Thursday, November 27, 1997

A 401(k) surprise: Fees keep going up and up

By ELLEN E. SCHULTZ and VANESSA O'CONNELL / The Wall Street Journal

Fees in 401(k) retirement plans are rising -- and employees are increasingly footing the bill.

The general wisdom has been that the growing mountain of assets in 401(k)s, profit-sharing and similar plans would lower costs, thanks to economies of scale. Similarly, growing competition among the "vendors" -- or mutual-fund companies, insurers, banks and brokerage firms that set up and run retirement plans -- should lead them to slash costs in order to win new business.

But that hasn't happened. In fact, an employee with $30,000 in his 401(k) could be paying more than $300 a year at a large employer, or more than $700 a year at a small employer, according to a study of more than 122 401(k) vendors to be released next month. Some of these vendors charge fees totaling more than 2.5 percent of a plan's assets.

"There often is a huge spread in the fees vendors -1/8the fund companies<STYL>-3/8 charge for essentially the same service," says Joseph Valletta, a principal at HR Investment Consultants in Baltimore, which did the survey. "An employee who is paying more than he needs to should ask his employer why."

Rising costs are worrisome because, as 401(k)-type plans to which employees contribute money for their retirement replace old-style employer-funded pension plans, the costs of managing the money have been shifted to workers. While pension managers pay "wholesale" for investments and services, employees pay "retail." Those higher costs can erode a retirement nest egg over time. In fact, pension experts caution that employers may face increased liability if they don't pay attention to high fees.

Concern over fees prompted the Labor Department to hold hearings Wednesday on whether plan sponsors are doing enough to protect employees from excessive costs, and whether disclosure of fees should be improved.

Employers and financial companies that run retirement plans generally oppose any increased disclosure in fees. The mutual-fund industry, which already discloses some fees in prospectuses, is in favor of more disclosure -- for other types of investments.

The Association of Private Pension and Welfare Plans, which represents employers and 401(k) service providers, says current disclosure is adequate and that competition for 401(k) accounts is keeping fees in check.

But fees have been rising. The study by HR Investment Consultants shows that administrative and record-keeping costs have risen. At companies with 100 employees, costs per participant have climbed to $54.42 in 1997 from $49 in 1995. Costs at companies with 500 participants rose to $37.16 from $36.58 in the same period.

Meanwhile, investment costs, which account for most of the expenses, have risen as well. At companies with 500 participants, costs as a percentage of assets rose to 1.11 percent in 1997 from 1.09 percent in 1995; at companies with 100 participants, costs remained flat over the same period.

But the numbers understate the actual cost increases. Smaller companies, which don't turn up in such surveys, tend to have even higher costs. And at larger companies, the growth in assets should have led to a decrease in fees, because costs are spread over a larger pool of money.

So why aren't costs falling? A primary reason is that an increasing portion of 401(k) assets, currently one-third of assets, are in mutual funds, whose expenses have been rising with growing distribution costs.

Increasingly, retirement plans resemble fund "supermarkets" like those offered by Charles Schwab Corp. That is, they include a variety of funds from a number of companies. Fund distributors know that it's crucial to get their funds on the shelf of a lucrative retirement plan "minimarket." So they pay distribution fees to retirement-plan providers to get into the plans. Those fees, along with any commissions, are passed along to employees through annual "12b-1" fees.

At the same time, many employers have an incentive to choose the costlier funds with 12b-1 fees, explains David Morse, a partner in the law firm of Whitman Breed Abbott & Morgan, in New York. That's because many employers get the 12b-1 fees kicked back to them, in the form of free or reduced-cost record-keeping. "Some employers choose the more expensive funds with the 12b-1 fees, in order to get the free record-keeping," he says.

The Erisa Advisory Council, a study group with ties to the Labor Department but no official regulatory function, just finished a report on these "soft-dollar" relationships between employers and plan vendors. The group's findings, to be made public this week, are expected to support fuller disclosure of soft-dollar arrangements, because the deals make it difficult to tell if employees are overcharged for routine administrative services.

The Securities and Exchange Commission also has concerns about soft dollars. Speaking Friday at an annual meeting of a Wall Street trade group, the Securities Industry Association, SEC chairman Arthur Levitt praised American Century Investments, Kansas City, Mo., and New York-based Scudder, Stevens & Clark Inc., for efforts to lower execution costs for mutual-fund investors, adding that "it should come as no surprise that neither firm accepts soft dollars."

Don Phillips, president of fund-trackers Morningstar Inc. in Chicago, says employers should take seriously their fiduciary duty to plan participants and form "a powerful collective voice to drive fund fees lower." He says plan sponsors control a huge amount of assets, and fund groups are champing at the bit to get that money.

"It would be a shame if employers didn't take this opportunity," he continues. "They should start by telling fund groups that a 1 percent fee should be the ceiling not the floor."