Open up the 401(k) black box!

By John F. Wasik, contributor


FORTUNE -- How much do you pay for your 401(k)? You probably can't answer that, because providers of the employer-sponsored retirement plans aren't required to tell you in clear language what they're charging. And now it appears that lawmakers in the Senate don't want you to know, either. At least not yet.

A proposal within the House's version of the jobs bill that aimed to make 401(k) plan costs transparent was dropped from the Senate version last week by finance committee chairman Max Baucus (D-Montana).

A Baucus aide said the most effective way to protect consumers was to let the Labor Department finish its work on similar rules before passing legislation. The disclosure requirement, written by Rep. George Miller (D-Calif.), was opposed by the mutual fund and securities industries. The Investment Company Institute, the trade association for mutual funds, called Miller's proposal "redundant and counterproductive."

While it's not known how the Labor Department rules will disclose expenses -- they are expected to be issued this month -- both measures have the potential of putting billions more into retirement funds.

That's a potential boon for the more than 50 million 401(k) investors, who have about $3 trillion invested. Plan fees could be pared by $700 million annually, according to Institutional Investor, if employers see their plan expenses are too high and move to lower-cost institutionally priced funds.

Transparency is generally a good strategy for employers, many of whom may not know exactly how much their 401(k) participants are being charged for recordkeeping, investment management and trading expenses. Even though mutual funds within 401(k)s display annual expense ratios, trading and administration costs within those portfolios may cut at least 0.4% annually from retirement fund returns and are not fully disclosed.

Small fees add up

Many plan providers and investment managers had a good reason to block the tougher Congressional legislation, which would have more teeth than DOL rules. A Los Angeles Times investigation found that not only were employers and employees unaware of how much 401(k)s cost, some of the expenses were so high that they reduced investment returns by as much as 20%.

In recent years, 30 large companies have been sued over alleged high 401(k) expenses. Companies such as Caterpillar (CAT, Fortune 500), Citigroup (C, Fortune 500), Exelon (EXC, Fortune 500), Hartford and Kraft (KFT, Fortune 500) were accused of shirking their fiduciary duties under the employment benefit law ERISA (most were filed in 2006) by running overpriced plans. While some of the claims have been dismissed, the companies have denied these allegations, and litigation continues.

Retirement plan expenses eat away at 401(k) balances. If a 401(k) stock fund charges 1% in annual expenses and returns 5% each year, an employee with a $100,000 balance would have about $970,000 in his kitty after 35 years.

Knock those expenses down by half -- to 0.5% -- and the total rises to almost $1.2 million, according to the SEC's mutual fund cost calculator.

Of course, merely disclosing a dollar amount of fees means little without some means of comparison. Are plans costly or cheap? Under the House bill, employers would have been required to provide a "plan fee comparison chart" along with descriptions of each fund within the plan. Although it's not clear what those fees would be compared to -- all mutual funds, similar funds within an asset class -- it's a step in the right direction. Having quarterly statements of net returns minus fees will be revealing for all employees, particularly executives with high balances.

Retirement plan expenses vary widely and depend on the size of the plan. Programs with more than $500 million in assets generally pay the least amount of fees due to economies of scale, according to a survey conducted last year by Deloitte Consulting and the Investment Company Institute.

"All-in" fees ranged from 0.14% annually for the largest plans to 2.2% for the smallest. The median expense ratio was 0.78% for funds with assets between $10 million and $100 million and 0.41% for those greater than $500 million. Benchmarks such as these would be useful in any fee comparison chart.

Winners and losers

The need to vet plan fees and lower program costs would likely boost the business of major benefit consultants such as Hewitt Associates (HEW) and Marsh & MacLennan's (MMC, Fortune 500) Mercer Consulting. Third-party advisors will develop new ways of benchmarking plans and shopping for lower-cost funds. A new online service called Brightscope already does this.

A few companies have already begun to feature full expense disclosure. Putnam Investments recently began to break out full costs for employers and will do the same for employees next month.

A greater shift towards cheaper, more efficient funds will benefit lower-cost fund operations such as the Vanguard Group, TIAA-CREF and Blackrock's (BLK, Fortune 500) iShares ETF group. Widespread transparency will also create a more competitive climate and force some of the largest plan vendors such as Fidelity Investments, T. Rowe Price (TROW) and Schwab (SCHW, Fortune 500) to become even more competitive.

If transparency clearly illuminates all middlemen and trading costs, the biggest losers would be the major full-service brokerage houses such as Bank of America's Merrill Lynch (BAC, Fortune 500) and UBS (UBS). Actively managed funds -- particularly "proprietary" vehicles -- tend to be among the most expensive to run since they run higher trading and management costs relative to passively managed mutual funds and ETFs.

While Baucus would not comment directly on why he dropped the 401(k) provision, it should be noted that the securities and investment industry is the single-largest contributor to his campaign fund, having given more than $1 million over the past five years, according to the Center for Responsive Politics, a campaign finance watchdog.

John F. Wasik is author of The Audacity of Help: Obama's Economic Plan and the Remaking of America.  To top of page