Despite recent rules designed to make 401(k) plans friendlier to retirement savers, new research suggests that we're still paying too much for investment options that are second rate.
"Overall, we find that investors in an average plan pay 86 basis points in fees in excess of low-cost index funds. We estimate in 16 percent of analyzed plans that fees are so high that, for a young employee, they consume the tax benefits of investing in a 401(k)," write Yale Law School professor Ian Ayres and University of Virginia associate law professor Quinn Curtis in a paper shared by the Social Science Research Network.
Any discussion of high fees in 401(k) plans is usually qualified by a statement that plans run by small employers are likely to cost more because they don't enjoy economies of scale. But Ayres and Curtis reject that, saying, "We find substantial variation in total costs over plans of similar size."
They also point to two other issues they say shortchange 401(k) savers:
Some plans create traps that set investors up to fail. They found that more than half of plans they examined offered investment options that were "clearly inferior." Since it is a common practice among inexperienced 401(k) investors to spread their money among all the available fund offerings, these funds will invariably get some of the savings, the researchers say.
Efforts to regulate 401(k) plans have focused on process, not results. The researchers admit that there would be great difficulty in an approach that attempted to regulate the outcome of investments, but they argue that the government should be investigating the cost of investment options and regulating them when they are unreasonably high.
Ayres and Curtis point to three relatively simple solutions they think would help solve these problems and boost retirement planning for 401(k) participants.
- All plans should offer at least one low-cost fund and any default investments should be placed in that fund.
- Plans where the total investment management cost actually incurred by participants exceeds a certain threshold should be designated "high cost," and participants should be able to roll their investments regularly into outside IRAs.
- Investors who want to use high-cost funds within a plan should be required to 1) take an exam that would indicate they are knowledgeable investors or 2) show that they are acting on the advice of a financial professional.
Some people might call the adoption of these policies "nannyism," but if we have to rely on retirement savings to survive during our old age, then we have a stake in improving the odds of investment success.
Are these suggestions likely to be adopted? Curtis says, "I think policymakers at the Department of Labor share some of those concerns, but there is a big industry built around 401(k)s, and that could make it difficult to make these changes."