Major Help on the Way for 401(k)

The black box of 401(k) fees is about to break open

If you have a 401(k) – or if you are eligible for one through your employer – mark April 1, 2012 on your calendar. That's when the latest updates to the federal law governing employee benefit plans take effect.

Among the updates: requirements that 401(k) vendors clearly and fully disclose all fees. The April Fools' Day cutoff is nothing if not appropriate; when finally presented with a line-by-line look at all the fees they've been paying, company benefits officers will feel the joke has been on them. (The deadline to disclose fees to individual employees is June 30, 2012, a delay that presumably gives benefits officers time to digest the bad news and perhaps begin to shop for a new 401(k) service provider.)

This fee-related frustration won't be wasted, however. In fact, it should help foster more transparency in the financial services industry, and ultimately lead to better-funded retirements.

To understand why, consider that by design, fees have for years been one of the notorious black boxes in financial services, including the segment of the industry that deals with retirement plans. Recently I tried to count up the various fees that can be tacked onto 401(k)s. I stopped counting at 17, a number that included several surcharges that were all but impossible to find in the documentation provided by the various firms plying their retirement wares.

More troubling is that the overall fee amount can range from 0.75 percent to as much as five percent, a somewhat shocking amount, given that the S&P 500 experienced overall negative growth in the first decade of this century. (Adjusted for inflation, $1 invested in January 2001 was worth just $0.90 at the end of 2010.)

These new transparency requirements are part of the Employee Retirement Income Security Act, or ERISA, which has been in existence since 1974. It was originally passed in response to the epidemic of poorly funded pension plans and has since been amended more or less annually. It now includes extensive rules about employee benefit plans, including 401(k)s.

If you are a 401(k) sponsor, you don't have to wait for next spring to roll around. You can likely improve your plan now by asking two simple questions. (And if the firms and advisors servicing your plan balk at answering, remind them that they'll be required to do so when the ERISA's new provisions take effect.)

The questions:

1) What is my plan costing my company?

This is fundamental and almost always goes beyond what you see on your statement. I anticipate that this single requirement will have companies scrambling to reduce cost or even exiting the 401(k) market altogether.

2) Will you represent my company as a fiduciary on this plan?

This is subtle request, and it's one of the new updates that has financial lobbyists out in force. Recall that a fiduciary duty requires the highest standard of care and means, subordinating one's own interest to that of his or her customer. The reason this provision is hated is that the financial services industry has a long history of explaining away predatory practices with a wave of the hand and a reminder that a certain degree of sophistication is assumed of all customers. In other words, whenever you hear some variant of "we're all big boys here," start looking for ways you are being ripped off.

Failure to comply with ERISA's updates will mean financial penalties for 401(k) vendors and any others reaping fees for servicing benefit plans. (The hallmark of retirement services today is a shell game between 401(k) vendors, advisors and record keepers – one that's so opaque that it's impossible for benefits officers to know who is paying whom. Such penalties include up to 100 percent of the amount involved in any given transaction and an ongoing excise tax.

These may sound too steep, but consider the costs invariably borne by most individuals with 401(k) plans today. The vast majority of these plans are underfunded, a situation that's no doubt caused by many factors but is exacerbated by excess fees. In the worst cases, these fees can eat away as much as 50 percent of monthly retirement income. Indeed, this worst-case effect is so large that I expect the new disclosure and fiduciary requirements to do more than just stoke anger on the part of benefits officers. I'll discuss some of the likely reshuffling in the market for 401(k) services in a subsequent column, but in the meantime, start demanding answers from your 401(k) vendors and advisors today.

Folgmann, AIF, is principal of Ark Advisors LLC,a fee-only firm in Traverse City. mark@arkadvisor.com.

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