Most people believe their 401(k) is free. It isn’t. In fact it’s probably costing you tens of thousands in lost retirement money over the course of your career. So says Ron Lieber in his recent New York Times article: Revealing Hidden Costs of Your 401(k).
One of the biggest underlying costs involves the mutual funds in these plans.
Costs of mutual funds
There are various administrative fees with a workplace plan and they are embedded in the expenses of many of the mutual funds you pick. The practice, known as revenue sharing, means that fund companies refund some of the expenses to the service provider running your plan to pay for your costs. The downside of this set-up is that it’s the big savers and people investing in actively managed mutual funds who get punished since people with higher balances and higher expense ratios on their investments end up subsiding their fellow workers.
Lieber explains it this way: Say 20 basis points of a retirement plan participant’s fund expenses go toward administrative costs each year, someone with a $100,000 balance contributes $200, 10 times as much as the $20 paid by someone with an identical allocation, but only a $10,000 balance.
Fair & Equitable – or Not?
Some may shrug their shoulders at this. After all it’s the way mutual funds outside of a 401(k) work too. Many see the set-up as fair and equitable and a way to encourage younger people and lower paid workers to participate without being scared off by a flat annual fee.
Still others have a problem with this Robin Hood approach and point to the cross-subsidy issue as another example of the current inequities in retirement plans.
“Let’s say an employer sets up a retirement plan that has some expensive actively managed funds that engage in revenue sharing and some cheaper Vanguard index funds …The people in the active funds will be paying the administrative costs for the retirement plans of those who are only in the Vanguard funds,” says Lieber.
Labor Dept to Step In
All this should change in 2012 when the Labor Department, which oversees 401(k) plans, makes investment companies itemize all the various expenses employees are paying and separate the underlying mutual fund costs as distinct from the administrative ones. Workers will also receive account statements that make mutual fund fees clearer and show that revenue sharing is going on.
Lieber concludes that the Labor Department is hopeful that these new disclosure rules will lead to some good old-fashioned consciousness-raising, particularly among smaller employers that often have no idea that any of this is going on behind the scenes.
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