of dollars each year through questionable and often hidden fees. Disclosure forms are so complicated and incomplete, they said, that even experts have trouble computing all the costs 401( k) investors pay.
The consultants said many 401( k) plans are charging from 1 to several percentage points too much. While that may not seem like a lot, even a slightly higher fee can deeply erode savings over time. The Department of Labor, which regulates 401( k) plans, posts this example on its Web site: If you have $ 25,000 in savings earning an average of 7 percent annually, with a 0.5 percent fee, your investment will grow to $ 227,000 over 35 years. Raising that fee by 1 percentage point, to 1.5 percent, will reduce the investment’s final value to $ 163,000.
“ We have to ask whether all these fees are necessary, and we have to examine whether they are undermining workers’ retirement security,” said committee Chairman George Miller ( D- Calif.).
Miller said he will consider legislation that would require 401( k) managers to provide better information to employers sponsoring these plans. Employers, in turn, would be required to tell workers more about the plans’ costs and risks, as well as about any potential conflicts of interest that money managers or the company might have. The Securities and Exchange Commission and Labor Department are also working on new rules to make disclosures more clear and complete.
But until new rules are enacted, workers are stuck with the status quo. That means plan participants must dig through dense documents and ask their employers tough questions they may not be used to asking.
For some workers and retirees, that can be frustrating. Ed Rosa, 71, who retired from Lockheed Martin nine years ago and lives in California, said he always assumed the defense giant did its best by him, but in the past few years, he’s begun to wonder whether he has gotten enough return on his 401( k) investment.
“ You look at the statements, but, oh gosh, it’s not real clear,” said Rosa, who is not a named plaintiff in the lawsuit against Lockheed. “ You’d have to be an accountant to figure out what you’re paying, and even then, how’d you know it’s correct? Are they managing my money as if it were their own? Could I get the same service for less?”
Crunching the Numbers
Retirement experts say you should not expect to get a hardand- fast number showing exactly how many pennies you pay for every dollar of investment gain or loss. That said, based on a fund’s performance and the disclosed costs, you can get a ballpark idea of how much you’re paying and decide whether that’s acceptable. Your employer’s benefits office can provide written material about the company’s 401( k) plan and direct you to information about specific 401( k) investments.
Mutual fund companies manage more than half of the $ 2.7 trillion now estimated to be invested in 401( k) plans, far more than banks and insurance companies, which also operate these plans. The Investment Company Institute, the mutual fund industry’s main lobby group, says most costs are disclosed through what are called expense ratios and turnover rates, which can be found in the fee table in a fund’s prospectus. While turnover rates give investors a sense of whether a fund’s trading costs have been high or low, some trading costs, namely brokers’ commissions, are listed in a separate document called a Statement of Additional Information, which investment companies provide to plan participants upon request.
The expense ratio — also known as operating fees — typically ranges from 0.5 percent in a low- cost fund to more than 1.5 percent in a more expensive one. That means an investor is charged from half a penny to 1 1⁄ cents for
2 every dollar invested. The expense ratio includes fees for management, marketing and some other costs. It doesn’t include most trading costs, which are one of the biggest additional expenses 401( k) investors pay and typically range from half to twice the operating fees, depending on how often a fund trades, according to retirement consultants.
ICI spokesman F. Gregory Ahern said putting the numbers in different documents can be confusing to consumers. Nonetheless, he said, the numbers are public and, if taken together, provide a nearly complete picture of the total costs an investor pays in a 401( k).
He and others say that though trading costs are important, they need to be viewed in the context of a fund’s performance — high trading costs might be worth paying in exchange for a 15 percent return, for example, but not for a bad performance.
Matthew D. Hutcheson, an independent pension consultant af- filiated with G Fiduciary near Portland, Ore., challenges the industry’s claim that costs are clear and complete. He and others say that in addition to operational costs, a fund company might impose extra charges to be part of a 401( k) plan, including auditing, legal and education fees. These costs can significantly increase the total amount investors pay, sometimes by 1 or more percentage points over and above a fund’s basic charges, retirement consultants say.
That’s why workers should not be shy about asking employers for information. “ I think plan sponsors are getting used to being asked more questions these days,” said Robert Liberto, a consultant with Segal Advisors, which specializes in helping companies provide retirement plans.
One question they should ask is whether their employer knows which costs are bundled into a mutual fund’s expense ratio, said Stephen J. Butler, founder of Pension Dynamics, a California company that advises companies on selecting and operating 401( k) plans. Listing the costs separately can make it easier to compare them among vendors and weed out unnecessary services.
And as more companies begin to offer investment advice through their 401( k) plans — as the pension act passed last summer now allows — workers should ask employers to make advisers disclose business relationships connected to the plan so potential conflicts of interest can be addressed. A worker will want to know, say, if an adviser gets a commission for steering someone to a certain investment.
Dallas Salisbury, head of the Employee Benefit Research Institute, a nonprofit group that focuses on retirement and economic security issues, says he worries publicity surrounding 401( k) fees might discourage some workers from participating in plans by making them sound as if they are riddled with problems, when, he says, “ they are not.”
“ Would people be better off if they read all the stuff, looked at everything on the Web sites and fully informed themselves? Yes,” he said, even though he thinks few workers would use additional pricing information. “ But the important thing is that people join the 401( k) in the first place as soon as possible.”