Opinion and Investing Column

SKARBECK: Hidden 401(k) fees can kill retirement savings

December 17, 2011

Ken Skarbeck InvestingNew regulations issued by the U.S. Department of Labor will require detailed disclosure of all fees charged in 401(k) plans by the end of May 2012. Remarkably, a recent AARP survey found that seven out of 10 participants (employees) incorrectly believe they do not pay any fees for their 401(k) plan.

The regulations are being implemented in response to suspicions of hidden fees and conflicts of interest within the 401(k) industry and several successful lawsuits proving that participants were charged excessive fees.

In one particular embarrassing case, Ameriprise Financial is being sued by its employees for using the company’s own underperforming mutual funds in their 401(k) plan. The suit charges that Ameriprise and its committees as plan administrators skirted their fiduciary duty in using Ameriprise mutual funds in the plan that cost employees “significantly higher than the median fees for comparable funds.” Employees claim they lost $20 million to high fees and poor performance.

In another case, Walmart and Merrill Lynch recently paid $13.5 million to settle a class-action lawsuit alleging they breached their fiduciary duty to nearly 2 million Walmart employees.

Filed in 2008, the suit claimed that Walmart’s 401(k) plan offered only 10 investment options that were mostly mutual funds charging “retail” fees—costs much higher than a large company should pay. The most explosive allegation in the lawsuit accused plan administrator Merrill Lynch of receiving undisclosed “kickback payments” from outside mutual fund companies simply for allowing them to be in the plan.

Other lawsuits have exposed that mutual funds were chosen by 401(k) vendors because they generated indirect compensation such as gifts, sales trips and so-called soft-dollar arrangements where a portion of client transaction fees are rebated to an investment firm to pay for things like computers and software.

A multitude of other charges—poorly disclosed in the past—include rebalancing fees, annuity fees, marketing fees, wrap fees, online access fees, and fees for daily pricing and transactions.

The new DOL regulations will require disclosure of all direct and indirect compensation that venders, investment firms and record-keepers charge to a company’s 401(k)—and ultimately are paid by the employee participants.

The costs can be substantial. For firms with less than 100 employees, some 401(k) plans have been charged total fees as high as 3 percent, triple what one might ordinarily pay to invest in a mutual fund.

A beginning investment of $25,000 reaches $370,000 over 35 years at 8 percent annual growth, but it amounts to only $138,000 at 5 percent. As one retirement plan director put it, “Hidden fees are a little like high blood pressure. You don’t really feel it, and you don’t necessarily see it, but it’ll eventually kill you.”

Historically, vendors got by with providing basic mutual fund expense ratios to 401(k) clients. Some charged one bundled fee that did not provide a detailed breakdown of costs to employee participants.

Keith Shadrick of locally based Axia Advisory, an investment adviser to 401(k) plans, is skeptical that venders will rise to the occasion and voluntarily disclose all hidden costs. Instead, he says, the new regulations impose a major fiduciary responsibility on plan sponsors to make sure a breakdown of all fee arrangements—direct and indirect—within their 401(k) plans are fully disclosed to employees.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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