With 401(k)s and Other Defined Contribution Plans, Watch Your Wallet

When financial matters are opaque, there must be a large discount to prices representing clarity to interest people to buy.  Unfortunately, with 401(k)s and other defined contribution plans, it is sometimes akin to being limited to the “company store.”  I’ve written about these issues before, both here and at RealMoney.  Here’s a good example of one of them:

David Merkel
Pension Consultants: Watch Your 401(k) Expense Levels
9/27/2006 5:36 AM EDT

I want to point you to an article of John Wasik’s of Bloomberg. Having worked in the pension business while an actuary at a mutual life insurer, I had the experience of reviewing the pension services proposals of a number of competitors, and of complementary service providers. Most players were honest, but there were a number of players, while technically not breaking the law, would stretch ethics by finding ways to disguise fees by wending them into the change in unit value of the funds inside a deferred compensation plan. Why embed them in the unit value change? Slice up a fee over hundreds or thousands of participants, and over 365 days a year, and it is remarkable how little people notice it, because most people don’t bother to go and look at plan expenses as disclosed in the Form 5500. Even if everything were disclosed in detail there (some charges don’t get unbundled), an individual doesn’t see that the pro-rata expenses are coming out of his hide. Unless the plan sponsor goes the extra mile to try to minimize costs to participants, there is little that an individual can do.

We had a rule at our firm. We only take fees from one source, and we disclose them. We had a second rule: we only pay commissions once, and they can be disclosed to the ultimate client, or nondisclosed, but not both, but if nondisclosed, the ultimate client must know that.

Oe reason why we did not hire certain investment consultants was the potential for conflict of interest. We eventually hired a consultant to aid us in manager selection that took no fees from the managers, so we could get unbiased advice. There were other consultants that were less than scrupulous in that matter. Without naming names, we terminated our first investment manager consultant because we learned they would not recommend managers to us, unless they were receiving a fee from the manager. That fee would get built into the expenses would into the unit value, or, come out of my firms profit margins, which were for the good of the participating policyholders.

Now that was just my experience, so take that for what it’s worth, perhaps I’m just an investment actuary with a axe to grind. If you want a more general view of the problem, you can review this 2005 study of conflicts of interest done by the SEC. Now, as John Wasik notes, “The commission didn’t take any enforcement action after the report was issued, nor did it name any of the firms surveyed.” The problem is still there, and I’m afraid your only advocate is for you to appeal to your plan sponsor to watch out for the best interests of all participants, which is the duty of trustees under ERISA.

Position: none, but at the mutual life insurer, we had a saying, “We’re out to save the world for 25 basis points on assets, plus shipping and handling.” Beats a lot of other deals out there…

Now, here is another piece from Bloomberg: Fees on 401(k)s Rock Boomers Facing Flawed Disclosure.

The difficulty here is that fees on small plans are sometimes high, and defined contribution plans don’t allow for easy examination of the total fee structures.  How much are the investment managers taking?  The recordkeeper? The custodian/trustee?  The marketer?  It is not always clear.  What can be worse is the manager selection, which are usually random on average (before fees) in terms of any outperformance versus indexes.

Now, in fairness, anytime you have a large number of small accounts, the costs will be high as a percentage of assets.  But there are limits.  Disclosure needs to be improved, but until then, ask your plan sponsor for all of the Form 5500 documents.  There are two classes of expenses.  Explicit: what the fund pays for directly.  Implicit: what gets deducted from investment returns.  Add the two together, because that is the total load.  Insist on as full of an accounting as the plan sponsor will give you.

If you are paying more than 1% of assets per year, then something is wrong, unless the asset classes are esoteric, which should not be the case for DC plans.  Remember, you have to be your own guardian with defined contribution plans.  No one will do it for you.  And, if a few of your colleagues complain at the same time, you will be amazed at how quickly it will be taken seriously, because the administrative staff of the plan sponsor usually doesn’t get that much feedback.