Reason WHY 401(k) is NOT a Full Proof Retirement Option: The Truth Behind Hidden Fees in 401(k) Plans Video

You should watch these videos if you plan to retire next year and think about the questions below:

1. What services justify these fees?

2. Why has the retirement plan industry endeavored to obscure these fees? (What are they trying to hide?)

3. If these fees are truly justified and legitimate, should they not be clearly shown on an invoice or statement? (In other words, why are they hidden?)

The Truth Behind Hidden Fees in 401(k) Plans (Part 1 of 3)

The Truth Behind Hidden Fees in 401(k) Plans (Part 2 of 3)

The Truth Behind Hidden Fees in 401(k) Plans (Part 3 of 3)

Generally, a plan has three major categories of expenses. These are:

1. Investment fees. By far the largest component of plan fees and expenses is associated with managing plan investments. Fees for investment management and other related services generally are assessed as a percentage of assets invested. Employers should pay attention to these fees. They are paid in the form of an indirect charge against the participant’s account or the plan because they are deducted directly from investment returns. Net total return is the return after these fees have been deducted. For this reason, these fees, which are not specifically identified on statements of investments, may not be immediately apparent to employers.

2. Recordkeeping and compliance or plan administration fees. The day-to-day operation of a plan involves expenses for basic administrative services — such as plan recordkeeping, accounting, legal and trustee services — that are necessary for administering the plan as a whole. In addition, a profit-sharing or 401(k) plan also may offer a host of additional services, such as telephone voice response systems, access to a customer service representative, educational seminars, retirement planning software, investment advice, electronic access to plan information, daily valuation, and online transactions.

In some instances, the costs of administrative services will be covered by investment fees that are deducted directly from investment returns. In other instances, when the administrative costs are billed separately, they may be borne, in whole or in part, by the employer or charged directly against the assets of the plan. In the case of a 401(k), profit sharing, or other similar plan with individual accounts, administrative fees are either allocated among individual accounts in proportion to each account balance (i.e., participants with larger account balances pay more of the allocated expenses, (a “pro rata” charge)) or passed through as a flat fee against each participant’s account (a “per capita” charge). Generally the more services provided, the higher the fees.

3. Individual service fees. In addition to overall administrative expenses, there may be individual service fees associated with optional features offered under an individual account plan. Individual service fees may be charged separately to the accounts of those who choose to take advantage of a particular plan feature. For example, fees may be charged to a participant for taking a loan from the plan or for executing participant investment directions.

Plan administrative and investment services may be provided through a variety of arrangements: Some or all of the various plan services and investment alternatives may be offered by one provider for a single fee paid to that provider (sometimes referred to as a bundled arrangement). The provider will then pay, out of that fee, any other service providers that it may have contracted to provide the services.

In other cases, plans may obtain services and investments from a variety of providers (sometimes referred to as an unbundled arrangement). The expenses of each provider (e.g., investment manager, trustee, record keeper, communications firm) are charged separately.

Plans also may use an arrangement that combines a single provider for certain services, such as administrative services, with a number of different providers for investments. Fees need to be evaluated keeping in mind the cost of all covered services.

Details on Who Gets Paid and Why: The One Who Drain your Money

In a conventional 401(k) plan, fourteen people, firms, or institutions could potentially be on the receiving end of payments from plan assets. These are listed in the order of involvement:

1. The brokerage firm for clearing the trades of the funds. Payments are taken as commissions out of plan assets and are not seen by participants or fiduciaries.

2. The fund company for providing research services to shareholders. These services are paid for by rebates from the brokerage firms’ commissions, and are also not seen by participants or fiduciaries.

3. The fund company for managing the fund. These costs are revealed in the fund’s prospectus. The average U.S. stock fund costs between 1% and 1.3% of assets within the fund annually. These expenses can be unnecessary because funds that cost more are generally trying to beat the market, which, although heavily promoted in the industry, is widely believed by experts to be a futile practice. Funds can cost much less (50% to 75%) by utilizing an indexing approach, which has lower risk and reasonably predictable results over the long term.

4. Plans managed by insurance companies may have extra embedded costs associated with mortality underwriting elements. This is a common expense within variable annuity contracts.

5. The clearing agent clears and consolidates trades from multiple- fund institutions and aggregates the associated data for efficient import into a custodian’s record-keeping system.

6. The custodian holds funds in an account for the benefit of the trust, and provides electronic data feeds to record keepers and third-party administrators so they can process and post to individual participant accounts held in sub-accounts at the record keeper level.

7. The record keeper or third-party administrator is paid to take aggregate or omnibus accounts at the custodial level and tracks them at a participant level. The record keeper generates participant statements, maintains an Internet access portal, and initiates transactions and uploads associated instructions to the custodian to act upon.

8. Sales people, brokers, and insurance agents may receive finders fees for bringing new business to the players described above. Generally, finders fees come from the fund institutions. These individuals may also receive trail commissions, such as 12(b)-1 fees or negotiated loyalty incentive compensation, intended to compensate these individuals for ongoing services they render.

9. Fiduciary investment advisors may be compensated from plan assets for rendering advice or other services to fiduciaries and participants. Fiduciary advisors are generally paid from plan assets after submitting an invoice to a plan trustee. However, many fiduciary advisors are paid directly from the plan sponsor and are not compensated from plan assets.

10. Consultants may be compensated from plan assets for providing a wide variety of services including plan maintenance, compliance, and other services that a plan sponsor believes are necessary.

11. Peripheral companies such as “educators” or “communications specialists” often share in commissions with brokers and insurance agents. In some cases they are paid from plan assets after an invoice has been submitted and approved by a trustee.

12. CPA firms may be paid from plan assets for accounting and annual auditing services. This is generally handled through invoicing the trustee.

13. A plan may have its own legal counsel, and a plan may pay for such counsel from plan assets in the same way a CPA firm would be paid—through an invoice to a trustee.

14. Insurance premiums may be paid from plan assets to indemnify fiduciaries. A plan may not indemnify fiduciaries for failures of duty. However, a plan may purchase insurance from a commercial insurer, which in-turn can provide insurance coverage for fiduciaries.

What NOW? Stop the 401(k) Rip-off!

David B. Loeper 2007 provided a 5 Action Plan to counter this as enumerated in his book. Here is the synopsis of this action plan.

Action 1. Understand how much you are really paying. Go over your financial statements and other records or contract.

Action 2. Complain without sounding like a complainer. Bring it to your employer's attention and inform about the situation. Having done this, what can you do when, as is often the case, nothing is done about the problem? Then it is time for Action 3.

Action 3. Rally your co-workers to join you. If the employer hears three or more complaints or questions, they will assume there might be many others who have not yet complained. At this point the employer may become concerned that they are losing the positive benefit they are trying to create by sponsoring the 401(k) plan, and they might take action to solve the problem.

Action 4. What happens if the employer ignores us? It is time to take more drastic action. File a class action lawsuit against your employer. There are other class action lawsuits that have been filed against employers before.

Action 5. If the situation is resolved, you and your spouse or partner can go through to figure out how and on what you can confidently use the "expense saving dividend" benefit of your repaired 401(k). Without this action, you really won't realize the benefits of the first steps you took to get your 401(k) fixed.

After things have been done, remember… Don’t spend too much money on things you WANT but spend on things you really NEED.



References:

1. HUTCHESON, Matthew D. 2007. Uncovering and Understanding Hidden Fees in Qualified Retirement Plans 3rd Edition—Published Fall: Elder Law Journal. University of Illinois Elder Law Journal, Pennsylvania Ave. Champaign, Illinois.

2. U.S. Department of Labor, Employee Benefits Security Administration. May 2004. Understanding Retirement Plan Fees and Expenses.

3. LOEPER, David B. 2007. Stop the 401(k) Rip-off!: Eliminate Costly Hidden Fees to Improve Your Life. Bridgeway Books, Austin Texas.

4. Bloomberg TV