Defined contribution plans — American workers’ golden road to retirement — are on the defensive. A mountain of class-action lawsuits is piling up against a who’s who of blue-chip companies and prestigious universities, accusing them of failing to look out for participants in their 401(k) and 403(b) plans.
The air is already thick with obligatory denials and earnest concerns for employees’ futures. But there’s no getting around the fact that employer-sponsored retirement plans are horribly broken.
If you have any doubt that retirement plans are ineffective, just take a look at the numbers. The Employee Benefit Research Institute and the Investment Company Institute jointly compile data on over 81,000 401(k) plans, representing nearly 25 million workers and $2 trillion in assets.
According to the latest EBRI-ICI data, 80 percent of participants — 80 percent! — in 401(k) plans had accounts smaller than $100,000 in 2014. Granted, a good chunk of those are millennials who are just getting started, but the numbers are no more encouraging even after accounting for age. Roughly 47 percent of workers with account balances smaller than $10,000 are in their 40s or older. And that same age group accounts for 70 percent of workers with account balances between $40,000 and $50,000.
Here’s the most disheartening part: Workers in their 60s who have been with their employer for 30 or more years have managed to rack up just $274,000 in their retirement accounts on average. By my calculation, the average worker will need at least three times that amount to retire.
So why are retirement plans — such an indispensable tool for insuring that workers have a comfortable experience in their twilight years — failing?
The lawsuits name two culprits, neither of which will surprise anyone with a work-sponsored retirement plan. The first problem is that many plans offer a bafflingly large number of investment options, often numbering in the dozens. How many workers have the requisite knowledge to sift through so many investment options to cobble together an investment portfolio?
The second problem — surprise, surprise — is high fees. Many retirement plans are chock-full of expensive, actively managed funds — the same high-priced funds that are constantly losing to more affordable index funds.
Also, the mutual fund choices in retirement plans don’t always offer the best pricing. Anyone who’s ever bought a mutual fund is likely familiar with the maddening alphabet soup of mutual fund share classes, each offering a different fee structure. There are A shares and B shares and C shares, and sometimes K and R and T shares.
But the cheapest share class is almost always the “I” shares — or institutional share class — because institutional investors have the size and stature to command the most favorable pricing. According to Morningstar data, the “C” share classes of open-end U.S. mutual funds carry a net expense ratio of 1.94 percent on average, whereas the comparable net expense ratio for the “I” shares drops to 0.89 percent.
Many retirement plans — particularly the massive plans named in the lawsuits — have the heft to demand institutional pricing. That alone would improve their employees’ retirement fortunes considerably, yet many plans don’t appear to be asking for discounted fees.
What’s most surprising about all this is that no one seems to know why retirement plans are plagued with these problems.
Recent lawsuits that Edward Jones and Morgan Stanley employees filed against those companies allege — you guessed it — excessive fees in their retirement plans. (Edward Jones has denied the allegations in the complaint against it, while Morgan Stanley has declined to comment.) In Morgan Stanley’s case, those fees were allegedly charged for Morgan Stanley’s own funds. If financial services firms can’t get retirement plans right for their own employees, that doesn’t bode well for everyone else.
This isn’t complicated. Employers can construct a simple and effective retirement plan with just two funds: A total U.S. stock market index fund and a U.S. aggregate bond index fund. There are many such funds available, and each would cost less than 0.1 percent annually.
Admittedly, this simple retirement plan isn’t likely to win portfolio engineering awards, but it would address most — if not all — of the complaints in the current barrage of class-action lawsuits. My guess is that it also would make retirement plans much more effective.
These lawsuits are likely to drag on for years. But however they shake out, employers should recognize that retirement plans are failing their workers and that meaningful changes are just a few simple steps away.
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