What You Don’t Know About Your 401(k) Plan
A 401(k) plan is not a free investment account. Many participants assume 401(k)s are as simple as putting money in savings and watching the account grow. In reality, they're paying for administration and investment fees, meaning millions of workers in employer-sponsored 401(k)s are putting their savings in jeopardy over time.
According to a report by the U.S Government Accountability Office (GAO), nearly 40% of 401(k) plan participants do not understand the fees associated with accounts, leading to less money at the time of retirement. Lacking awareness of 401(k) fees will have long-term cumulative effects on the value of retirement savings, so plan providers and employers need to make sure 401(k) plans are managed effectively.
Insight Into GAO's Findings
41% of participants are misinformed that there are no fees to be paid in the plan.
The GAO’s findings question the transparency and accountability of plan providers. In 2012, the U.S. Department of Labor (DOL) unveiled new regulations on fee disclosure and transparency for 401(k) plans under the Employee Retirement Income Security Act (ERISA).
Along with participants not understanding the fees associated with accounts, the GAO survey also reported that 45% of participants could not use the information provided in disclosures to calculate the cost of their investment fee, and 41% of participants are misinformed that there are no fees to be paid in the plan.
Employers are legally responsible for ensuring the plan is beneficial to employees, but participants need to understand the fees in their plan to confirm that it is favorable.
Understanding Plan Fees
A 401(k) plan typically charges individual service fees, administrative fees, and, of course, investment fees. The Department of Labor provides a look into 401(k) plan fees to help participants make better decisions.
Along with the plan administration, investment and advisory fees, there are additional fees such as management fees, sales charges, surrender and transfer charges, and insurance-related charges.
One of the major fees is the 12b-1 fee which is charged by mutual funds and typically described as marketing fees paid to advisors for considering the fund. In reality, 12b-1 fees are commissions paid to brokers
These fees can be charged directly from the plan by the service provider or charged by the investment accounts in the plan. The fees appear excessive, leading to many not understanding them and their implications. Participants may not be privy to reasonable fees, which should be below 1% for medium to larger-sized plans.
The Harm of Fees Overtime
Many Americans unknowingly pay high fees hidden in the fund performance. These fees are usually described as a deliberate overcharge at the fund level used to pay other vendors of the plan in the form of eroded returns.
In a study conducted by the Center for American Progress (CAP), it was found 401(k) participants pay an average of 2.22% all-in fee on their assets, although the fees can range between 0.2% and 5%. These percentages seem insignificant to most people, but with time, they can substantially reduce asset value.
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GAO Recommendations
GAO provided various recommendations to the DOL to improve understanding of 401(k) fees.
First, ensure consistent terms for investment fees, such as gross expense ratio. The expense ratio makes up part of 401(k) investment fees and tends to vary depending on the plan and how it's managed, so having consistent terms will allow participants to tell how much a plan will cost and if it has reasonable fees.
Next, require disclosures that show the actual costs of investment fees be more transparent and easier to understand. This prevents dealing with hidden fees such as revenue sharing fees, leading to high expense ratios. Additionally, it is recommended to educate participants about the long-term impact of fees on savings through DOL offered resources.
Finally, participant fee disclosures should include fee benchmarks to help participants better understand their impact on investments. Fee benchmarks and ticker information guide the participant to compare and determine which investments offer the best returns on competitive terms without too much risk.
Other Actionable Steps
It's not conclusive whether the DOL will implement GAO's recommendations to improve the outcome on participants' awareness of fee information. However, other actionable steps can be taken, including plan sponsors or advisors taking the initiative to allocate full fee disclosure to fulfill their fiduciary responsibility to participants.
In addition, an employer can do more research into the services offered by the plan providers, including the fees charged. Since the providers are obligated to provide full disclosure, it is possible to have a good understanding of how much the plan pays in fees and how it impacts employees' savings.
Furthermore, the employer can cooperate with the plan financial advisor to educate employees on their options and types of fees and expenses associated with the plan. The organization can arrange for meetings or sessions to expound more on fees and costs associated with the 401(k) plan provided. It's also ideal to consult a tax professional or financial advisor who can look into the fine print of 401(k) fees and help plan participants maximize their retirement savings.
Moving Forward
As the DOL pushes for transparency in the interest of plan participants, almost half of respondents in the GOA’s report have exposed the underlying knowledge gap on fee information. However, the statistics also provoke action by concerned parties including plan providers, employers, and employees to take charge of retirement account fees. The 401(k) plan can be a viable vehicle to grow retirement savings if plan providers and employers ensure participants are fully aware of the fees and expenses, as well as understand how to use them to gain maximum return on their investments.
Brian Menickella is a co-founder and managing partner at The Beacon Group of Companies, a broad-based financial services firm based in King of Prussia, PA.
Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This information is not intended as authoritative guidance or tax or legal advice.
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2yBrian, thanks for sharing!