Do you understand how your 401(k) really works? Do you know how your employer selected the designated investment options? Do you know the investment performance of each of your options? And most importantly, do you know the fees being charged against your account and who is paying them?
Starting today, new Department of Labor (DOL) disclosure rules will provide workers with insight about how much they are being charged for their retirement plan. Under the new rules, workers must receive annually an explanation of all of their investment options and their terms and conditions, including performance and fees. Workers also will receive quarterly personal benefit statements that must specify fees directly deducted from their accounts. The new rules are designed to boost transparency and help workers and employers compare retirement plans and shop around for the best option.
It may seem hard to believe, but, until now, employers didn't always know and weren't required to explain to workers exactly how one of their most important benefits -- their retirement security -- actually worked. And Americans are equally confused. According to an AARP survey, more than 70 percent of 401(k) participants mistakenly said that they do not pay any 401(k) fees at all.
As 401(k) plans became more prevalent in the workplace in recent years, I asked the Government Accountability Office (GAO) to examine how these plans are functioning. The GAO's findings have been consistently disturbing. GAO and the DOL also found that a one-point percentage difference in fees can reduce a worker's retirement nest egg by 17 to 28 percent over a career. And GAO reported that, increasingly, employers are charging fees to workers' accounts that traditionally have been paid by employers.
These gaps in worker protections are partly due to the way 401(k) plans have evolved over time. When Congress passed a private sector pension law in 1974, it established rules primarily for the kinds of retirement plans that existed at the time -- mainly defined-benefit and profit-sharing plans. The 401(k) was only established in 1978 and intended for executives. It didn't expand to rank-and-file workers until 1981. And Congress and the regulatory agencies have been playing catch-up ever since.
Congress never expected 401(k) plans to become the primary retirement plan, but they have. And we have an obligation to make these plans work the best they can.
One of the fundamental weaknesses of 401(k) plans is that they ask workers to be their own investment experts. The 2007 market meltdown painfully showed everyone that not even the highest paid financial experts always know how to protect their investments. But expertise does make a difference. Studies have consistently shown that professionally managed defined benefit plans outperform 401(k) plan returns by 1 to 2 percent a year or 20 to 30 percent over a working lifetime. Studies also show that a higher fee does not translate into better investment performance.
The new disclosure rule will let employees know how big of a bite 401(k) fees are taking out of their total savings.
Starting today, workers' quarterly benefit statements must list all fees directly deducted from their accounts including administrative fees for maintaining accounts and consulting fees paid to design the plan. Workers will need to understand and check the annual documents for equally important investment management fees that are separately taken out. Good employers will make sure that these materials are understandable to workers. If your employer provides electronic access to materials, make sure you read the email.
It's time to shine some light on 401(k) plans. If we are going to rely on these plans for retirement security, then employers and workers need to understand the different investment alternatives and their investment performance and fees. Median 401(k) account balances are less than $20,000, and the average balance is $60,000 when many times that is needed to stretch a retirement nest egg into a comfortable retirement for more than a decade. Workers and employers need to contribute 10 to 15 percent of wages a year to accumulate adequate retirement income.
Keeping fees low won't solve every 401(k) weakness, but it could increase workers' investment returns by up to one-third at retirement.
Armed with this information, workers can press their employers, and employers can press their service providers, for a better deal that minimizes fees and protects their retirement nest eggs. The new DOL rules start to give workers a fighting chance.
So, be sure to read those benefit statements, America.