The latest report from the U.S. Government Accountability Office (GAO) says 41% of 401(k) participants don’t believe they’re paying fees. This shouldn’t surprise anyone familiar with the retirement plan environment.
“Employees are busy managing their day-to-day lives and don’t regularly review their 401(k) to be aware of 401(k) costs,” says Stuart Robertson, CEO of ShareBuilder 401k in Seattle. “Many people don’t feel educated enough on investing.”
It’s not just ignorance or apathy, part of it can be blamed on the fact that, unlike taxes, retirement plan fees are not “in your face” and the assumption is often that someone else is paying all those plan service providers. Mohamed A. Desoky, Academic Dean at SKEMA US Inc. in Raleigh, North Carolina, says the belief that employees don’t think they’re paying for their retirement plan is because “either fees are not reflected on pay stubs or perhaps because a 401(k) is perceived as an employee-based plan where the employer pays the fees on total capital invested.”
But disclosure alone isn’t the answer. The GAO also reports that, even when provided information on plan fees, “45 percent of participants are not able to use the information given in disclosures to determine the cost of their investment fee.”
“One of the biggest challenges that 401(k) plan participants have faced for years is non-transparent pricing,” says Eric Phillips, Director of Financial Partnerships at Human Interest in San Francisco. “401(k) plan providers do share out information with participants and are required to do so at least every 14 months, but the documents are often lengthy, hard to parse and not overly clear.”
It’s more likely, however, that employees really like the “forget it” part of “set it and forget it.”
“There are a few reasons that people do not know that they are paying fees in their employer plan,” says Sean Burke, Vice President and Director of Institutional Money Management at Stuart Estate Planning Wealth Advisors in Coconut Creek, Florida. “First and most prevalent is that most people set up their 401(k) when they start their position and never check or look at it. If they do, they may look at the balance but they are not checking the transaction history for account maintenance or record keeping fees that are being deducted. Second, if someone is not financially curious or an active investor, they likely do not know that mutual funds have internal fees. This is not something that is advertised to people who have 401(k)’s nor would they typically know what an expense ratio is.”
The GAO addresses “investment fees” and, in particular, fund expense ratios (the fund’s operating costs including fees paid to the fund’s investment adviser). This is a delicate form of disclosure mandated by the Securities and Exchange Commission (SEC) that is included in every mutual fund’s prospectus, including those used by both retirement savers and retail investors.
“Many plan participants don’t believe they are paying fees because the fee is built into the cost of their funds and therefore not transparent to them,” says Thomas J. Scalici, Chief Executive Officer at Cornerstone Advisors Asset Management in Bethlehem, Pennsylvania. “The letters and numbers after the name of a fund are all codes for compensation. While they are disclosed on most websites or in a prospectus, most participants do not take the time to read them and therefore think it is free. Nothing is free.”
Additionally, because these fees are associated with the mutual fund and not with the plan, there is often confusion as to who is paying what.
“Many plan participants incorrectly assume that their employer covers all retirement plan expenses,” says Andrew Wang, Managing Partner, Runnymede Capital Management, Mendham, New Jersey. “Also, the method that mutual fund and exchange traded fund (ETF) companies use to deduct fees, by making adjustments to the net asset value (NAV) of the fund, does not make investment management fees visible to plan participants. That is, the fund expenses do not show up anywhere on the participant’s statement.”
In fact, these fees don’t show up anywhere that the employee can readily see. If you don’t see it, you don’t feel it. And if you don’t feel it, does it really exist? That’s the way many employees view retirement plan fees. With mutual fund expense ratios, that view can be extended to all mutual fund shareholders, not just retirement savers.
Hannah Whatley, Financial Advisor at Rather & Kittrell Capital Management in Knoxville, Tennessee, says, “Many 401(k) plan participants don’t believe they’re paying fees because they are not feeling the pain of paying the fee from their bank account. In the case of expense ratios, they don’t even see the fee come out of their 401(k) account because that cost is baked into the fund. In the case of managed accounts, the fee is taken from your 401(k) account balance but it is not always transparent as to how much and how often the fee will be taken out.”
Unfortunately, all this emphasis on mutual fund expense ratios can be misleading. There is one thing more noticeable by mutual fund investors, and that’s mutual fund performance, which automatically includes the impact of the fund expense ratio.
While the mutual fund expense ratio should be considered an operating cost (per the SEC), there are actually out-of-pocket fees incurred by the company’s retirement plan that have nothing to do with investments.
“Many participants do not realize the many layers of fees,” says Nicholas Tzoumas, President of ClearscopeHR in Old Brookville, New York. “Participants tend to concentrate on the fund-level expenses. However, those fees are only a part of the overall cost to participants. They also pay fees to the plan’s financial advisor and record-keeper. Both parties historically received compensation from the actual funds and those fees were generally embedded and difficult to find. Under the current laws, all fees must be listed on the plan’s 408(b)2 along with the service provided in exchange for those fees.”
Ironically, the greatest problem with 401(k) fees may be embedded within the GAO’s report. Its five proposed solutions assume fees are an undeniable issue and that people actually care about this issue.
When the Department of Labor promulgated its 401(k) Mutual Fund Fee Disclosure Rule, it purposely did not require plan providers to always use the lowest fee. Why? Simply because the DOL recognized “sometimes you get what you pay for.” Instead, the DOL only required the fees to be comparable to the value provided.
Unfortunately, “value” is not easily measured. But even if you could measure value objectively, would it matter?
“A lot of 401(k) participants don’t even log in to their accounts in the first place,” says Mark Fonville, CEO and President. Financial Advisor of Covenant Wealth Advisors in Richmond, Virginia. “This is why plan providers often ‘auto-enroll’ employees into the plan. Left to their own devices, people procrastinate. As a result, they don’t see the fees that may be disclosed via the website login of the plan provider. Additionally, fees are often embedded in the stacks of paperwork which participants don’t read. Essentially, if the fees are being debited directly from their checking account, they simply won’t notice them.”
Finally, should an employee have an issue with fees, what can be done? And if there’s very little plan participants can do about plan fees, why might it be OK for participants to ignore fees and what might be better for them to concentrate on instead?