Bankrate.com
Why's your 401(k) plan heading south?
Wednesday March 5, 6:00 am ET
Barbara Whelehan


In recent years, people who run 401(k) plans increasingly have come under legal assault.

In the LaRue v. DeWolff Boberg case, the Supreme Court unanimously found in favor of Texan James LaRue, who lost $150,000 in his 401(k) plan because his former employer allegedly neglected to move his assets to more conservative investments despite LaRue's repeated instructions to do so.

The case was a big deal because previously individuals couldn't sue under the Employee Retirement Income Security Act, known as ERISA, unless the losses affected the entire plan's assets. It's the first time the court directly addressed whether workers could sue over individual losses.

But people can lose money in their 401(k) plans in less obvious ways than being in the wrong investments during a market freefall. In fact, most of the lawsuits out there focus on the fees charged to these so-called "defined contribution" plans. Over time, fees can significantly impact a portfolio.

Capitol Hill's focus on fees
Lawmakers now are paying attention to fees and introduced several bills lately, including the 401(k) Fair Disclosure for Retirement Security Act. But it took them a while to notice that most Americans didn't have the cushy retirement plans they enjoy.

The buzz about 401(k) plans
When Congress was working on the Pension Protection Act a couple years ago, many members "discovered that most Americans aren't covered by a defined benefit plan," says Brian Graff, executive director of the American Society of Pension Professionals & Actuaries, or ASPPA. A defined benefit plan is an old-fashioned pension plan that pays a benefit for life based on your earnings and tenure at a job.

"That came as a real shock to them. And they figured out that less than 20 percent of the work force has one of those things, and most people get their savings from 401(k) types of plans."

Graff spoke to retirement plan professionals at the recent ASPPA 401(k) Summit in Orlando, Fla.

Many lawmakers were also surprised to learn that the 401(k) plan is not a guaranteed benefit, Graff said. But they promptly realized that 401(k) plans are impacted by three things: plan contribution amounts, investment returns and fees. Lately they've become "very, very, very interested in fees," says Graff.

The government's retirement plan
Congress' retirement plan is covered by the thrift savings plan, "sort of the federal government's 401(k) plan," Graff explains. "And they're very proud of the fact that the fees in the thrift savings plan are extremely low. Some describe it as only 6 basis points to run the thrift savings plan. And they don't understand why the rest of the world can't operate on just 6 basis points."

Mind you, 6 basis points is equivalent to 0.06 percent, or six hundredths of 1 percent. This is about half the cost of the cheapest index fund available to individual investors in the marketplace. Graff says the rest of the world can't operate on a fee that tiny, in part because businesses have to comply with ERISA -- those massive federal regulations that require plans to follow certain protocols. Costs for small business plans are higher than those of the single largest employer plan in the world, which enjoys certain economies of scale.

"For small plans, fees and expenses tend to be higher as a percentage of assets than for large plans," explains Fred Reish, an attorney with Reish Luftman Reicher & Cohen. "That's because many of the same services need to be provided to small plans, but they have less money by definition."

Reish, who specializes in employee benefits law, says that similar-size plans should be charged about the same amount, and the prices should be reasonable. But "reasonable" is more of a range than an absolute number.

"The problem is that, by and large, many providers in the 401(k) marketplace do not give clear and complete information to plan sponsors," he says. Plan sponsors, for your information, are employers who offer retirement plans to their workers.


The Labor Department's focus on fees
The fee disclosure problem is being addressed by the Department of Labor, which is working on three regulatory proposals. The first of the Labor Department's initiatives are proposed changes to an ERISA-required form that every plan must file annually with the federal government. It will require additional disclosures about plan fees to the government and is expected to go into effect in January of 2009.

Next they're working on point-of-sale disclosures to plan sponsors (remember: employers) by service providers. These proposed regulations are designed to make fees more transparent to companies. Because plan sponsors are always considered fiduciaries, they have a responsibility to do due diligence as they select a plan for their workers.

But here's the irony: Service providers have not been required to disclose fees unless they are fiduciaries (and -- pssst -- many in the industry try to avoid this fiduciary label because of its attendant responsibilities). However, plan sponsors have a fiduciary duty to understand and monitor plan fees. How can they employers effectively do this if they're not supplied with adequate information by service providers?

The new regulation addresses this conundrum -- it was the main source of buzz at the 401(k) Summit. The biggest concern among attendees was this: How in the world can the complicated fee structures of 401(k) plans be easily conveyed to plan sponsors? During the conference, some of the diagrams displayed on the screens depicting these fee arrangements resembled Rube Goldberg drawings.

If the service providers are grappling with how to approach this onerous task, what can this mean about the size of these fees?

By some estimates, upward of a dozen people have their hands in the retirement-plan pie. Any of the following charges may apply: subtransfer agent fees, early redemption fees, custodial fees, wrap fees, investment adviser fees, 12b-1 fees, brokerage commissions, administrative fees, revenue sharing fees and fees for services from attorneys, accountants and actuaries.

Some of these fees are direct and some are indirect. Some are tangled up in so-called "bundled arrangements," which is industry jargon for when more than one service is provided by a service provider (such as record keeping and investments, for example).

How high can fees go?
"We have seen a few cases where expenses are more than 3 percent of assets," says Reish. "But those have been in small plans. I don't think I have ever seen that situation in a large plan."

Whether a 401(k) plan costs 1 percent in fees versus 3 percent can make a dramatic impact on one's retirement savings. For example: Joe puts away $250 a month for 30 years and earns an 8 percent annualized return net of fees. His plan assets grow to $372,590. Tim puts away the same amount but earns 6 percent net of fees, or 2 percentage points less than Joe. Tim accumulates $251,129. The result: Joe's nest egg is nearly 50 percent bigger than Tim's.

The Department of Labor, or DOL, has come up with a fee disclosure form on its Web site that's designed to help service providers and plan sponsors get a handle on fees.

Says Reish: "I think the DOL did a great job in their new proposed regulations. They will bring a lot more disclosure and 'sunshine' into the marketplace. However, I don't think they went far enough. There are still a variety of fees and payments that do not need to be disclosed."

For example, the disclosures do not apply to accountants, actuaries, appraisers, auditors or legal services if they are getting directly compensated from plan assets. Only if they are indirectly compensated by third parties do their fees need to be disclosed. Also, there won't be a need to break down compensation on a per-service basis. And the amount of revenue sharing that exists within some bundled arrangements does not have to be disclosed, as the proposed regulations stand right now.

Controversy in the courts
Fees, and particularly revenue sharing arrangements, are the focal point of the recent spate of lawsuits brought about by, among other law firms, the St. Louis-based firm Schlichter, Bogard & Denton. So far that firm has filed suit on behalf of employees from more than a dozen Fortune 500 companies, including General Dynamics, Northrop Grumman, United Technologies, Lockheed, Caterpillar, John Deere, Unisys, Boeing and International Paper. The companies targeted by the law firm generally have 401(k) plan assets in excess of $2 billion.

It would be nice to think that altruism is the law firm's underlying motive for engineering these lawsuits. Plan participants deserve to pay the lowest fees possible to ensure a decent retirement. But Stephen Saxon, an attorney with Groom Law Group, paints a different picture.

"They're not an ERISA firm," he said at the ASPPA 401(k) Summit. "They won a ton of money in asbestos litigation. They won all these asbestos cases and they're looking around for the next area and they found it in the ERISA area."

It's clear that the issue of 401(k) fees is upfront and center in various government forums. But there seem to be two schools of thought about how much you and I need to know about fees. If it's so hard for service providers to explain fees to plan sponsors, how in the world can anyone explain fees to simple folk like you and me?

Focus on fees to participants
This concern will be addressed this spring, when the Department of Labor is expected to propose new disclosure rules for plan participants. At long last, we may be able to get a handle on the expenses in our company retirement plans. Or maybe not. Some people argue against too much disclosure.

"What I want when I look at my 401(k) plan, if I do at all, I look at net investment performance," says Saxon. "I don't look at what the custodians get paid, the record keepers get paid. I don't look at what the investment managers get paid. I'm looking at whether I'm making money. Are these funds performing well or not? And so requiring loads and loads of financial information about all these fees separately, each separate fee disclosed, would put folks in an information-overload situation."

But what if, like right now, we're facing a volatile market situation and our investments are heading south? How much of this can we attribute to a declining Dow and how much to burdensome fees? At this point we have no way of knowing whether we're getting fleeced by fees or by turbulent market forces.

Reish argues in favor of more fee disclosure rather than less. "I can't imagine that openness and honesty would ever result in a problem -- unless people are overcharging for their services. While that would be a problem for them, it would be good for plan fiduciaries and participants to have that information and, informed in that fashion, to reduce the fees and costs of the plan."