The Problem of High 401(k) Costs

by Mark Hebner - Monday, 14 April, 2014

In December of 2012, Demos, a think tank, published The Retirement Savings Drain—The Hidden and Excessive Costs of 401(k)s. It caused quite a stir and provided much of the source material for the PBS Frontline Documentary, The Retirement Gamble. Recently, another think tank, the Center for American Progress (CAP) published a similar study, Fixing the Drain on Retirement Savings—How Retirement Fees Are Straining the Middle Class and What We Can Do about Them. It too has received a great deal of media coverage, which we consider a good thing.

Both studies cite examples of the deleterious effects of high costs on long-term retirement savings. For example, a 25-year-old who makes the median income of $30,500 and contributes 5% of salary with an employer match can expect to have $96,000 less at retirement at age 67 if he pays 1.30% in mutual fund management fees compared to 0.25% for an index fund. To have a comparable retirement balance as the worker with the low-cost index option, he would have to delay retirement to age 71, and that is unlikely to be a viable option. Of course, the $96,000 did not just vanish into thin air nor did it die and go to money heaven. It was simply a transfer of wealth between the worker who took all of the risk and the company that supplied the investment choices to his 401(k). The 1.30% is based on a 2011 study1 by Deloitte Consulting which found that plans with fewer than 100 participants have an average fee of 1.32%.

Undoubtedly, all of us can agree that while the Department of Labor disclosure requirements for 401(k) plans were an important step in the right direction, more remains to be done. As the authors of the CAP study point out, quality of disclosure is more important than quantity, and the current disclosures averaging around 30 pages are overwhelming to plan participants. According to CAP, the three guiding principles for future disclosure requirements should be:

  • Concise: brief and easy to navigate.
  • Accessible: prominently displayed on all retirement fund materials.
  • Relevant: highlighting key cost information in ways investors can understand.

The argument for conciseness is easy to accept. The authors cite several studies showing that in the face of dense disclosures, consumers simply shut down and are likely to spend more time researching which smartphone to buy than which mutual funds to invest in, and they will spend more time planning vacations than planning for retirement.

While accessibility of disclosures has been greatly improved with the DOL mandated quarterly requirement, CAP sees no reason why disclosures about fund fees shouldn’t be “readily visible on all materials, with the same level of ubiquity that we see with nutritional labels on food and warning labels on cigarettes.”

As for making disclosures relevant for plan participants, CAP suggests that showing a simple annual cost per $1,000 invested is completely inadequate because it overlooks the enormous impact of compounding over decades. Instead, CAP suggests a “20/20” disclosure, showing the impact of fees on $20,000 over 20 years. According to CAP, a label such as the one shown below would fulfill all three requirements of conciseness, accessibility, and relevance.


If such a labeling system could indeed be implemented over the dead bodies of the mutual fund providers, the authors cite several positive reverberations:

  • Help educate investors about the importance of controlling fees and expenses.
  • Lead plan sponsors to offer more lower-fee or index funds.
  • Induce mutual fund providers to lower their fees to avoid unflattering comparisons.

One of CAP’s proposals that we found untenable is the requirement that IRA providers also have a 20/20 disclosure so that a separated plan participant can decide whether to roll over her 401(k). The problem is that since an IRA can be invested in practically anything, there is no way to determine what the investor's fees would be in advance, other than an annual account fee, if applicable.

In closing, although we may not agree with everything that comes out of these think tanks, we at Index Fund Advisors are quite happy to see these reports, and we hope there will be more of them until a tipping point is reached, resulting in American workers getting a better shot at a secure and dignified retirement.

1Deloitte Consulting LLP, “Inside the Structure of Defined Contribution/401(k) Plan Fees.”