Clearing Up Misconceptions About The New 401(k) Laws
In August, the 401(k) laws will change and, much like the CARD Act that forced the credit card industry to become more customer friendly, the new 401(k) laws will provide transparency for plan participants. Although the law makes your 401(k) plan more transparent, it won't fix all of the problems you have with your retirement plan.
How It Works
Imagine going to your local grocery store and not finding prices on the shelves, and when checking out, the clerk gives you a total without itemizing your purchases. How about if you purchased a home and prior to the closing, you were given the total closing costs, but nothing that detailed each of the fees?
You might be shocked to know that your 401(k) operates similarly. You can view the expenses you're paying for each of the funds you choose, but do you know how much you're paying for the operation of the fund itself? In reality, not only are you paying people to manage the mutual funds, but you're also paying people to administer the actual plan.
This will soon change. The new laws require 401(k) administrators to disclose the fees paid to the administrators of the fund. Once these laws take effect, you will know exactly what you're paying in fees and expenses, but it may change very little about your current plan.
The Person in Charge May Be Ill-Equipped
In his book, "Fixing the 401(k)," author Joshua Itzoe found that very few of the company administrators had the comprehensive knowledge required to construct a fee-efficient plan for their employees. Much like purchasing an automobile, lack of knowledge and experience may lead to overpaying for services which drives up the fees charged to participants.
Disclosing fees will likely make the investment and insurance companies that provide 401(k) services more competitive in their fees, but that won't change the scalability factor. Larger companies with more participants have more negotiating power when designing their plan than smaller businesses. Larger companies pay less 401(k) administrative fees, making their plans more efficient than smaller companies with less employees.
It Doesn't Fix the Second Biggest Problem
Mint.com says paying just 1% extra in fees is enough to reduce your retirement plan balance by 17% after 20 years. This is the largest problem faced by participants, but other problems exist as well. The next largest issue may be the lack of suitable investment options in the plan. According to Itzoe, too many plan administrators take the advice of advisors who have a financial interest in recommending high fee, low performing investment options.
It's Going to Be Confusing
Remember those pamphlets you received when you opened your 401(k)? They're each called a prospectus and if you're like most, you didn't read them because you didn't understand the language. The statement of fees that you receive because of this new law might not be much better.
You'll Pay It Anyway
Even with more transparency, other than putting pressure on their company representatives, participants will still have to pay the fees. Because most companies match a certain percentage of employee contributions, paying higher-than-necessary fees makes more sense than turning down free money from the company.
The Bottom Line
The new 401(k) laws will go into effect August, 2012. More transparency is likely to have a positive effect on the 401(k) fee structure going forward, but participants still have to take an active interest in their retirement accounts. Itzoe advises participants to focus on passively managed index funds with low fees instead of looking for funds that try to beat the market.