Scott Burns: How much is your 401(k) plan costing you?

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“Fee disclosure has had an effect. The amount of requests for proposals has increased. Plan sponsors are getting bids to compare offers and plan fees.”

That’s what Joe Valletta, co-publisher of The 401(k) Averages Book, told me in a recent phone interview.

If all this seems obscure to you, let me assure you that it isn’t. This is the Year of Full Disclosure for 401(k) plans, the first time — ever — that plan providers must disclose all their fees, charges and revenue-sharing arrangements to comply with new Department of Labor standards. The new statements are just going out, now, to plan participants.

Some plan sponsors will be shocked. Their employees may be even more disturbed when they learn that 2 percent, or more, can be coming out of their plan assets every year. While 401(k) plans with lower costs have received a lot of media attention in recent years, they were mostly plans offered by large employers: Think ExxonMobil and Texas Instruments. In 2009, for instance, Business Week lauded IBM for “reinventing” the 401(k) plan.

What did reinvention mean? Cutting fees to about 10 basis points — 1/10 of 1 percent — largely by shifting from managed mutual funds to low-cost index funds. As I have pointed out in many columns, cutting plan costs can be as important as having a hefty employer match.

Cutting plan costs can also mean having a much larger retirement nest egg. Here’s an example:

Suppose twins Joe and John choose identical careers with salaries of $50,000 at age 30. Suppose both save 10 percent of their income and both receive raises of 3 percent a year. Suppose both also target retiring at age 65 and have plans that have identical returns of 7 percent, before fees. The only difference is that one plan has expenses of 1.5 percent while the other has expenses of 0.5 percent. How big a difference will costs make?

The twin in the high-cost plan will accumulate 6.59 years of final income, while the twin with the lower-cost plan will accumulate 8.85 years of income, a difference of 34 percent. Reduce the cost to 0.1 percent, and the amount accumulated will rise to 9.6 years of final income.

It helps, of course, to have the muscle of a very large plan. When Business Week applauded IBM, its plan had some $27 billion in assets. That’s a whale of a plan. While expenses have declined marginally for all plans over the last five years, the bigger the plan, the greater the likely cost reduction. Here, for instance, is how costs for smaller plans have changed from the 2007 to the 2012 edition of The 401(k) Averages Book:

  • Between 2007 and 2012, the average total expense of plans with 2,000 participants and $100 million in assets fell 15 basis points, from 1.09 percent to 0.94 percent.
  • Over the same period, the average total expense of plans with 200 participants and $10 million in assets fell 8 basis points, from 1.28 percent to 1.2 percent.
  • Plans with only 25 participants and $1.25 million in assets saw an expense reduction of only 3 basis points, from 1.59 percent to 1.56 percent.

When I asked Valletta if he had seen any change in the cost of smaller 401(k) plans since the new disclosure law went into effect, he said, “We’re not seeing it at the lower end. There has been an increase in the offerings of large-cap index funds in the lineup but not across the board. ... There’s just not the pricing flexibility in the smaller plans.”

One category of small plans he thought would benefit from fee disclosure was that of many small medical groups. These plans, he pointed out, typically have a few doctors with most of the assets and other employees with much smaller amounts.

“With fee disclosures,” he said, “doctors will have better choices because they will be shown what they are paying.”

Who, I asked him, would be shining a light on plan costs?

“A lot more people [consultants] are specializing in 401(k) plans. And these people know how to use index funds and reduce costs,” Valletta said. “And if it doesn’t happen at the plan level, individuals can look at the plan fund menu and make choices for lower-cost funds, such as the target date funds.”

 

SCOTT BURNS is a principal of the Plano-based investment firm AssetBuilder Inc. His website is www.scottburns.com.

— Universal Press Syndicate


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