A Congressional Pledge to Preserve 401(k)s, Despite Their Flaws

Bogle also echoed Miller’s sentiment that high fees are indeed a big problem in 401(k) plans. He suggested all fund options available in 401(k) plans be tied to a market index. “The average equity fund carries an annual expense ratio of about 1.3% per year, or about 0.80% when weighted by fund assets. But that is only part of the cost,” Bogle said. “Mutual funds also incur substantial transaction costs, reflecting the rapid turnover of their investment portfolios. Last year, the average actively managed fund had a turnover rate of an astonishing 96%. Even if weighted by asset size, the turnover rate is still a shocking–if slightly less shocking–65%.” Admittedly, he continued, “the costs of this portfolio turnover cannot be measured with precision. But it is reasonable to assume that trading activity by funds adds costs of 0.5% to 1.0% to the expense ratio. So the all-in costs of fund investing (excluding sales loads, which are generally waived for large retirement accounts) can run from, say 1.5% to 2.3% per year.” By contrast, he said, “low-cost market index funds have expense ratios as low as 0.10%, with transaction costs that are close to zero.”

Alicia Munnell, director of the Center for Retirement Research at Boston College, told the committee in her testimony that “Even before the financial crisis, we have been concerned about the ability of 401(k) plans to provide secure retirement income.” Evidence indicates, she said, “that people make mistakes at every step along the way. They don’t join the plan, they don’t contribute enough; they don’t diversify their holdings; they over-invest in company stock; they take out money when they switch jobs; and they don’t annuitize at retirement.” She said that an annuity should be a default option in a 401(k) plan so that participants could choose to opt out. “People hate annuities,” she said.

Dean Baker, co-director of the Center for Economic and Policy Research, told the committee that the collapse of the housing bubble, coupled with the plunge in the stock market, “has exposed the gross inadequacy of our system of retirement income.” He suggested allowing Americans to contribute to a government-run pension system that would provide a modest guaranteed rate of return. “The system would be a universal system like Social Security, however, it would be voluntary,” he said. “To try to maintain high rates of enrollment, there can be a default contribution from all workers of 3%, up to a modest level, such as $1,000 a year. Workers could be allowed to contribute some additional amount, for example an additional $1,000 per year, that would also earn them the same guaranteed rate of return.”