A 401(k) is one of the most commonly used approaches in saving for retirement. But thanks in part to the advent—and robust growth—of low-cost funds such as passive ETFs, it has become increasingly apparent that the traditional 401(k) model has serious flaws.
Back in the day, this might not have mattered as much because retirement was addressed by a company’s pension, also known as defined benefit plans. But with 401(k)s, which are called “defined contribution plans,” investors now have several decisions to make in the process, and they have neither the tools nor the help to do so from plan sponsors.
This matters because we are talking about a 401(k) market that already exceeds $4 trillion today, and solving the retirement puzzle is increasingly an issue with a U.S. working population that’s quickly aging, and mostly underinvested.
In most current 401(k)s, good luck trying to figure out how to navigate the sponsor website to determine how much you are paying for your funds, or even what funds you actually own. This lack of transparency is the first hurdle investors face, Grant Easterbrook, co-founder of Dream Forward Financial, a company that focuses exclusively on 401(k)s, told us.
“There’s no transparency on fees; there are complicated disclosures; there’s a lot of ‘legalese,’” Easterbrook said of a typical 401(k) plan and sponsor website. “It puts the burden on investors’ shoulders to figure it out, which is why the retirement system isn’t really working.”
Beyond transparency, there are three key issues with most 401(k) plans today:
1. High Fees
Calculating 401(k) fees is “notoriously hard,” but the average cost an investor pays for a work-sponsored 401(k) plan today is about 1.44 percent a year of total assets invested, according to data cited by Easterbrook. That’s an average, which means there are plenty of plans charging less than that, and plenty charging more.
But consider that an ETF-centered 401(k) plan Easterbrook put together costs approximately half as much—75 basis points, or $75 for every $10,000 invested—and his company is still going to be perfectly profitable. That 75 bps covers all plan sponsor fees as well as any fees associated with individual funds.
Lower price tags on retirement plans should be the norm, not the exception, but investors are catching on. An example of that is Fidelity, which settled lawsuits alleging that it was overcharging employees by offering expensive funds, and profiting at their expense. Fidelity is the largest retirement plan provider in the country today.