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Retire Early: Are you getting the shaft in your 401k?


Are you getting the shaft in your 401k?

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This article was updated July 1, 1999.

You are and it's almost epidemic. It's gotten so bad the US Labor Department held hearings on the subject in November 1997. The hearings included all the usual suspects; consumer groups advocating increased disclosure, and the mutual fund industry championing the cost effectiveness of reduced disclosure.

What's really the problem ?

Like most investment problems, it's a question of "fiduciary duty." Believe it or not, the administrator of your 401k account is supposed to make every attempt to get you the best deal. Ideally, this means a wide selection of investment options and low administrative costs. Unfortunately, few employers appear to be doing right by their employees

The Wall Street Journal (11/12/97) reported that investment fees paid by employees ranged from 0.53% of assets on the low side to 2.56% of assets for the highest cost plans. With the stock market returning about 10% per year over the long term, high cost 401k plans are "skimming" 25% of your expected total return. That kind of reduction in your investment return will have a big effect on your retirement. The plan providers are being enriched at the expense of hard working employees. Indeed, it's probable that the profit margins enjoyed by high-fee 401k plan administrators rival those seen in cocaine distribution and prostitution. Yet it's all legal, thanks to the millions of dollars investment companies and thier lobbyists pour into Congress in the form of "campaign contributions."

There are also recordkeeping and administrativce costs for your 401k. Recordkeeping charges can run as high as $75 per year. (This is a fixed cost, it's not based on "percent of assets.") These are usually paid by your employer, but its not a requirement. Regrettably, there's a way for employers with a penchant to play fast and loose with their workers retirement savings to actually make money off recordkeeping and administrative costs.

The "soft dollar" problem in 401k plans.

Greed knows no bounds. Astonishingly, there's a "soft dollar" scam in some 401k plans similar to what we've seen in mutual funds. (See, "Are you getting the shaft in your mutual fund?") An employer may deliberately choose a high cost fund with 12b-1 fees and commissions so that the investment company can "rebate" those fees to the employer in the form of free or reduced cost recordkeeping services. The way the game is played today, it's difficult for an employee to determine if he's being hosed with exorbitant recordkeeping fees. That's one of the items the Labor Department is looking into.

What's an employee to do?

Read your 401k plan prospectus. Find out how much your paying in fees and commissions. If it's more than 1.0% of assets, you're most likely being taken. I worked for one company that hired a high cost bank to manage the employee's 401k plan. Rumor was that the CFO's nephew was an officer of the bank in question. (From the fees we were paying, it was obvious they didn't put the contract out for competitive bid.) This from a company with a slogan "Our goal: to be the best performing company in our industry." How about making sure we have the most cost effective 401k plan?

The problem is the people who decide how your 401k account is managed and administered my have other agendas beside the interests of the employees. The staffer in the Treasurer's Office or Employee Relations who choose the high cost provider with the 12b-1 fee kickbacks probably got a promotion out of the transaction. It was at the expense of your retirement.

Make your own calculation.

Retire Early has developed an Excel Spreadsheet called the 401k Shaft Detector which allows you to evaluate the merit of your 401k plan. Click here to download a free copy.

Other Useful Links:

US Department of Labor - Study on 401k Fees - good, unbiased information from the people who regulate 401k plans.

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Copyright 1999 John P. Greaney, All rights reserved.