It's not that people don't want to save for retirement, it's because they can't afford to.
By Cyril Tuohy
A new academic study reviewing the performance of 401(k) plans argues that millions of workers have been ripped off by excessive fees charged by plan sponsors and advisors to defined contribution plans.
The study, authored by Ian Ayres of Yale Law School and the Yale School of Management, and Quinn Curtis at the University of Virginia Law School, says that “fees are the central regulatory issue in improving retirement outcomes.”
The two researchers recommend that the requirements for default fund allocations be “reasonably low cost,” that the Department of Labor (DOL) designate some plans as “high cost” and that participants in high-cost plans be allowed to roll over assets into low-cost plans.
The conclusions are laid out in the study titled “Beyond Diversification: The Pervasive Problem of Excessive Fees and ‘Dominated Funds’ in 401(k) Plans.” The paper was issued earlier this year by the John M. Olin Center for Studies in Law, Economics and Public Policy.
Ayres and Curtis also recommend that retirement plan participants demonstrate a “minimum degree of sophistication” by passing a test approved by the DOL before investing in funds that don’t satisfy the default requirement.
High-cost plans outweigh any advantages of diversification, they argue. Advisors tout their importance in educating investors about retirement – for which advisors argue they should earn a fee. But the two researchers found that the higher the cost of the plans, the more likely costs will discourage investor participation.
High-cost plans “are not inducing more employees to participate more or to contribute more,” the two authors write.
The study used data from more than 3,000 401(k) plans with more than $120 billion in assets. In 16 percent of the analyzed plans, “the fees charged in excess of an index fund entirely consume the tax benefit of investing in a 401(k) plan,” the authors found.
“One important finding is that more than half of the impact of fees comes from choices investors make,” the study found. The more choices plans offer employees, the more likely workers are to make poor choices.
Fees charged in connection with administering 401(k)s have come under fire over the past two years as the defined contribution system has turned into the de facto vehicle through which American workers and managers fund their retirements.
These plans, launched in the late 1980s, contain trillions of dollars in retirement assets. Bills pending in Congress seek to expand the private defined contribution system to help employees prepare for a retirement without the professional management services of a defined benefit plan.
A regulatory focus on providing choice and investment selections at the expense of highlighting fees has done a disservice to investors, the authors also said.
Ayres and Curtis also say that revenue sharing “creates perverse incentives for plan advisors” to suggest high-cost funds. Warped incentives promote a “pernicious cross-subsidization of plan-level expenses from less sophisticated to more sophisticated investor/employees,” the researchers write.
Critics of the 401(k) defined contribution system say it was never intended for the investing masses, as the 401(k) clause in the tax code was originally designed as a savings vehicle for highly compensated executives who had maxed out their other employer-sponsored retirement programs.
It is a scheme that allowed companies to move retirement liabilities off their books and onto the shoulders of workers, many of whom have no business making bets on their own long-term futures in the first place, the critics say.
Advisor fees for retirement plans are buried in the fine print and few workers bother to dig into what they are paying. It’s almost impossible to tell at a glance if, say, a “New Opportunities” growth fund offered by Fidelity is cheaper than a similar “New Horizons” growth fund offered by T. Rowe Price.
Many plan participants, meanwhile, say they like the employer-based 401(k) system because it is simple, convenient and portable.
Workers can roll over their 401(k) assets from one job to the next. The convenience of the payroll deduction – for those who take advantage of it – makes it a truly effective “invest and forget” ways to fund future needs, 401(k) supporters say.
For workers who invest in 401(k)s, balances always go up since the principal grows with every payroll deposit. Only a thorough rate of return analysis – which workers never really have time to do – would reveal whether workers are also successful investors, and how much they pay in fees for one fund compared to another.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at email@example.com.
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