Management fees, commissions, and profits severely compromise what can be accumulated in 401(k) and other defined contribution retirement plan accounts. Defined contribution participants typically lose from 20 to 30 percent and more of their accumulations to investment management fees charged by the financial services industry. The administrative overhead costs for defined benefit plans are much lower, though, surprisingly, there are no national comparative studies. A part, but only a part, of the reason why defined contribution plans have more administrative costs is because it takes more time to manage fifty individual defined contribution personal plans than it does to manage one common defined-benefit plan. Beyond that honest difference, the financial services industry has multiple opportunities to charge fees and commissions for its services to defined contribution plan participants. Most of these fees are hidden. By law defined contribution plan participants must receive regular statements with information about their accounts. That doesn’t mean, though, that the statements must disclose what fees have been taken out. Nor does it mean that the statements have to present their information clearly. Most people who I know are at a complete loss for deciphering the information in their statements. They instead immediately look for how much has been accumulated in the account, which is usually more than the amount on the previous statement. What they don’t see is what the account balance was before management fees and commissions were taken out.
401(k) balance statements vary in how much information they disclose about fees and commissions. Some only disclose account balances. Others include information on expenses, but it is deceptively limited information. The most accessible fee is that charged by the administrator of the plan, sometimes called the third party administrator fee. That company will charge a percentage of the account balance. But since the administrator is putting your money into other funds, the administrative charges don’t stop there. Each of those funds has its own administrative fees. To determine that, you have to find the “expense ratio” of the fund.
Deloitte Consulting LLP surveyed 130 defined contribution plans in terms of what it called “all-in” fees, which combined the third party administrator and expense ratio fees. It found a range between .35 and 2.37 with a median of .72. In general, the greater the assets and number of participants in a plan, the lower the fee was likely to be. Plans with fewer than 100 participants paid an average of 2.03 percent of assets in fees compared to 0.49 percent for plans with 10,000 or more participants.
That though may be the just the tip of an iceberg in which there are greater more deeply hidden fees. If I invest in a fund that is made up of other funds, a fund of funds, each of the combined funds will have separate fees that are not reflected in the fees of the parent fund. Commissions that are paid by mutual funds to brokers for purchases and sales are not included in expense ratios and thus also hidden. There are multiple other hidden rake offs to which you could be subject. These have such financial services industry names as wrap fees, mortality and expense charges, surrender charges, money market spreads, and floats. Then, not to be forgotten, wherever your investment ultimately lands, you will not receive all of the profits that it facilitates. The company where the investment is made will deduct its expenses, which could include large CEO bonuses, before distributing dividends to shareholders. By treating bonuses as expenses rather than profits, top managers essentially using an accounting trick to expropriate profits for their own use rather than distributing them to owners, including 401(k) investors. It is a practice that is all the more easier when the 401(k) “owners” are so far removed from any actual control over what they theoretically own.
When the fees, commissions, and profits are added up, their impact is far greater on accumulations than the sum would indicate. If the growth rate on your fund is 7 percent, a reasonable sounding 1 percent fee amounts of a loss of one-seventh or 14 percent of its value in the first year. It gets worse as time goes on. Over 25 years it results in close to a 21 percent loss of accumulation if the average growth in value stays at 7 percent because of the combined effect of compounding. For lower average growth rates, proportionate losses to the fees will be still greater. If, as predicted by many, the stock market growth rate will be low or flat for the coming years, the impact of 401(k) and other defined contribution plan fees, commissions, and profits will grow.
The financial services industry collects fees whether or not you change your investments. I did nothing with mine from 1994 to 2010, but they inexorably collected their fees based on my growing balances, which of course produced growing fees for them for doing nothing.
James W. Russell