Here's A Big Secret About Your 401(k)

Last week, after Obama’s State of the Union address, the Departments of Labor and Treasury issued a triumphant joint announcement. It said that as part of Obama’s “blueprint for an American economy built to last,” Labor took action to provide more transparency around 401(k) fees.

If you can see past the political posturing, you’ll find that this is important. It means someone’s about to reveal a great, big secret about your 401(k) – how much you’ve been paying for it.

This is information that has taken five years to force into the open. In November 2006 the Government Accountability Office issued a report suggesting more transparency was needed into fees, the kind participants are (often unknowingly) paying to companies like Fidelity, Bank of America's Merrill Lynch, BlackRock and PIMCO, among others. The murkiness has made it hard to be a smart shopper. “Participants may have more limited investment options and pay higher fees for these options than they otherwise would,” the GAO said in another report the following March.

The GAO calculated that an additional 1% charged to a $20,000 portfolio for 20 years would reduce the amount in retirement by a whopping 17%. Small fees have big effects.

Congress didn’t take on this 401(k) secret. Granted George Miller (D-Calif.) took up the cause and in 2007 introduced a bill whose basic premise was to make clear to employees and employers on quarterly statements how much money employees were paying in 401(k) fees. One version of his bill also asked that all workers be offered at least one passively-managed index fund.

But the House didn’t take up the bill. Miller reintroduced it after Obama was elected, but the new Congress was busy with other priorities including healthcare and Wall Street’s follies. Last year Miller’s bill finally passed the House as part of a tax package and made its way to the Senate, which stripped out Miller’s provision. In unsuccessful protest, Miller sent pies to every member of the Senate Finance Committee. Each pie had a slice cut out to represent retirement savings being eaten up by fees.

Maybe you were waiting for regulators to address the problem instead. That’s good thinking, says Bradford Campbell, the former assistant secretary of Labor for Employee Benefits, who says the issue of increasing transparency was one best addressed by the existing regulator. Under his watch, in 2007 the Labor Department proposed a rule to increase transparency. The rule – known as the 408(b)(2) service provider disclosure rule -- was finished in 2008 and sent to the White House, but Campbell says it hit a bottleneck. “They just weren’t able to get to everything” before George W. Bush left office, he says. Campbell is now of-counsel to the law firm Schiff Hardin LLP, and his clients include 401(k) service providers, as well as employers offering 401(k) plans.

Obama’s Department of Labor didn’t move any more quickly. Many people there focused on the health care bill before, in July 2010, they tweaked the 401(k) rule and issued it as an interim final rule. But when months later they still hadn’t sent the rule to the White House for review, a process that can take three months, the Labor Department said the rule would be delayed. Finally, a year later, on Feb. 3 of this year, it issued the final rule, framing it as part of Obama’s “blueprint for an American economy built to last.” Don’t get too excited because even though the rule was issued, it came with an immediate extension, announced in the same paragraph of the press release. Presumably it will go into effect this year.

“I wonder if any participants have experienced irreparable harm as a result of a three-and-a-half year delay in something everyone agreed was needed,” says David Witz, managing director of PlanTools, which sells 408(b)(2) compliance software to 401(k) providers. I think that delay is more like five years, but let’s figure out what harm it could have done. Investors had $2.9 trillion in 401(k) plans as of last September. One third-party administrator estimates that half to two-thirds of plans are at risk for high fees, but let’s assume for the sake of argument that that number is very high so we’ll use 25% of assets, or $725 billion. If fees are inflated by 1%, that’s $7.25 billion in annual fees that may be unnecessary. So multiply that by five years and you have $36 billion – with a B -- in lost savings. That doesn’t even include earnings on lost savings.

“Without a doubt, investors have suffered an opportunity loss by the delay in implementation,” says Greg Carpenter of Employee Fiduciary, a 401(k) record keeper. Campbell, it should be said, argues that investors haven’t lost nearly this much. He says the debate over the Department’s regulation caused employers to start asking questions, which led providers to drop fees to compete. “The rule began having a positive impact long before it was finalized,” he said.

It would be nice to say that people are about to find out if that’s true. The trouble is, this fee secret is so well kept that some don’t know it's even a secret. Studies have shown many people don’t realize they even pay 401(k) fees. When your account is up or down 15%, you’re probably not watching the seemingly small 1% in fees. Financial-speak doesn’t help things. And the bad news is the rule doesn’t even get into the money paid out due to “revenue sharing.”

Because this is a big deal, my colleague and I will be writing more about it. We'll explain what fees you still won't be able to see, but we'll also spell out what fees you need to look for to make sure what you've been paying is reasonable. If you're at a small company, you'll want to pay particularly close attention. As it took five years to spill this secret, it could be a juicy one.