So-called defined contribution plans—such as 401(k) plans—have become “the primary private savings vehicle for most Americans’ retirement.”[1] The assets held by 401(k) plans have more than doubled over the past decade, and as of 2019, these plans held a whopping $6.4 trillion in retirement savings.[2] With trillions at issue and the retirement security of millions of American workers at stake, it is crucial that these assets are managed responsibly. However, while some plans are in good hands, many suffer from what has been dubbed the “pervasive problem of excessive fees”[3]—that is, participants in 401(k) plans often pay more in fees than they should, and more than they would if their plan was managed and administered more prudently.
Excessive fees undermine workers’ ability to save effectively for their retirement and line the pockets of plan administrators, recordkeepers, and investment managers. Differences in fees that may appear small when considered in isolation can add up to enormous differences over time. Given that workers typically spend decades saving up for their retirement, excessive fees in the context of a 401(k) plan have an outsize impact—for example, a difference in fees of less than one-half of a percent can cost employees tens of thousands of dollars by the time they retire.[4] In fact, one study found that for a substantial number of plans, the amount paid in excessive fees was so significant that fees consumed the entire tax benefit of saving through a 401(k) plan, rather than on an after-tax basis.[5] It is important to avoid paying excessive fees as you save for your retirement—but figuring out whether the fees you pay in your 401(k) plan are reasonable is a difficult exercise.
Types of Excessive Fees Paid by 401(k) Plan Participants
Retirement plans are highly complex entities, and unreasonably high fees can therefore hide in various nooks and crannies of your 401(k) plan.[6] The following is a non-exhaustive list of places where excessive fees may be found in your 401(k) plan:
#1. Excessive Recordkeeping and Administrative Fees
Virtually all 401(k) plans charge participants a fee for recordkeeping and administration. The fiduciaries of your plan have an obligation to monitor and control the plan’s recordkeeping and administrative fees and ensure that the compensation paid to the plan’s service providers is reasonable.[7] However, just because fiduciaries are required to monitor these fees, that does not mean that they will in fact do so—indeed, fiduciaries may well have simply accepted quoted rates for recordkeeping services, without any attempt to bargain for lower fees.[8] And fiduciaries may also fail to regularly obtain quotes from other potential service providers—an important way to check whether the fees they are paying continue to be reasonable.[9] Although there is no single, uniquely reasonable fee (or fee model) for administrative and recordkeeping services, courts have found, for example, that paying recordkeeping fees as a percentage of assets under management rather than at a fixed per participant can be unreasonable.[10]
#2. Overly Expensive Mutual Funds
There are thousands of mutual funds that plan fiduciaries could decide to include in the investment line-up of your 401(k) plan. In choosing which funds to offer as investment options, they must pay attention not just to the performance of a fund, but also to the fees charged by the fund’s investment manager—after all, plan participants will be limited to the funds selected by the fiduciaries when deciding how to invest their retirement savings, and thus must be able to rest assured that the curated menu of investment options will give them reasonable returns for reasonable fees.[11] Due to the large number of mutual funds that can be included in your 401(k) plan, there is no excuse for a failure to ensure that the investment options offered to plan participants charge fees that fall on the lower rather than on the higher end of the spectrum.[12] Nonetheless, plan fiduciaries regularly fail to provide workers seeking to save for their retirement with a menu of investment options that are both well-priced and well-performing, and not loaded with fees for things such as marketing and broker commissions that do not benefit investors.[13]
#3. Needlessly Expensive Share Classes
A third problem that can beset a poorly managed 401(k) plan is a failure by the fiduciaries to save expenses by leveraging the plan’s size to get access to institutional share classes. Mutual funds typically offer several share classes, including both “retail” share classes that are available to all investors, irrespective of the size of their investments, and “institutional” share classes, that are available only to large institutional investors—such as pension and 401(k) plans, which control the assets of many individual investors at the same time. Institutional share classes tend to have lower expense ratios compared to retail share classes. When those share classes are available, offering participants retail share classes can be unreasonable.[14]
#4. Overpriced Advisory Services
A fourth potential place where excessive fees may be hiding is in the offering of advisory services that offer little or no benefit to plan participants. Some 401(k) plans offer participants the option to engage in financial advisory services, to help participants decide how to allocates their savings in the plan. While such advisory services can be useful, the price charged for them should be commensurate with the value of the service provided.[15]
ERISA Helps Protect Your Retirement Savings Against Excessive Fees
In recognition that workers have to be able to trust their employers to manage their retirement savings well, Congress enacted the Employee Retirement Income Security Act of 1974 (“ERISA”).[16] Under ERISA, employers and other plan fiduciaries are subject to the twin duties of loyalty (requiring them to act for the “exclusive purpose of providing benefits to participants”) and prudence (requiring them to act with the “care, skill, prudence, and diligence” that can be reasonably expected of them under the circumstances).[17] Offering workers a 401(k) plan that is saddled with excessive fees may well be imprudent, and, where those fees benefit the employer or an affiliate, disloyal as well, in violation of ERISA.
Whether excessive fees are hidden in your 401(k) plan can be quite difficult to discern— while your 401(k) plan must provide you with an annual fee disclosure, those disclosures can be very hard to interpret, as discussed previously on this blog. If you are worried about the fees that you pay as part of your 401(k) plan, or if you believe that your plan is otherwise mismanaged, you can contact a financial fraud and mismanagement lawyer at our firm.
Footnotes
[1] Ian Ayres & Quinn Curtis, Beyond Diversification: The Pervasive Problem of Excessive Fees and “Dominated Funds” in 401(k) Plans, 124 Yale L.J. 1476, 1479 (2015).[2] Christine Benz, 100 Must-Know Statistics About 401(k) Plans, Morningstar (Sept. 4, 2020), https://www.morningstar.com/articles/1000743/100-must-know-statistics-about-401k-plans.[3] Ayres & Curtis, Beyond Diversification, supra note 1, at 1476.[4] To see this, consider an investment portfolio of $100,000 that receives a 4% annual return. If subject to an annual fee of twenty-five basis points (0.25%), this portfolio will grow to $210,000 over twenty years. If it is subject to an annual fee of fifty basis points (0.5%), it will grow to $200,000 over twenty years—a difference of $10,000. And if this portfolio is subject to an annual fee of one hundred basis points (1%), it will grow to $180,000 over twenty years—a difference of $30,000. Because many workers save and invest well more than $100,000 in retirement savings over the course of their career, excessive fees in their 401(k) plans can cost them tens of thousands of dollars. These examples are taken from Secs. & Exch. Comm’n, Investor Bulletin: How Fees and Expenses Affect Your Investment Portfolio (2014), https://www.sec.gov/investor/alerts/ib_fees_expenses.pdf.[5] See Ayres & Curtis, Beyond Diversification, supra note 1, at 1481.[6] Indeed, the Department of Labor (DOL) has noted that the structure of fee arrangements can be complex to the point that it is “difficult for plan sponsors and fiduciaries to understand what the plan actually pays for the specific services rendered.” Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 72 Fed. Reg. 70,988 (proposed Dec. 13, 2007), 2007 WL 4335424.[7] See, e.g., Tussey v. ABB, Inc., 746 F.3d 327, 335–36 (8th Cir. 2014).[8] See, e.g., Morin v. Essentia Health, No. 16-cv-4397, 2017 WL 4083133, at *9 (D. Minn. Sept. 14, 2017), report and recommendation adopted, No. 16-cv-4397, 2017 WL 4876281 (D. Minn. Oct. 27, 2017).[9] See, e.g., George v. Kraft Foods Glob., Inc., 641 F.3d 786, 799–800 (7th Cir. 2011) (denying defendants’ motion for summary judgment on claim that fiduciaries acted unreasonably where they failed to solicit competing bids for recordkeeping services).[10] See, e.g., Bell v. Pension Comm. of ATH Holding Co., LLC, No. 1:15-cv-02062, 2019 WL 387214, at *8 (S.D. Ind. Jan. 30, 2019) (denying defendants’ motion for summary judgment where plaintiffs adduced evidence indicating that defendants failed to understand difference between types of fee arrangement and failed to regularly review reasonableness of fees); Marshall v. Northrop Grumman Corp., No. 16-cv-06794 AB, 2017 WL 2930839, at *11 (C.D. Cal. Jan. 30, 2017) (denying defendants’ motion to dismiss claim of excessive fees based on allegation that it was unreasonable to pay recordkeeping fees as a percentage of plan assets rather than as a fixed amount).[11] See Ayres & Curtis, Beyond Diversification, supra note 1, at 1496–97.[12] See Arielle O’Shea, What’s a Typical Mutual Fund Expense Ratio?, Nerd Wallet (Oct. 26, 2020), https://www.nerdwallet.com/blog/investing/typical-mutual-fund-expense-ratios/ (explaining that fees “vary widely, even among the same type of fund” and imploring investors to “[s]hop around”).[13] See, e.g., Sweda v. Univ. of Penn., 923 F.3d 320, 331–34 (3d Cir. 2019), cert. denied, 140 S. Ct. 2565, 206 L. Ed. 2d 496 (2020) (reversing district court’s dismissal of claim of breach of fiduciary duty based on allegations that defendants included needlessly duplicative, costly, underperforming funds).[14] See, e.g., Braden v. Wal-Mart Stores, Inc., 588 F.3d 585, 594–98 (8th Cir. 2009) (reversing district court’s grant of motion to dismiss claim that defendants breached their fiduciary duties where they offered only retail share classes, rather than institutional share classes).[15] See, e.g., Pizarro v. Home Depot, Inc., No. 1:18-cv-01566, Dkt. 74 (N.D. Ga. Sept. 20, 2019) (denying defendants’ motion to dismiss claim of excessive fees based on robo-advisory service, where fees were not in line with market prices for robo-advisory services).[16] Codified at 29 U.S.C. §§ 1001 et seq.[17] See ERISA Section 404(a), codified at 29 U.S.C. § 1104(a).