401(k) rip-offs: How to protect yourself

June 13, 2011

There may be larcenous gremlins in your 401(k) eating your retirement money. They aren’t easy to identify and are often buried in plan documents. You will need a trained professional to exterminate them.

Many of the biggest 401(k) money-eaters escape the notice of your employer, who is legally obligated to ferret them out. Your company may have bought 401(k) services from middlemen who suck up your money in the form of commissions, administrative or management fees.

How do you know if your money is being siphoned off? In many cases, you will never know, nor will your employer take the time to audit your plan to get rid of the worst abuses.

The U.S. Department of Labor is working on new rules that would make money managers connected to retirement plans fiduciaries. That would set a higher standard that would put your interests first.

The money trust is vigorously opposing these guidelines, which could potentially eliminate or curtail some of the worst skimming practices. Yet that may not have much impact if the Labor Department does little or no enforcement, which has been the case in the past.

“I believe that anybody who sells 401(k)s should be a fiduciary,” said Mark Mensack, chief ethics officer with Piedmont Independent Fiduciaries in Marlton, N.J., “because very few 401(k) plan sponsors that I’ve dealt with (primarily in the under $100 million market) understand their fiduciary responsibility.”

Extra expenses are often loaded into what you pay for fund management and administration within a 401(k). The difference between fees on one share class or another can add up to $100,000 a year in additional fees that are drained from a group plan, Mensack has found.

It’s all too common for fund managers and middlemen to charge retail expense ratios for funds that should be much cheaper. And since those fees are percentages based on assets under management, fund managers make more money as account balances rise — even though they don’t have to do any additional work. It’s like paying an exorbitant “rack” rate at a hotel even though you qualify for a group discount.

Here are some of the most common abuses:

Charging exorbitant expense ratios. You should get a discount on the funds within a 401(k) plan, especially in large plans where there are economies of scale. Are you getting an institutional rate? Has your plan administrator considered low-cost exchange-traded funds?

Group Annuity Plans. These are among the most expensive plans with up to four layers of fees, all of which deplete your wealth. They are rarely a good deal for you, but enrich brokers, agents and middlemen.

Expensive Share Classes. With broker-sold products, the difference in the share class can add up. It’s generally a bad idea to buy a plan through a broker or agent — unless they add value. Ask for the cheapest share class or buy directly from the fund manager.

Fees on “sub-advised accounts” or “collective investment trusts.” Your plan sponsor may have brand-name mutual funds that seem to have low expenses, but you may be secretly nailed with additional fees that can only be found by sifting through plan documents.

Wrap Fees. These are unnecessary expenses that are larded on by middlemen. Also look for “third-party administrator” fees.

There are really simple ways to weed out expensive 401(k) abuses: First, form an employee committee to review your plan.

Then ask your employer to request an audit with an independent fiduciary adviser who specializes in retirement plans. This professional receives no compensation from selling funds and is legally charged with getting the best deal for employees. A new service called E-Luminary can help you find the right person.

Once you have a fiduciary lined up, audit the plan you have and see what can be done to lower fees and boost returns. You may have to dump some actively managed funds and replace them with passive index mutual or exchange-traded funds. Hands-on education is also important.

Real savings can be reaped and money put back into your retirement kitty. And don’t pooh-pooh the seemingly small differences — expressed in “basis points” or portions of a percent. Mensack found in one plan he reviewed that middlemen were taking 0.12 percent annually. That added up to $163,000 a year or $2,000 per participant.

The basic premise of a 401(k) audit is simple: Get rid of the money-chompers and put in place the lowest-cost, most-diversified plan possible. With the past awful decade still hurting investors, every dollar counts and there’s no need to suffer a lower standard of living in retirement because of a few avaricious gremlins.

7 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

As someone who has been in the retirement plan industry for over 25 years, I have certainly seen abuses of the kind the writer mentions; however, most companies and individual brokers and advisors that market 401(k) and other retirement plans are ethical and diligent in trying to provide competitive, cost-effective plans.

What no one seems to realize with 401(k) plans is that they are not free, and the companies/individuals that provide them have to feed their families too. Who do you suppose is paying for the posters in the lunchroom announcing the upcoming enrollment meetings? Who is providing the shiny kits that are passed out at that meeting? Who maintains the website where you check your account balance, educate yourself, and perform transactions? Who is that knowledgeable person standing in the front with a clear, professional, FINRA-compliant presentation at enrollment meetings? Who is explaining what a QDRO is to the employer? Who is processing the death claim? Who is educating the employer on their responsibilities when laws change? Employees (and the writer of this article) need to understand that for many small to mid-size firms, if their employers were paying all of these costs out of pocket, they would not have a plan, especially in this economy. Wrap fees, commissions, and TPA subsidies are a way to pay fees and provide plans to hundreds of thousands of employees who would not otherwise have them.

My firm has been fully disclosing all the “hidden” revenue we receive for years; I am very much in favor of the disclosure legislation and I hope the DOL is diligent in enforcing it. Employers and employees should know what they are paying; but they should also understand that you get what you pay for. If you don’t want to pay anything, that is exactly what you get.

Posted by Susan201 | Report as abusive

not a 401k expert, but “you get what you pay for” is not the problem as I see it. You/we pay people for things we don’t understand because they supposedly do. Yet it’s in their own best interest to not explain all choices fully. Charges/fees have made finance what it is…confusing to wage earners, profitable to banks. Another thousand paragraphs defending good firms won’t eliminate the unscrupulous ones. Nor should enforcement of sound legal rules offend the scrupulous. Education and enforcement both work if properly applied.

Posted by pHenry | Report as abusive

If you were the compare the performance of a (a) passive 401k with no management fee and another (b) 401k that is actively managed but with a management fee, which would do better? I suspect that in many cases (a) would outperform (b)

Posted by MaunaKea | Report as abusive

[…] The U.S. Department of Labor is working on new rules that would make money managers connected to retirement plans fiduciaries. That would set a higher standard that would put your interests first. via blogs.reuters.com […]

Posted by 401(k) rip-offs: How to protect yourself | 401k Plan Advisors | Report as abusive

Susan201,
Respectfully, it doesn’t appear you know what is going on behind the scenes. Absolutely all of us ought to be paid for our efforts and there is a cost to doing business. However, the amount of money being pilferd from the American 401k participant, by many of the largest 401k service providers, above and beyond the advisor compensation constitutes theft, pilfering to be precise.

Please Google “caveat emptor” along with my name, or review my presentation from the FI360 conference last month, or read “Stop the 401k Rip-off”. Until three years ago I was in your shoes. pHenry’s comments are exactly right, as are MaunaKea’s.

I’m happy to talk to you off-line to show you exactly where to look. I’m on LinkedIn

Mark Mensack

Posted by PrudentChampion | Report as abusive

Susan ” Wrap fees, commissions, and TPA subsidies are a way to pay fees and provide plans to hundreds of thousands of employees who would not otherwise have them. ” There are far better more cost effective ways to provide these services that benefit both the Employer & the participant. 12b-1 fees casue NOTHING but Friction in plans. Reach out to Mark or myself on Linked In

James

Posted by jmhMIRA | Report as abusive

MaunaKea – As an advisor you would have to be careful predicting performance. Assuming past history repeats itself, then most of the time a passive approach beats an active approach assuming fees are the same. If fees for passive are lower than active then passive beats active even more often.

Susan: I consider 401k’s to be the “Madoff scandal of the average person”. It’s a shame that small business, i call them our “economic patriots” — are the people that suffer the most. Often the business owner has the largest balance. It’s like filling up a bathtub with water and it is filling, but slower than it should because of an unseen leak.

Much of the time, the non-fiduciary financial product salespersons are blissfully unaware! Just as well – they would quit if they realized the full extent of the harm they are doing.

I’ve had business owners say, “But they buy us pizza when they have a education session.” It was all I could do to nod and smile. It is a travesty and a shame.

I’m saving one small company this next week as we move them to a really top notch ERISA 3-38 fiduciary plan, transparent fees, managed model portfolios, low exp ratio (0.26) high quality inst. passive funds. Very cool. One company at a time. make the world a better place…

Posted by JOR | Report as abusive

[…] the open with new disclosure rules, and reporters – including Ron Lieber at the New York Times, John Wasik at Reuters and me, here at Forbes – keep writing about high […]

Posted by A 401(k) Trap | Report as abusive

[…] Read more about this disturbing trend, and how you can protect yourself from Reuters. […]

Posted by Staying Safe With Your 401(k) | Expert Financial Planning | Report as abusive

[…] the open with new disclosure rules, and reporters – including Ron Lieber at the New York Times, John Wasik at Reuters and me, here at Forbes – keep writing about high […]

Posted by A 401(k) Trap — Clearing and Settlement | Report as abusive

[…] The money trust is vigorously opposing these guidelines, which could potentially eliminate or curtail some of the worst skimming practices. Yet that may not have much impact if the Labor Department does little or no enforcement, which has been the case in the past. via blogs.reuters.com […]

Posted by 401(k) rip-offs: How to protect yourself | Report as abusive

Is is disgusting that so many people have been ripped off and those responsible should be brought to justice. Good honest people have paid into pensions which are now in danger. For other ways to protect yourself see http://protectyourself.cc/blog which is a good read.

Posted by protectys | Report as abusive