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Friday, December 7, 2007

Retiring 401(k) Plan Fees

In all business transactions,
pay for performance.
Pity the Wall Street Banker! Earlier this month, I heard that their bonuses were expected to fall $200,000 on average, from $2 million. After all, by many accounts, this year’s equity market hasn’t performed as expected. But then I read about the latest record-setting Wall Street bonus payout.

Ask five economists about the source of this Wall Street bounty, and, all things being equal, they might give the same answer, all things being considered, each with 25 different qualifications, all things being possible.

One conclusion many economists might propose, all things being bright and beautiful, is that Wall Street bonuses are not necessarily tied to performance. (Duh?) In fact, some economists might find a correlation between the size of an average banker’s portfolio and the average payout. So without begrudging those hard working folks at Wall Street the trillions of pennies they scrape from the millions of average investors like me, here’s a rub: no matter how the financial market performs, Wall Street bankers seem assured of receiving record bonuses every year. Whereas recipients of Wall Street’s annual windfall have to worry about ways to double that income next year, the average mortgage-paying, life-loving, family-supporting, global-rationing guy like me is thinking – or should be thinking – about ways to accumulate enough in retirement assets to simply live comfortably during those looming forgetful years. A pretend-economist like me, therefore, might not be faulted for assuming that a major chunk of the average household’s wealth is tied to retirement savings like a 401(k).

In a November 5, 2007, article published on, (Time for Employers to Cut Cord to 401(k) Plans), John F. Wasik cites a troubling calculation from the US Government Accountability Office, stating “that paying an additional 1 percent in 401(k) fees will reduce your retirement fund total by 17 percent after 20 years and 30 percent over 30 years.” In other words, those pennies scraped by Wall Street bankers will make a substantial impact not only on those record-setting Wall Street bonuses but also, in reverse, on the average retirement savings account. Those fees cited by Wasik, however, are not limited to 401(k) plans; but, in the interest of limiting the number of words in my first entry on this blog to .1% of an average Wall Street bonus, I will focus on 401(k) plans.

If a household’s goal is to accumulate $1 million in retirement savings over the course of two married careers, something that is not only possible but also recommended for the average middle income household with two working parents, then 1% percent in 401(k) fees, according to US GAO quoted by Wasik, will shave off $170,000 over 20 years! $300,000 over 30 years! What’s more troubling, according to US GAO, 83% of 401(k) plan participants don’t even know how much in fees and expenses they are paying for their 401(k) plan, and many investment advisors are not helping the situation. In fact, short of full disclosure, some investment advisors have a conflict of interest vis-à-vis their investment recommendations.

Looking to the regulatory agencies hasn’t paid dividends either. While the US Securities and Exchange Commission has instituted rules for using “plain English” in writing disclosure documents in financial statements, facilitating the ordinary investors’ understanding of a company’s financial health, understanding the costs of a 401k or any other retirement plan, it seems, require the help of a consultant like Jeb Graham. Graham correctly distinguishes between hard dollar and soft dollar costs, and it is through the so-called soft dollar costs that an average contributor to an employee retirement account can lose up to 30% of 401(k) value over 30 years. It is not hard to accumulate 1% in hidden fees – fees that are not disclosed in prospectuses – and even though the issue has been identified, raising the ire of an increasingly untrusting public, the problem is compounded, in my experience, by plan providers who have lied to their customers about those fees.

In deference to Graham, pin-pointing soft dollar costs does not require a consultation. Stephen J. Lansing describes 401k costs in plain English. Though Lansing underestimates the basis points charged by plan providers, even Lansing’s calculation of soft dollar fees amount to more than 1%: finder fees starting at .25%, 12b-1 fees starting at .25%, and sub-transfer agent fees up to .65%.

But rather than cutting the “cord to 401(k) plans”, as Wasik suggests, employers should seek a plan that adopts Wasik’s recommendations, which are also summarized interrogatively by the 401k help center dot com:

· Give plan participants control
· Eliminate conflicts of interest
· Provide access to all investments
· Pay only hard dollar costs to plan providers (no finder, no commission, and no asset-based fees)
· And shop for the best value

And, most importantly in all business transactions: pay for performance.


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