Money and you: Employers expected to be responsible for 401(k)s

Posted: Nov 06, 2006 12:01 AM

Last week, I asked readers if they knew how much their 401(k) plan is costing them. Since then, I've heard from many irate readers who suspect that they're being ripped off.

So far, however, only one guy who has contacted me thinks he's pinpointed how much he's paying.

During the past 16 months, this reader figures he's paid close to $7,000 in 401(k) fees. When he complained to his company about what he considered to be a bloated tab, here's the response he got: "Suck it up. There is nothing you can do about it."

In one respect, this candidate for employer of the year is right. In the 401(k) arena, workers are about as powerful as a bunch of kindergartners storming Chuck E. Cheese. Employees don't get to select the mutual funds that end up in their 401(k) menu and they don't have a say in what their workplace retirement plans cost them. While the employer holds all the aces, it's the voiceless workers who have the most at stake.

And that's why it's infuriating when stuff like this happens all too frequently: A boss chooses his old college roommate, who is a stockbroker, to put together a 401(k) plan for his firm or replace an existing one. The lucky broker is careful to only choose mutual funds that will, in turn, reward him financially. Some of these guys can make tens of thousands of dollars - and in some cases, hundreds of thousands of dollars - a year for pretty much being in the right places at the right times.

And it's the workers who are picking up the tab. Every time they sink money into their 401(k) mutual funds, the worker's investment returns are eroded by higher fees that are assessed, in part, to cover the broker's reward plan.

So what does the broker have to do to justify his windfall? In some cases, not much. Even if the broker does little more than annually entertain the firm's owner with dinner and a round of golf, he'll continue to be paid handsomely year after year.

Employers, however, can't immunize themselves from completely botching their 401(k) responsibilities. Employers, big and small, are supposed to be following the Employee Retirement Income Security Act of 1974, better known as ERISA, that mandates that they act as fiduciaries for their workers' retirement money.

One of ERISA's requirements is that every employer with a 401(k) plan must establish a prudent management process to oversee retirement plan providers.

And that means they have to know what the heck is going on in plain sight and under the table.

As part of this oversight duty, an employer needs to know what the retirement plan is costing and where the money is going. In my lucky broker example, it's highly doubtful that the boss understands how much his 401(k) point man is pocketing from the fund fees versus what his expenses are. And this same lack of knowledge can be true for much larger companies that depend on major 401(k) players such as Fidelity Investments, Vanguard Group, T. Rowe Price, Merrill Lynch, Principal Financial Group and Hartford to run their plans.

What a workplace should be doing is monitoring how much cash is being generated for 401(k) expenses and where it is going. Companies should also compare how the costs and the services stack up to other 401(k) vendors. When companies aren't vigilant, it's more likely that workers will be gouged.

"A missing prudent management process will almost always lead to excessive costs," observes Ronald E. Hagan, chief executive officer at Roland/Criss Fiduciary Services in Dallas, which advises workplaces on their fiduciary responsibilities.

What is an unreasonable cost? It depends upon how big a workplace plan is.

If a company has less than $1 million in assets, the costs are going to be much higher than for employees who work at a place that has at least $10 million in the 401(k) kitty. Little plans are often stuck with insurance company providers, which typically assess among the stiffest fees. With insurance plans, the mutual funds or variable annuities will typically be expensive and they will often be slapped with dubious wrap fees. Most 401(k) annuities will also stick investors with onerous mortality insurance fees, which are unnecessary.

Companies should be looking for alternatives as soon as the plan acquires $1 million in assets, suggests Hal R. Schweiger, a fee-only adviser at Capital Financial Advisors in San Diego, which puts together 401(k) plans. Actually, companies of any size should be seeking bids from 401(k) vendors every three years or so in an attempt to lower costs and obtain better services.

If you're feeling helpless right about now, here is something you can do: Ask your company if it has documented your plan's fees and costs. Chances are it won't know, and that's partly because of a phenomenon I wrote about called revenue sharing: Outside 401(k) administrators and commission-based financial advisers often pick mutual funds for a workplace menu that includes 12b-1 fees that originally were supposed to be used by funds for marketing. In the 401(k) universe, the funds use this cash to pay the 401(k) administrator or plan adviser for picking it. Of course, you don't have to be a cynic to ask if the funds being selected are the best of show or simply the ones with the deepest pockets.

Typically, the administrator uses at least some of this money to cover such costs as the bookkeeping responsibility. But as the assets in a 401(k) plan grow over the years, few employers ever ask if this revenue sharing has gone beyond paying the basic expenses and mushroomed into a huge cash cow for the administrator. This can happen, since expenses such as bookkeeping and maintaining a toll-free number are pretty much fixed costs, or vary by number of employees not by the dollars in the account. The revenue-sharing money, however, can continue mushrooming, thanks to stock market gains and workers' weekly contributions.

While it's standard practice, workplace retirement plans don't need to rely upon revenue sharing to pay costs. Companies can use low-cost mutual funds for their employees that don't generate revenue-sharing cash. When going that route, employers can pick up the tab for administrative costs or pass them along to their employees. The big 401(k) players can set up these types of plans, as can fee-only investment advisory firms that routinely make sure all expenses are transparent.

For employers who blow off ERISA, here's something that might get their attention: Dozens of lawsuits have been filed against employers for failing to live up to their 401(k) responsibilities. CEOs might assume that it's the outside 401(k) administrators who risk getting clobbered in court, but they are wrong. The targets of these employee lawsuits, which should continue to multiply, are the workplaces and their executive officers.


Next week: One more week on 401(k)s.