In October 2010, the Labor Department ruled that starting in 2012 all employer-sponsored 401(k) plans will have to disclose all fees on investments and transactions.
Investors usually can find expense ratios on the funds they hold, but it's much more difficult to find plan administrative costs such as legal fees, accounting, and record-keeping. You usually can request this information from your plan administrator, but they'll now be required to provide it up front.
The rule, established by the Labor Department's Employee Benefits Security Administration (EBSA), mandates that participants must receive quarterly statements that show the dollar amount of the plan-related fees along with descriptions of what they cover. They also must provide clear performance data, benchmark information, and fee and expense information.
The rule will affect an estimated 72 million participants with more than $3 trillion in assets.
Christine Benz, director of personal finance at Morningstar, says employers will be required to provide information not just on individual investment choices but also on administrative costs in the program. It'll be a major milestone because employees now will be able to take a close look at some of the costs that previously may have been buried in fine print or not easily available to employees. Benz says that although some plans have had transparency, administrative fees were almost all but hidden.
"A real missing link to gauge the plans has been what participants are paying in administrative fees," Benz says. "It's a big step forward. It was typically available in the summary plan description but was never handed out to participants when they signed up for a plan."
Small fees can pack a wallop over time
Because many 401(k) participants may not be savvy investors, they may not be too conscious of the impact of expenses. Internal transaction costs, some of which can be larger than the expense ratios in the funds themselves, can have a huge impact on cumulative returns.
Expenses and fees often depend on the size of the company and its 401(k) holdings.Eric Carter, the resident financial planner at Financial Finesse, El Segundo, Calif., a provider of workplace financial education, provides this example: If one were to take $100,000 over a 30-year period with a rate of return at 7%, it would grow to $761,000. If a mere 1% in expenses were deducted from that account annually, it would be worth only $574,000 in year 30. That difference would equate to $187,000 in fees during the time span and minimize the total return by a whopping 24.5%.
"That is a huge chunk of change, and that's just on a 1% difference," Carter says. "Imagine if it was more. Many people just don't realize the impact."
Russell Kinnel, Morningstar's director of mutual fund research, says that money management is often a person's third-largest expense after a home and vehicle. Many investors fail to pay attention to just how large of an impact fees can have.
And the impact of fees, because they're collected in such small amounts—cent by cent, dollar by dollar every day—makes them hard to see. If a fund is performing well, it's even easier for 401(k) investors to focus on return and not notice the amount in fees that's going out the back door.
"Because it is built into the net asset value, you are not seeing it going away," Kinnel says. "People tend to underestimate how much they are paying. If they sent people a bill for $25,000 at the end of the year, they would scream."
Asset-based fees are usually taken directly out of your account, and you'll likely never even see them on the statement. They include management fees and the expense ratio. Some companies also have investment advice charges they pay to external firms that advise them on their investment selections.
Plan administration fees typically cover the administration of the workplace retirement plan itself. These fees can vary dramatically by company, and smaller firms typically have higher fees because of the smaller asset size in their plan. Whether a company passes those fees on to its employees is up to the employer.
These fees typically include monitoring the employee match, employee deferrals, profit-sharing contribution, and handling the legally required reporting to the Labor Department. In some plans, these administration fees are assessed to cover the costs of educational seminars and Web access to the plans.
"Those fees go to cover the administration and customer service," Kinnel says. "Some [401(k) plan members] can be high-maintenance because they might have more questions about investing."
Expenses and fees often are dependent on the size of the company and its 401(k) holdings.
According to Ryan Alfred, co-founder and president of the 401(k) rating company BrightScope, San Diego, a plan with $1 million in assets could charge anywhere from 75 basis points to 300 basis points. Meanwhile, costs for a plan with $1 billion in assets could run from 25 basis points to 100 basis points.
Making better-informed choices
As the rule brings more transparency to 401(k) fees, some investors may be inclined to move their money out of high-cost plans. Benz says there's a risk that some employees might not save any money at all. Others will look at other options, such as diverting those funds to their own IRAs.
For those whose employers offer a match, Benz recommends contributing just enough to take full advantage.
"It's very hard to argue against that match," she says. "In most cases it would be worthwhile contributing to make the full match even in a high-cost plan."
Kinnel says better disclosure ultimately will lead to better investing decisions on the part of both employers and employees. Employers will have the information to make better decisions, and the transparency will make it more difficult for them to drop high-cost plans on their workers without them noticing.
That transparency also may make employees take a closer look at 401(k) fees when they're deciding where to work, since it can play a large role in total compensation.
"A 401(k) can be a huge piece of your retirement," Kinnel says, "and if one company is charging you 100 basis points more than another, you're going to think hard about that." Kinnel says smaller companies are going to have fewer mutual funds to choose from and likely higher fees.
With little bargaining power, many smaller companies often have to go with banks based on relationships and may be tempted to move a 401(k) program to a particular institution if it provides them with lower interest rates on their own loans.
Participants must receive quarterly statements that show the dollar amount of 401(k) plan-related fees, along with descriptions of what they cover.
Employees at such companies are usually stuck with few options and, in many cases, with those fees that are passed down to them.
"Some [companies] may already have a relationship with the bank, which may give them a good deal on loans if they move their 401(k)s there and buy their funds," Kinnel says. "Smaller employers will be impacted because this will now be transparent."
Benz believes that more transparency of these fees can help bring expenses down over time.
As more employees see exactly what they're paying, they'll be more inclined to push their employers to better low-cost plans. On the other hand, employees at some companies may find they have more insight into the low fees they're charged and as a result may be inclined to invest more in their 401(k)s.
Investors should always carefully select the mutual funds in their plan, looking at factors such as turnover and management tenure. But costs are one area where their knowledge can make a difference.
"We do have control over how much we pay," Benz says, "and expenses are more predictive in determining performance than past returns."
* * *
This article was originally published by BetterInvesting. Since 1951, BetterInvesting has helped more than five million people become better, more informed investors. BetterInvesting helps its members build wealth through educational webinars, Web-based mutual fund and stock tools, in-person learning events, publications, an active online community, and software. For more information, visit the website or call 877-275-6242.
Neither CUNA nor the author of this article is a registered investment adviser. Readers should seek independent professional advice before making investment decisions.
Published March 6, 2012