401k Fees And Expenses – Hidden Costs

Savvy investors are always beefing about the high expenses they’re forced to pay when they invest in mutual funds. But few of them grasp the soaking they’re taking on their 401(k) plans–an almost invisible drain on their assets that is getting worse every year.

There’s much to be gained by keeping fees a secret. Those who are responsible for negotiating 401(k) fees on your behalf are very concerned with corporate cost cutting. And they have found a way to use OPM–other people’s money–to spruce up the company balance sheet by shifting their costs to you. Over the last 15 years of frenzied corporate cost cutting, employers first shifted the cost of saving for retirement to their employees. Then they shifted the administrative costs onto them as well. The mutual fund companies that charge the fees are busily empire building in the 401(k) business, adding fancy technology and services to bring in more business. If they can use OPM to do it, so much the better for them. Mutual fund companies have pulled in $300 billion in 401(k) assets, becoming the leading providers of these plans, and they have laid the costs for building this business onto existing shareholders and 401(k) participants.

Dirty Little Secrect

The result of this cozy little partnership? Mutual fund fees in 401(k) plans are roughly double what they should be, according to Adele Langie Heller, director of defined contributions consulting with RogersCasey in Darien, Connecticut. Part of the reason is that mutual fund expenses in general are roughly double what they should be.

“There is real pillaging going on,” says William McNabb, head of the institutional business at the Vanguard Group in Valley Forge, Pennsylvania.

For the most part, though, 401(k) participants don’t understand what’s happening to them. “I think it’s a secret waiting to be discovered,” Heller says. “When plan participants find out about it, they’re going to get really angry.”

401k

There are three basic cost components to a 401(k) plan, according to Timothy G. Murphy, a consultant at Hewitt Associates, benefits consultants in Lincolnshire, Illinois, who has written articles on this issue:

Investment management costs, or the cost of managing the money in the plan, which is expressed as a percent of assets.

Trustee costs, which Murphy separates into custody charges and general processing fees. Services in this category–such as the cost of cutting a check for a loan–can be charged per activity.

Administration costs, including record keeping and employee communication and education, as well as many of the fancy frills like voice-response systems.

Are high fees inevitable? Of course not. The Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF), the giant pension fund for education personnel, reduced its expenses. Many employers in the private sector are negotiating good deals, too.

It’s clear to mutual fund investors what they pay in fees–it’s too much, and they can find out how much by reading the prospectus. But 401(k) participants often cannot get the whole story because expenses can be shaved off these plans in so many ways.

“As an industry, we haven’t done a very good job of explaining expenses to people,” says Mary Rudie Barneby, president of Delaware Investment & Retirement Services, a subsidiary of the Delaware Management Company, a group of mutual funds that services and sells 401(k) plans. “We have to get together and decide what we’re going to disclose and how we’re going to do it.”

Too many vendors just say, Trust us. We’re honest. Consultant David Huntley argues that those who make the investment decisions for the plan have more money at stake than most participants and more incentive to keep costs down. That reasoning is flawed, though. These same people have even more at stake in keeping costs down at the company. There are too many opportunities to cut the company’s cost by using OPM.