Monday, July 13 1998

By Julie Tripp, Oregonian columnist
 

Too many Americans are paying too much for too little with their 401(k) retirement savings plans, and U.S. Secretary of Labor Alexis M. Herman wants them to wise up.

 To speed the process, she's taken to the stump to promote her department's new booklet, "A Look at 401(k) Plan Fees." Even a small increase in the percentage of fees paid to a plan administrator can radically affect a retirement account.

 Herman brought home the point in a recent interview with the example of $25,000 deposited in a 401(k) growing at 7 percent per year. After 35 years, it was worth $227,000, assuming fees of 0.5 percent per year. But it was worth only $163,000 if fees were 1.5 percent.

 Because 401(k) participants have $1 trillion riding in the accounts, fees and how to find out if they are "reasonable" is the topic of this column. The law says fees must be reasonable but never establishes a limit or a definition.

 401(k) plans allow workers to deposit up to $10,000 annually into investment accounts from pre-tax income. (The amount is adjusted annually for inflation.)

 Employers generally contract with a plan administrator, which can be an insurance company, bank, brokerage or mutual fund company. The administrator and employer devise a menu of investments, ranging from conservative cash instruments to volatile growth stock funds, hoping their employees will diversify among several choices. To encourage participation, two-thirds of employers match the employees' contributions.

 Currently, 27 million Americans have an average $40,000 in a 401(k) with eight investment choices, reports David Peckman, principal of the 401(k) Forum, a San Francisco-based advisory service for plan participants. But 80 percent of participants aren't getting any advice about how to best use the plans, he said.

 With fees, for instance, who knows what is "reasonable"? If your plan administrator makes 1 or 2 percent annually on your account -- $400 or $800 on the average -- is that enough? Too much? And in the recent bull-market environment, where every fund seems to make double-digit returns, who cares?

 "People aren't sensitive to fees," notes a Portland adviser to 401(k) plans, Bill Parish. "You can show them charts that show their lifetime savings are being plundered" and it's still hard to get their attention, he says.

 But as the labor secretary emphasized, a small percentage becomes a big deal over time. And you can bet investors would howl about fees if the market turns downward, and fees make the difference, say, between a fund that's a winner or loser.

 Fees of 1 percent might mean your 30 percent return on a growth fund drops to 29 percent, a 3 percent decline. But a one-point difference on a bond fund earning 7 percent is a 14 percent decline in your return.

 Mutual funds have different costs of doing business, depending upon the type of fund. Their management fees, the ongoing expenses of managing the assets in the fund, reflect the differences. A bond fund wouldn't have brokerage commission expenses and should be lower in fees than, say, an aggressive growth stock fund that buys and sells many stocks. International funds cost more to manage because operating in foreign markets is generally costlier.

 To find out the expenses of the funds in your plan, which are expressed as a percentage of total assets, ask your company human resources department or call your plan administrator. The information also is included in the prospectus for each fund.

 Then compare your expenses with averages for like funds.

Morningstar, the Chicago mutual fund research company, on Friday figured these average expense ratios for six fund types among several hundred funds in each category:
 

 But Parish, the Portland plan adviser, takes it much further. Participants in 401(k) plans should not be paying retail expense rates; they should be paying what institutional investors pay. Their size gives them a volume discount to half the retail rate.

 Other feet-to-the-fire suggestions from Parish include:

• Holding plan administrators accountable for comparisons with broad market benchmarks. He thinks participants should be told, for instance, how their funds did relative to the actual performance of stock and bond indexes.

• Giving employees more investment choices, including index funds that mirror performance of stock and bond markets and don't require portfolio managers to pick stocks. Many plans don't include index funds because administrators earn far less on funds they don't actively manage, Parish says.

• Checking stock-turnover rates within funds, which reveals how much of the fund's content is sold and how often, thus incurring more commission costs.

 "Any fund with a 100 percent turnover is not an investment fund, it's a casino," Parish says.

 One local company with 110 employees hired Parish to check out its plan and ended up switching from Columbia Funds to Vanguard, he said.

 "Columbia has great stock funds," Parish said, although he had some reservations about the high turnover in the Special Fund. "But they don't have index funds."

As of July 1, the company plan now has ten Vanguard funds, including five index funds and five others representing real estate, health care, energy and big companies. And the overall expense average is under 0.5 percent, he said.

 "It's the best 401(k) plan I've ever seen," Parish said.

 R. Theodore Benna, a Pennsylvania benefits consultant whose major role in creating the idea has landed him the title "Father of the 401(k)," reports that the problem of excessive fees generally occurs with small plans.

 "The issue is more significant with companies which have fewer than 100 employees," he says. Often, an insurance company or brokerage bundles several "name" brand funds together, then tacks another fee on top of the management fees already included within the funds.

 "So the total can be 2 or 3 percent of a participant's assets," he warns. Benna thinks administrators should be required to make clear disclosure of fees.

 "Then participants can judge whether they are getting value or not. In too many instances, someone is getting the fees without providing extra services."

 Benna advised the Department of Labor and suggested it should consider making plan administrators who don't fully disclose their hidden fees put a warning label on their fund prospectuses.

 Employees who question their plan's fees or its investment choices, should put their questions in writing, Benna says.

 "Write the benefits person at your company, and make it specific -- not just 'Our plan stinks.' "

 Workers can clearly have an impact on what their companies decide, Benna says. It's not all altruistic, either -- if employees begin to drop out of the plan, the decision-makers can't contribute as much to the plan as they might want because of the so-called discrimination rules that require contributions to be distributed over all income levels.

 Employers can listen, and either monitor the plan themselves or hire third-party consultants to assess fees and investment choices, on a voluntary basis. The Department of Labor, so far at least, has not demanded more explicit disclosure requirements.

 To get the free booklet on fees, call 1-800-998-7542; or read it on the agency's Web site at www.dol.gov/dol/pwba.

Julie Tripp's column appears each Monday. She is pleased to answer questions, but she does not give financial advice. Contact her via e-mail at julietripp@news.oregonian.com or by writing her at 1320 S.W. Broadway, Portland, Ore. 97201.