Honesty may be the best policy, but sometimes, the truth hurts.
New rules for 401(k)s that go into effect July 1 will require more complete disclosure about retirement account fees. that means that when investors open their statements this fall, they’ll be able to see in detail how those previously hidden fees are chipping away at their retirement savings.
As part of the Department of Labor’s new rules, 401(k) plan administrators will have to give employers details of all of the fees they charge, and employers will be required share those details with employees; including how much they’re paying in fees for every $1,000 invested.
That will help. But to really shine a light into the murky 401(k) waters, consider the following advice:
1. Avoid Ignorance and Passivity
It is a truth universally acknowledged that most us of are hands-off and in the dark when it comes to our 401(k) plans.
According to one AARP survey, 71% of people believed they didn’t pay fees on their 401(k). In reality, they were getting docked for administrative services, “record keeping” and other hidden costs.
It’s a major problem with the current system: the misguided expectation that people will take the time to do their due diligence.
“The [current] disclosure is only helpful for the most sophisticated individual,” said Robyn Credico, senior consultant at Towers Watson. “Participants only spend about two hours a year on their 401(k) plan.”
“Congress gives way too much credit to the employee to do all kinds of detailed analysis,” said Ken Himmler, president of Los Angeles-based Integrated Asset Management. “Those are not the kind of people who go home and want to be research analysts at night.”
And even among those with a desire to become investing wonks over their plans, the information providers offer is fundamentally unclear.
“This is one of the only industries where you’re not really clearly aware of how much you’re paying,” said Chad Parks, CEO and founder of The Online 401(k). “Imagine you go to buy a car and they say, ‘here’s the sticker price but we’re going to take 1% of your account each month just because.'”
2. Decode the Disclosure and Understand the Consequences
Fee disclosures prior to the new rules were full of technical jargon, with fine-print galore and incalculable totals.
“I’m pretty good at math,” Himmler said, “and I read through two companies, and I had to set up a spreadsheet. I can’t imagine the average employee even with a degree in finance can understand, and they’re not going to take the hours to figure it out.”
“A problem with these disclosures is there’s so much detail and so much volume that so many people aren’t reading them and paying attention,” said Credico, “On top of the volume of information, it’s not easy to understand to begin with.”
The Department of Labor has now placed responsibility on the employer to offer employees the right choices on their 401(k)s, and this makes disclosure all the more important.
“Transparency is a good thing, ” said Charlie Jeszeck, an economist at the Government Accountability Office. “And we can’t afford to keep participants coddled or ignorant about fees, because it can have a negative impact on their retirement. Financial literacy is a big deal, and we need to educate them in how to invest and what can eat away at their futures.”
3. Beware of Insider Deals
But there’s a bigger obstacle standing between you and a healthy 401(k) balance than confusion: Too many companies have let their 401(k) vendor pick their funds for them, and then failed to monitor the plans well. It’s a combination that can lead to corruption on the back-end.
“Sometimes those investment companies say to the record keeper, ‘I’ll give you a little bit of the investment to offset your record keeping fees,” Credico said.
Fidelity, for example, takes a cut from your investment earnings in revenue sharing and pays off the record keeper. Your company doesn’t benefit in the role of sponsor, but if it hasn’t been performing the proper due-diligence, officials won’t notice you’re being bilked.
It’s one thing to ding your account for a fee, said Himmler. “But what’s worse is while they may use funds internally and say it’s Fidelity, they’re actually licensing the name and management for a sub-account.”
This means if you are an investor, you won’t be able to go to a public source to get the true information that the fund returned, say, 10%. The fund doesn’t have to make the same disclosures that would be required if it were truly a Fidelity fund, so the investment managers can take their fee, the insurance company gets a cut, and the investor is simply told the fund returned 7%.
“It’s mugging,” Himmler said, “And it’s in our contract.”
He also likens it to counterfeiting.
“It’s like you went into Macy’s, stole the Louis Vuitton label and stuck it on a Walmart bag,” Himmler said.
4. You Better Shop Around
“The most valuable part of the fee disclosure is the participants have to take a close look at the funds and the expenses,” Credico said, “so that they can answer participant questions like ‘Are my fees reasonable?’ ”
The disclosures will cause sponsors to look at the funds and see if the rates are measuring up to certain benchmarks.
“People will finally know what they’re paying, and they can assess that they’re getting a good value for the fees they’re paying,” Parks said. “But you only know if you have something to compare it to. There are so many out there who are paying more than they need to because of these hidden asset fees that are in the contract but not talked about.”
But it’s not just about choosing the fund with the lowest fee. Sometimes firms can charge higher fees but outperform index funds.
“[People shouldn’t] pick the least expensive fund, just because it’s the most inexpensive,” Credico said. “It might not be the best for their portfolios.”
Another mistake to be wary of is choosing index funds that have performed well recently. You can’t count on that continuing to be the case, so use caution when selecting options based on past market performance.
5. Act to Spark Change
Beyond the new reforms, transparency advocates are fighting for more active involvement from 401(k) participants.
For starters, participants would do well to have an active involvement in encouraging their plan sponsors to choose which plan providers charge–either in a flat fee or a percentage of the assets. No matter how small or large the investment, the same effort is required for record keeping, but if you are charged on a percentage of your assets, those people with higher balances will pay more. But 401(k) participants usually don’t have a say in choosing and don’t know enough to ask their employers to advocate for a set-up best suited to the participants.
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This lack of choice is symptomatic of a larger problem with 401(k)s, one that the fee disclosures highlight: Himmler thinks people are almost imprisoned in the lack of decision-making and in their inability to tailor their accounts.
“Employees are in what I call investment jail,” Himmler said. “It’s not like you have three choices of 401(k)s. You don’t. You just order what’s off the menu. It’s off-the-shelf 401(k)s with no customization.”
Participants should be more active in choosing self-directed investment options — and they should consider doing it outside their 401(k) plans, Himmler said. The new fee disclosures will encourage this by helping them see the ramifications of choosing specific investment options.
That increased activeness and independence regarding 401(k) plans would encourage people to fight for even greater options within the plans, such as annuities — which have been off the table because of the mutual fund industry’s control of the 401(k) sphere. But with greater transparency and more options, it should be easier to achieve the ultimate goal of a secure retirement.