401(k) Fees Are Still Exorbitant, Buried Secrets
By John F. Wasik Aug. 21 (Bloomberg)

While the new U.S. pension­reform law gives a few savings plums to employees, it still hides the pitfalls of 401(k) plans in the form of excessive expenses.

Middlemen in 401(k)s who provide administrative support and line up mutual funds for employers may conceal their compensation in individual fund expense ratios, an annual percentage deducted from your plan assets.

In some cases, third­party administrators and broker­consultants may be raking in one­third or more in total expenses through what the industry calls revenue sharing or soft­dollar deals. That's like a car dealer taking a $10,000 commission on a $30,000 vehicle.

Administrators are able to pass along their fees to you because they can legally hide them in expense ratios, and their compensation isn't disclosed in the 5500 form that employers must file with the U.S. Labor Department.

Matthew Hutcheson, an independent pension fiduciary in Lake Oswego, Oregon, who audits 401(k) plans for employers, says "deals between fund managers and brokerages are not disclosed directly.'' "It's hidden from most people and only a few know where to find revenue sharing and soft­dollar disclosures at the `trade' level,'' Hutcheson adds. "This is possibly the highest area of expense to a plan. Add up all of the fees and you get 1.5 percent to 5.75 percent (deducted from your assets annually). About one­third is hidden, and maybe more.''

Breaking Down the Fees
Using a legal practice common in the brokerage industry, administrators, also called record­keepers, can engage in revenue sharing and soft­dollar practices where expenses are shifted between third parties. Here's how a revenue­sharing deal works. An employer tells a record­keeper to set up a 401(k) plan with a certain number of mutual funds and services. The record­keeper typically tells the employer their labor is "free,'' then collects a percentage from the expense ratio paid to fund managers or from a per­employee charge called an "investment offset.'' Say you're charged 0.75 percent annually for a fund. From 0.10 percent to 0.50 percent may be paid back to the record­keeper for plan administration, auditing, communication and other services. Who pays this added expense? In many cases, you do, not the employer. This mostly hidden expense has a corrosive effect on your retirement fund. Let's say 0.50 percent a year is added to a fund already charging 1 percent annually. If you have $100,000 initially in your plan, over 30 years at an 8 percent annual return the extra half­percent has cost you about $105,000. Run your own cost comparisons using the SEC mutual­fund cost calculator at http://www.sec.gov/investor/tools/mfcc/holding­period.htm .

Employees in the Dark
Very few employees are aware of this practice and have no idea it's ravaging their investment returns. Leslie Smith, a director of New York­based Deloitte Consulting LLP, said a recent survey conducted by her company found that slightly more than half of the record­keepers told employers the total costs of revenue sharing. Her study covered more than 800 plans of varying size. For fund companies offering in­house or "proprietary funds,'' Smith found that 89 percent of administrators didn't disclose these arrangements. "Although we've seen an increase in awareness of this issue, it might not be transparent,'' Smith said. "Since the average mutual fund's return averages about 3 percent less than the stock market's total return and since a basic 401(k) plan could be run for far less than 1 percent of plan assets, participants are being bamboozled out of more than two­thirds of the investment return they should be getting,'' said Brooks Hamilton, a Dallas­based retirement­plan attorney.

What You Can Do
Not all plans are gouging you, and the best 401(k)s have most expenses absorbed by employers. Since U.S. law doesn't mandate full point­of­sale fee transparency, though, you're on your own and need to ask a few questions of your human­resources department or plan administrator:

• Does my plan's record­keeper engage in revenue sharing or other soft­dollar arrangements? If so, how much is added into expense ratios to cover these services?

• When was the last time your employer ``benchmarked'' the plan or put it up for bid to obtain lower fees? Ideally, shopping around for a better plan should be done every two to five years, said Smith, who found that 401(k) expenses averaged 0.75 percent annually.

More Questions

• When was the last time your employer did an investment review of fund performance within your plan? Does it have an investment policy statement that provides for dumping poor performers? It should.

• When will your employer add automatic enrollment and increase features, diversification and advice provisions to your plan? Under the new pension law, this is all perfectly legal and will help you contribute more and lose less.

When you get some answers ­­ your employer must provide this information ­­you can also suggest to your boss to start disclosing and cutting costs. That's the way they run most of their business. Since you have to police a 401(k), that's the way you can run yours.

(John F. Wasik, author of "The Merchant of Power,'' is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net. Last Updated: August 21, 2006 00:01 EDT http://www.bloomberg.com/

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