Four Biggest 401(k) Conflicts
There's often a boat load of conflicts hidden in the fine print of your 401(k) or pension plan.
Many of these conflicts are hidden from plain sight because your employer and fund managers don't want you to know about them. The bottom line on all of these hidden fees is that they are costing you money and imperiling your ability to finance a dignified retirement. Here are the four worst conflicts.
* 12b-1 Fees. If you're a broker or fund company, you have to love these charges, which take money from retirement plan investors and pay you to market funds to others. Although I've seen really squishy arguments over the years that somehow they help investors, it's tortured logic.
Regulators have known about 12b-1 fees for years and know that they serve little or no useful purpose for future retirees. The SEC even did a big research reporton them.
Last year, the Department of Labor went after an investment advisory firm and settled a case for $1.2 million involving 12b-1 fees. If a firm—or employer for that matter—has a legal duty to protect its employees, it can't justify charging them 12b-1 fees. It's simply a way of taking money from retirement assets without boosting returns or contributions.
Ask your employer if any funds within your plan charge these fees. If so, ask them to dump the funds and find a manager or broker who doesn't impose them.
* Revenue Sharing. In exchange for placing specific funds within a retirement plan, a fee is paid to a 401(k) provider by an investment or mutual fund firm. These fees go by many names and 12b-1 fees are a subset of the revenue sharing pot.
Where does the money come from to reward the 401(k) sponsor? Your retirement kitty in the form of a percentage taken from your account. Is it fair? Not if you're an investor.
Ask if you're being charged for “subtransfer agency, shareholder servicing or profit-sharing payments.” Don't let the language fool you. None of these fees are in your best interest if they come out of your funds and don't provide you better service or enhance your returns.
* Cross-trading. You’ll likely never know about this practice because disclosure is incredibly opaque. This is a trade between two accounts run by the same investment adviser. Although it’s legal, it’s brimming with potential conflicts.
According to a recent study by Prof. Ashish Tiwari at the University of Iowa:
“Based on past administrative actions that the SEC has initiated against certain investment advisers, the practice of cross trading creates the potential for one party to be favored over another client… This may happen, for example, when an adviser, acting as an agent, causes an illiquid security to be sold by one client fund to another client fund at an inflated price, thereby benefitting the shareholders of the first fund at the expense of the latter. Another example could be a case in which the incentive to earn additional compensation, in the form of trading commissions, may create a conflict of interest when facilitating agency transactions among client funds. Such conflicts would be reflected in relatively high commission costs borne by the client funds.”
* Broker Proprietary Funds. This is a practice where a brokerage house recommends its “in house” funds, which are often loaded with excessive fees. Few, if any, of these funds justify their high expenses.
This is what financial planner Roger Wohlner had to say about them:
“It is not uncommon for registered reps and brokers, who are compensated all or in part by commissions or trailing fees from the mutual funds they sell, to suggest mutual funds from the family run by their employer. While some of these funds are perfectly fine, all too often in my experience they are not. Whether from high fees and/or low performance these are often investments to be avoided.”
How do you, as an employee, vet your retirement plan to ferret out these conflicts?
First, look at your disclosure statements and compare them to the lowest-cost plans run by similar-sized employers on Brightscope. Then see what you’re being charged. Chances are, you will not be able to see some of the trading conflicts, but you will be able to see the expenses of 12b-1 fees and proprietary funds. Are you being overcharged?
It's a simple rule of thumb that will help you tackle conflicts: The cheapest retirement plans are usually stocked with index mutual or exchange-traded funds with little or no middlemen expenses such as revenue sharing.
Better yet, ask your employer to audit your plan and ask for an independent fiduciary to review plan expenses and structures. Given the intense competition in the mutual fund business now, chances are excellent they can find you a better deal that will help you save more for retirement. But you'll never move ahead unless you start asking questions.
John Wasik is an expert on investor protection and author of Keynes's Way to Wealth: Timeless Investment Lessons from the Great Economist. A speaker, journalist and investor, he also contributes to Reuters, The New York Times and Fiscal Times.