Defined contribution plans like 401(k)s have long ago become the dominant vehicle for retirement saving and investment.
Between 1990 and 2011, plan assets have expanded nearly fivefold to $4.3 billion. And yet, it has often been the case that participants have difficulty finding information regarding the panoply of costs and fees levied against the plan to support investment, administrative and marketing activities.
These costs vary widely and can range from 1 percent to 4 percent or more. Small company plans often carry the highest fees.
Thanks to anticipated changes in Labor Department rules, some help is on the way. The new regulations will require better disclosure of fees charged by plan administrators and mutual fund companies that are typically passed on to employees indirectly.
It is essential that participants have full knowledge of all the costs they incur, since these costs act as a significant drag on invest-
ment performance over the long time horizon typical of retirement plan participation.
Running a 401(k) plan involves much more than just offering a menu of investment choices. Significant administrative, legal and reporting duties must also be fulfilled. Often these tasks are assumed by a third party administrative firm, although some mutual fund companies provide these services or seamlessly outsource them.
Generally, the costs of these administrative functions have been paid for out of the marketing fees embedded in the mutual fund investments. These costs clearly impact retirement savers, but they have previously been frustratingly difficult to measure.
Furthermore, this system of indirect cost shifting can lead to choices of investments that may be sub-optimal for employees but generate higher marketing fees to cover administration.
The new Labor Department rules will require that investment, recordkeeping and other fees deducted from employee accounts be disclosed in an annual summary document.
The first annual statement of costs is due by Aug. 30. Then, beginning in November 2012, plan sponsors must issue quarterly fee disclosure statements.
The importance of minimizing costs can be demonstrated with a simple example. Suppose an employee had $50,000 in her 401(k) plan, invested in funds earning an average 6 percent after all fees. Without any additional contributions, she could expect to have $287,000 at retirement in 30 years. However, were she able reduce the annual plan expenses by 0.75 percent, she would retire with $355,000, nearly a fourth more.
One benefit of the increased reporting transparency is a heightened sensitivity to fees on the part of employers. Many firms are already engaged in a review of their 401(k) plans, seeking to reduce overall costs or to add lower cost alternatives like index funds and ETFs.
According to a survey conducted by AARP, 71 percent of 401(k) plan participants believe that they pay no fees at all. This is about to change, as employees begin receiving their first expense statements and start asking questions of their employers.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Christopher A. Hopkins CFA, is a vice president at Barnett & Co. Submit questions to his attention by writing to Business Editor Dave Flessner, Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by emailing him at dflessner@timesfree press.com.