Next month, more than 30 years after 401(k)s began to appear, employers with plans will finally receive standardized and detailed information from plan administrators about how much they pay in fees. Within the following 60 days, and no later than the end of August, plan investors will get their own reports showing these costs.
How much is this new rule needed? Many 401(k) investors have said in polls that they believe the investment programs are free. Even the people at their employers who oversee the plans are often clueless about fees and other 401(k) matters, according to a recent study by the U.S. Government Accounting Office.
The fund industry has hardly rushed to embrace the notion of self-regulating itself with consumer-friendly disclosures of hidden 401(k) fees.
It argued for years that it was either impossible or too expensive to unbundle its services and allocate specific fees to individual investor accounts. Yet, after a seemingly endless rulemaking process, the U.S. Department of Labor's new rules are set to take effect July 1.
By the time investors finally see these new reports, 401(k) fees will be much less of an issue than they were just a few years ago. Attention on high-fee funds has been generating negative publicity at least since the market crash made investors painfully aware of how easily their investment gains can vanish.
As the market plunged, the experts overseeing 401(k) investment funds were shown to be mortal like the rest of us. More to the point, funds that charged relatively high fees were shown to not produce returns superior to funds charging low fees. Yet the impact of these fee differentials on nest eggs was often huge over the long life of many employees' participation in 401(k) plans.
Low-cost funds have since come into favor and prospered, usually through the introduction of index mutual funds and exchange traded funds (ETFs) that try to match market averages. Costs for these passively managed funds often are much lower than for actively managed funds. Now, courtesy of the Labor Department's rules, we will also be seeing other layers of the 401(k) fee structure.
"We want people to focus on keeping their fees at 1 percent or lower," said Stuart Robertson, general manager of ShareBuilder 401k, which offers plans to small and medium-sized employers. Figuring out your fees may be challenging at first, he says.
In a sample disclosure form from the Labor Department, there are four components of total 401(k) plan expenses:
1. Investment product fees. This is normally the most important and revealing set of disclosures, and also the most extensive. Your 401(k) plan may include diverse investment choices, so these fees can involve a range of charges for the different mutual funds, annuities, and other investments held in your 401(k). Investment providers charge a range of fees for each choice, including management fees, fund expenses, trading costs, purchase fees (for funds with front-end loads), and other items.
2. Expenses of administering the overall 401(k) plan. Fidelity, Vanguard, T. Rowe Price, and other investment firms charge varying costs to provide 401(k) services to employers.
3. Charges to start up or convert your 401(k) account.
4. Charges to terminate your plan, should you move it to another employer, roll it over to an IRA, or take a lump-sum settlement upon ending your current job and participation in the plan.
Most expenses will be in the first category of investment product fees, but you may see charges under the other items. The report is not personalized, but shows the fees for all plan investment options, stressed Dave Gray, a vice president at Charles Schwab. Typical reports will be seven to 12 pages long, he added, so investors need to spend some time with the new document.
To determine their average expense ratio, he said, participants will need to look at where their plan assets are invested and then figure out their costs for each holding. Then they need to add these expenses plus any charges in the other three categories. Dividing this total by their current total of invested assets will yield their overall expense ratio.
Even then, it may take some further research to figure out if you're paying more in expenses than experts think is proper. "When you have the data for the first time, you probably have no perspective on whether your fees are high or low," Robertson says.
Simply buying your plan's cheapest investment is not wise, either. "The cheapest isn't always the best," Gray says. The disclosure document does include investment returns over different time periods, and this can help guide investment decisions. But investors also need to pay attention to the proper mix of different types of investments so their plan's holdings are diversified, he explains.
BrightScope (www.brightscope.com) offers fee reports on 401(k) plans at no cost, so when you have calculated your plan expenses, you will be able to see how they compare with plans of other employers that BrightScope thinks are similar to your employer. The employers in these peer groups are identified so you can see whose plans are being compared.
BrightScope also offers a 401(k) fee report that allows you to enter the details of the investment choices you've made in your plan and get a personalized report on your plan expenses. While the report is free, you will have to register on the BrightScope site to use this feature.