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All About 401(k)

By on July 28, 2015
Categories: EXECUTIVE COMPENSATION, FINANCIAL PLANNING, RETIREMENT

A Victory for 401(k) Investors 

Workers who invest in 401(k) plans won a big victory in May in the U.S. Supreme Court.

In a lawsuit that took eight years to wind its way to the Supreme Court, 401(k) sponsors were essentially told that they need to be more diligent about the fees that mutual funds are charging their employees’ 401(k) accounts. This is a promising development for employees because too many workplace retirement savings plans are stuffed with expensive investment choices.

In the litigation, former and current workers at Edison International, an energy company, alleged that their employer had selected some funds in the 401(k) lineup that were unnecessarily costly. The company’s 401(k) lineup offered 40 funds, but six of the choices were the more expensive retail funds when a cheaper institutional class of the same fund was available.

In a unanimous decision, the Supreme Court ruled that offering these costlier funds when cheaper versions were available violated the company’s fiduciary duty to its employees.

Why Fees Matter

Even modest increases in fund fees can significantly erode a worker’s retirement nest egg. Over a four-decade career, according to a study by the Center for American Progress, higher fees of just 1% would reduce the average worker’s 401(k) account by roughly $70,000.

Most workers wrongly assume that their 401(k) accounts are free. It’s the employee, not the employer, however, who typically picks up most, if not all, of the 401(k) costs through the fund fees they pay.

Workers aren’t usually aware of the fees that they are paying because no one presents them with a bill. Just like mutual funds outside of 401(k) plans, the fees are automatically taken out of investors’ accounts.

Why Fees Are High

Someone once observed that in the history of mankind, no customer has ever paid to wash a rental car. It’s a handy analogy to remember when this fact sinks in: While millions of workers are paying 401(k) fees, it’s their employers who select the plans.

Ted Benna, who is credited with creating the first 401(k) plan, once told me why keeping 401(k) expenses have not been a priority. These fees, he observed, “don’t get the attention they deserve because in so many plans, the company doesn’t have to write a check for services. If they did, companies would be more aggressive about managing costs.”

In response to the Supreme Court decision, experts in the 401(k) niche say that 401(k) sponsors will need to scrutinize costs and especially the share classes of funds in a lineup and do so on a regular basis.

How companies select 401(k) investment choices is critical to millions of Americans who are increasingly relying on these voluntary plans as so many traditional pension plans have disappeared. According to industry figures, 53 million Americans have $4.5 trillion invested in their 401(k) accounts.

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