Participants in 401(k) plans deserve to know exactly how much of their money is paying for their funds and services.
Participants in 401(k) plans deserve to know exactly how much of their money is paying for their funds and services. It's best for them and the retirement industry. Most participants think 401(k)s are free. That's probably be-cause employees are accustomed to seeing price tags on what they buy — and 401(k)s don't have price tags. A recent survey by AARP of Washington found that 65% of 401(k) participants believed they paid no fees for their investments. Another 18% didn't know if they did. None of this comes as a surprise to industry leaders.
Why hasn't the business gotten ahead of this issue?
Most likely, some form of government-mandated fee disclosure for participants is coming soon. Employees will find out that 401(k)s have never been free. And they surely won't be pleased. "If you didn't shoot straight with us about fees until the government made you, what else are you not telling us?" Lack of employee trust is bad for 401(k)s — and the retirement industry.
Isn't much of the reason 401(k) fees have been hidden (or at least not highlighted) simply historical — because that's the way it's always been done? In the middle of the last century, retail-mutual-fund companies were calculating fees as "expense ratios" and "basis points." Even then, when there were fewer mutual fund buyers, and those who did buy them were presumably more sophisticated, it's unclear if they realized that those terms were jargon for "fees."
When retail funds were brought into 401(k)s in the 1980s, retail jargon came with them. The funds got the Department of Labor generally to go along with using the fund prospectus to disclose "fees." The funds were not trying to do anything bad. They wanted to keep their costs down by using the same approach they used in the retail market.
Today, in the reinvented retirement world, the industry still uses the same pricing scheme — although it was never intended to be highlighted or explained clearly. And it was not created with the idea of using it in employer-sponsored plans, or explaining fees in a manner that typical employees would understand.
If the structure is too hard to explain, why not change it?
Many in the retirement industry protest to legislators that it is expensive to calculate exact fees for individuals under the current pricing method and that such calculation takes more out of participants' pockets. They say that it is also difficult to explain the complicated expenses. No doubt, all of that is true. And it's probably why some in the industry would prefer to show participants cost estimates rather than exact charges.
But in the era following the scandal at Houston-based Enron Corp. — with elections on the way — is now a good time to tell the government (politicians) that the industry does not want to let employees (voters) know exactly how much they pay for their 401(k) accounts?
No one in the industry wants to hear a politician who's looking for votes say, "I'll force those multimillion-dollar-a-year fund managers who are taking money out of your 401(k) — even when your account goes down — to tell you exactly how much of your money they're taking. And I'll submit a bill that's even stricter than the other guy's. My bill will put a cap on how much they can take from your account, and I'll make them offer you funds at the same price federal employees pay."
That is hopefully an exaggeration, but why take the risk?
In any event, showing fee estimates won't make the issue go away. Ask plan sponsors if they think giving engineers, architects and other analytical employees general fee estimates will satisfy them. Most likely, people who are accustomed to dealing with precision will demand accuracy.
Most plan sponsors want their employees to become "retirement consumers." One way to do that is to show them exactly how much everything in a 401(k) costs and explain the value they receive for what they're paying for. Maybe then they will take more interest in their 401(k)s.
And if 401(k) fees are as competitive as the funds claim — and they probably are — then shouldn't employees be shown the fees and some benchmarks to prove what a great bargain they're getting?
Some government officials want employees to see a breakout of various 401(k) costs. But the focus should be on the customer, not on the process. Just because the cost of a related 401(k) service or product can be broken out isn't a reason to show it to participants. The price tag of a gallon of milk could show the cost of transporting it to the store. But would that help consumers make better decisions?
Isn't there another good way to price the services?
Rather than defend a half-century-old pricing approach that was invented to serve sophisticated investors who had defined benefit plans, maybe it's time for a new one. Haven't most other types of service providers reinvented their fee structure every few years?
The fund industry is full of smart people. They can develop a new pricing approach for 401(k)s that's easy for participants to understand.
What if a fund could figure out how to run its business by charging the same price for all the funds offered? That would be easy to explain. And it might help support the "level compensation" option under the Pension Protection Act's advice provisions. If that won't work, how about borrowing the cable TV fee approach? Let's say a flat amount is charged for "basic services," and an extra charge is added for any "premium funds" the employee selects. Or how about using ideas from hundreds of other models? Is the current approach the only one that will work?
The retirement industry needs a pricing system for employer-sponsored plans that is as simple and transparent as those of other service industries. Any approach that appears to be an attempt to hide fees will not strengthen the industry. And Americans need a strong retirement industry. The alternatives aren't good.
Dennis Ackley, president of Ackley Associates in Lee's Summit, Mo., is an employee communications consultant specializing in retirement programs and worker benefits.
