31 October 2024

How to Fix the 401(k)

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The 401(k) is in need of a tuneup.

Originally designed to supplement pension plans, 401(k)s have become the primary retirement-savings vehicle for many employees. But critics say the plans are plagued by a variety of ills, including high fees that can eat into investment returns, as well as certain advisers who may not have a legal obligation to work in the best interests of plan participants.

"The system is broken," says Monique Morrissey, an economist at the left-leaning Economic Policy Institute in Washington. "The best way to encourage people to save more is to give them something that will make them confident that if they put more money away, they will have sufficient and secure retirement income."

Here are five suggestions to strengthen the traditional 401(k).

Simplify fee disclosure

High fees are at the root of many of the criticisms lobbed at 401(k)s.

According to BrightScope, a San Diego analytics firm that rates retirement plans, average total plan fees for large 401(k) plans with more than $1 billion in total assets are about 0.34% of assets annually, or $340 a year for an account with a $100,000 balance. However, at smaller plans with $1 million to $100 million in assets, the average is 1.16%, or $1,160 a year. Total plan fees include various administrative costs as well as the expenses built into the underlying investment choices.

It can be difficult for small businesses and plan participants to get a handle on what fees and expenses are attached to their 401(k) plans because the numbers are often buried in the dense, complex and lengthy disclosure documents that became the norm after the U.S. Labor Department in 2012 required plan providers to reveal detailed information about their services and the compensation they receive.

The Labor Department in March proposed new rules designed to make navigation of these documents easier, citing concern that small businesses in particular might be having trouble.

In addition to plan administrative costs, the expense ratios associated with individual funds also can hurt workers' returns, which has led to calls for simpler, easy-to-read disclosure of these expenses, too. Some have envisioned a disclosure similar to a new car's gas-mileage label or energy-cost labels on appliances, says John Rekenthaler, vice president of research at Morningstar Inc.

The left-leaning Center for American Progress, for example, wants funds to carry a warning label explaining how high fees eat into savings, and showing how the fund's fees compare with a group of comparable, low-fee offerings.

"The ability to see that fee metric in a way that signals to them whether they are buying a low-cost fund or a higher-cost fund would be incredibly valuable," says Jennifer Erickson, the director of competitiveness and economic growth at American Progress.

Require plans to offer low-cost index funds

Some critics say that along with better fee disclosure, 401(k) plans need to include more low-cost index mutual funds and exchange-traded funds.

Click here for the full article in the Wall Street Journal.

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