Could the FTC Save Consumers from Hidden 401(k) Fees?

I recently read an interesting article in the New York Times titled Stop the Hidden-Fee Rip-Off. In the article, a lawyer for the Institute for Policy Integrity calls on the Federal Trade Commission (FTC) – a government agency charged with protecting consumers from deceptive, unfair and anticompetitive trade practices – to ban “hidden fees in all industries.” I could not agree more. Hidden fees make it harder than necessary for consumers to make informed buying decisions. I think the FTC should start with hidden 401(k) fees given their impact on retirement’s affordability.

The Department of Labor’s 408b-2 and 404a-5 fee disclosure regulations are supposed to inform workers and employers - who have a fiduciary responsibility to pay only “reasonable” 401(k) fees on behalf of their workers – about their 401(k) fees. They’re not working. Recent studies from the Pew Charitable Trusts found that only 17% of workers and 19% of small to midsize business leaders are “very familiar” with their 401(k) fees.

This confusion is a big problem when you consider how much cost matters when saving for retirement. 401(k) fees can cost a worker hundreds of thousands in lost principal and compound interest by the time they retire. To best manage these losses, 401(k) fees must be transparent.

No 401(k) plan is free. All 401(k) providers charge fees for delivering plan administration services. Given their drag on retirement savings, none of them should be hidden. I think the FTC has the power to ban hidden 401(k) fees. I hope they do.

What are Hidden 401(k) Fees?

401(k) providers can charge direct and/or indirect fees for delivering plan administration services such as asset custody, participant recordkeeping, Third-Party Administration (TPA), or investment advice. The difference between the fee types is how they are paid. Direct fees can be paid by the employer or allocated among plan participants, while indirect fees reduce the returns of plan investments.

Indirect fees are often called “hidden” 401(k) fees because they lack the transparency of direct fees. While the dollar amount of direct fees must be explicitly disclosed in 408b-2 and 404a-5 fee disclosures, plan financials, and participant statements, indirect fees can be estimated in 408b-2 fee disclosures, buried in 404a-5 fund expense ratios, and not appear at all in plan financials or participant statements.

There are three basic forms of hidden 401(k) fees:

1. Revenue sharing – Mutual fund companies add these fees to the operating expenses of some share classes and then pay them out to plan service providers. 12b-1 and Sub-Transfer Agency (sub-TA) fees are the two most common forms of 401(k) revenue sharing.
2. Wrap fees – Many insurance companies offer variable annuities as 401(k) plan investments. A variable annuity is basically a mutual fund that’s been “wrapped” by an annuity contract. The wrap can add administration fees, sales commissions, and surrender charges to the cost of the mutual fund.
3. Sales Loads - Mutual fund companies can add a “load”– a form of sales commission – to the shareholder expenses of their funds. A front-end load is paid to a salesperson when shares are bought, while a back-end load is paid when shares are sold. The most common load-paying share classes are A, B, and C shares.

Why Direct 401(k) Fees are Better

Transparency is hardly the only advantage direct 401(k) fees have over hidden fees. Additional advantages include:

• Direct fees can better match service level – hidden 401(k) fees are usually based on a percentage of assets. As a result, their amount increases automatically as plan assets grow. That’s a problem when you consider the primary driver of a 401(k) provider’s service level is employee headcount, not assets. This disconnect can result in a 401(k) plan with lots of assets paying much higher fees than a comparable plan with fewer assets for the same level of administration services. That’s not right and a recipe for excessive fees. Direct fees can be based on headcount.
• Direct fees eliminate conflicts of interest - Studies show index funds outperform most comparable active funds over time, net of fees. However, index funds from leading providers such as Vanguard, BlackRock, and Schwab pay no hidden fees. To earn hidden fees, a 401(k) provider could block access to these popular funds. 401(k) providers that charge direct fees exclusively have no financial motivation to block them.
• Direct fees can be more equitable – Unless all 401(k) plan investments pay the same rate of hidden fees, participants will pay a different rate of administration fees. That means participants invested in funds that pay a high rate will pay a disproportionate share of administration fees.

In short, there is zero consumer benefit to hidden 401(k) fees. They only benefit 401(k) providers.

About the FTC

I’m no lawyer, but it sure seems to me the FTC has the authority to protect consumers from hidden 401(k) fees. From their website:

Our Mission

Protecting consumers and competition by preventing anticompetitive, deceptive, and unfair business practices through law enforcement, advocacy, and education without unduly burdening legitimate business activity.

Our Vision

A vibrant economy characterized by vigorous competition and consumer access to accurate information.

Our Strategic Goals

1. Protect consumers from unfair and deceptive practices in the marketplace
2. Maintain competition to promote a marketplace free from anticompetitive mergers, business practices, or public policy outcomes
3. Advance the FTC’s performance through excellence in managing resources, human capital, and information technology

How FTC Benefits Consumers

As a consumer or business person, you may be more familiar with the work of the Federal Trade Commission than you think. The FTC deals with issues that touch the economic life of every American.

The FTC is the only federal agency with both consumer protection and competition jurisdiction in broad sectors of the economy. The FTC pursues vigorous and effective law enforcement; advances consumers’ interests by sharing its expertise with federal and state legislatures and U.S. and international government agencies; develops policy and research tools through hearings, workshops, and conferences; and creates practical and plain-language educational programs for consumers and businesses in a global marketplace with constantly changing technologies. FTC’s work is performed by the Bureaus of Consumer Protection, Competition and Economics. That work is aided by the Office of General Counsel and seven regional offices.

Let’s Ban Hidden 401(k) Fees Now!

When 401(k) fees are paid out, savers won’t just miss out on their principal in retirement – they’ll also miss out on the earnings the principal would have earned had it remained invested. Due to the power of compound interest, this cost could be steep. For example, a $200 401(k) fee paid out at age 25 would cost a retiree $11,473.76 at age 70 assuming a 9% annual interest rate compounded daily.

And yet, despite the dramatic impact of 401(k) fees on the affordability of retirement, it’s perfectly legal for 401(k) providers to hide some - or even all - of their fees today. Simply disclosing hidden 401(k) fees has not worked – workers and employers still have no idea how much they’re paying. It’s time to ban them.