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What Should 401(k)s Cost? What Do They Cost?

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By now, you’re probably aware of all the hubbub surrounding Yale law professor Ian Ayres’ letter to more than 6,000 retirement plan sponsors, suggesting that they may be violating their fiduciary duty by overcharging their participants (See Melanie Waddell of ThinkAdvisor’s news article, “Yale Professor’s Fiduciary Threat Has Retirement Execs Fuming”).

My first thought upon reading Melanie’s story (and a sampling of the myriad others which fill many Google search pages) was to wonder whether the good professor can get away with it. That’s particularly an issue considering that Professor Ayres’ research report, which backs up his claims, won’t even be released until next spring. The retirement plan industry is calling the move “harassment,” and it sounds kind of libelous to me. But he is a law professor, so let’s assume he knows the law in situations like this. 

My second thought is: What a brilliant PR move! And it couldn’t have come at a better time. Currently, Phyllis Borzi and the DOL are meeting their stiffest resistance yet to expanding advisors’ fiduciary responsibilities to participants in retirement plans: Two new SEC commissioners, two new bills that could slow down or derail the DOL, and troubling new cost benefit data to consider (see Melanie Waddell’s August Investment Advisor column, “Fiduciary Stumbling Blocks Surface”).  

Just when things at the DOL seem to have reached a turning point, along comes Professor Ayres—and suddenly the conversation in the media has shifted to “Why are 401(k) plans overcharging their participants?” It’s the kind of publicity that politicians can’t ignore, and may even contain a head’s up for many RIAs. 

A quick look down the Google list shows most major media outlets are covering the story, including: CBS, ABC, CNN, NPR, USA Today, Forbes, Money, The Wall Street Journal, The New York Times, Kiplinger, and MarketWatch, to name a few. More importantly, the Ayres story has drawn renewed attention to a number of “watchdog groups” that have been trying to blow the whistle on 401(k) fees for years, without much traction.

From mountains of collected data, there seems to be two stories that the “sound bite” media have focused on. The first is that most all 401(k)s offer a menu of mutual funds with expense ratios of 127% (the reported 401(k) average), while index ETFs historically deliver about the same performance for 5 to 10 bps. Not surprisingly, the nuances of the decades-long debate over managed vs. indexed portfolios have escaped the media’s attention. 

Of more substance is the data that seems to have originated with a research group called Demos, which tallied up the various costs associated with 401(k)s (including administrative fees, 12(b)1 fees, mutual fund management and expense fees, transaction costs, wrap fees, consulting services and revenue sharing). According to the group, the combined costs over decades can reduce portfolio returns by up to a third, or some “$278,000 over the working lifetime of ‘higher-income’ earners.”

(A few years back, an article by Mary Beth Franklin in Kiplinger’s ran the numbers, concluding, “…if the fees were 1.5% annually, the average net return would be reduced from 7.0% to 5.5%. Over 30 years, the additional charges whittle the account balance by nearly 25%.) 

For many years, I’ve felt that 401(k) fees were outrageous but I never bothered to do the calculations. I never dreamed that they’d reduce returns up to 25% or 33% of a portfolio. Even if these figures are off by 50%, they’re still ridiculous. In fact, if these projections are anywhere close to right, it raises the question of whether the tax deferment was worth it in the first place, doesn’t it?  

In turn, that raises the question of whether fiduciary RIAs today can, in good conscience, recommend that their clients put money into their retirement accounts.  (How many advisors actually get the cost figures from clients’ plans and run the calculation?) 

So far, in addition to calling Ayres’ mailing “harassment,” the pension industry has had two responses, both of which may be more revealing than the professor’s data. The first is that Ayres’ not-yet-released data is based on 2009 filings, and are therefore “outdated.” Perhaps. But Ayres’ letter merely suggested that plans “might” be overcharging their clients. If retirement plans have stopped overcharging—or never were overcharging—you’d think they’d welcome the opportunity to demonstrate this to their clients. 

The second response is that “higher fees are warranted by higher levels of service and/or performance.” Again, maybe so. But also again, it seems as if this would be easily demonstrated to plan participants. After all, that’s how the free market works: I get to decide whether I want to drive a Hyundai or a Ferrari, not the Ferrari dealer. 

There’s no denying that 401(k) costs are higher—often much higher—than comparable taxable investment accounts. Maybe sometimes they are worth it. How do we know? The best way is to let plan participants see what all of the costs are, what benefits they get, and vote with their retirement dollars. 

It looks to me as if Ayres may have given Phyllis Borzi and the DOL a fighting chance to make that happen.