“In controlling costs, the plan sponsor enhances the stature of the plan, and the value of the 401(k) benefit, by ensuring that the bulk of investment returns are used to increase the value of participant accounts, not to pay investment management fees.”
Over the decades since Section 401(k) was added to the Internal Revenue Code in 1978, 401(k) plans have become the primary retirement savings vehicle for most Americans. The Investment Company Institute (ICI) reports that at the end of 2012, 401(k) plans held approximately $3.6 trillion in assets, the largest single plan category in the almost $20 trillion retirement plan market. For comparison purposes, private employer pension plans held $2.6 trillion, and all types of governmental plans held $4.8 trillion. Since 2000, 401(k) assets have more than doubled, while governmental plan assets are up about 50%, and private pension plans just 30%.
As 401(k) plans become more prominent, so too, fees charged to 401(k)s have become a bigger topic for regulators, legislators, and plan sponsors. Collectively, three primary factors have focused attention on 401(k) fees:
- Regulation and Disclosure: The Department of Labor (DOL) completed a multi-year regulatory project with the promulgation of regulations that requires far more comprehensive disclosure of 401(k) fees to plan participants. Initially proposed in 2008, for most plans these regulations took effect in August 2012. DOL estimates that 72 million participants in 483,000 plans received initial fee notices in 2012.
- Litigation: Dozens of large employers faced class action litigation for breach of fiduciary duty relating to allegedly excessive 401(k) fees, including 13 cases filed in October 2006 by Saint Louis law firm Schlichter, Bogard & Denton. While many cases were rapidly dismissed, and others settled, Schlichter and plaintiffs secured a big victory in March 2012 when a federal district court ruled against technology firm ABB and its 401(k) provider, Fidelity Management Trust, awarding plan participants at ABB $36.9 million, plus court costs and legal fees of $50 million. This case is on appeal to the Eighth Circuit. Similarly, in Tibble v. Edison, decided in California, the Ninth Circuit upheld a district court ruling that it was imprudent for 401(k) fiduciaries at Southern California Edison to fail to consider institutional mutual funds for its plan.
- Public Sentiment, Legislative Activity: Both Congress and the popular media have positioned 401(k) fees as a significant threat to Americans’ retirement security. For example, in April 2006, the Los Angeles Times ran a series of articles on 401(k) plan fees, including “Fees Eat Away at Employees’ 401(k) Nest Eggs.” Proposed 2008 legislation, “The 401(k) Fair Disclosure Retirement Security Act”, sponsored by Congressman George Miller, then Chairman of the House Education and Labor Committee, focused further attention on fees. While the bill was not enacted, Congressman Miller further inflamed public sentiment with statements like, “”Many 401(k)-style plans charge hidden fees that can cut deeply into worker’s retirement savings,” and, “The purpose of this legislation is to take these hard-earned savings away from the special interests and return them to their rightful place – the retirement accounts of American workers.” More recently, in April 2013, an episode of the PBS newsmagazine “Frontline” titled The Retirement Gamble reported that, “One household may be paying 10 times as much to invest in a 401(k) as the household next door,” “Popular 401(k) providers often charge a plethora of hidden fees, burying them under opaque names like “Expense Ratio,” and, “The best way to maximize your return might be to cut Wall Street out of the equation and invest in low-cost, unmanaged index funds.”
If we very roughly estimate the average annual cost of supporting 401(k) plan operations at 0.75% of assets, 401(k) expenditures total approximately $27 billion annually. Given the size of the 401(k) fee pie, it’s not surprising that banks, insurance companies, brokerage firms, money managers and mutual fund companies are competing vigorously to secure increased market share. Yet, despite this competition, numerous surveys indicate that 401(k) service fees are high. To address why fees are as high as they are, and what plan sponsors can do to control costs, we’ll:
- Analyze the forces driving costs in the 401(k) market
- Review regulatory developments that seek to provide better fee disclosure and control the rate of fee increases
- Investigate techniques that plan sponsors can adopt to ensure that fees charged to their plans are not excessive