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| Lower Fees and Better Disclosure on the Horizon?
Over the past few years, due in large part to the efforts of teachers like Dan Otter and John Moore, the founders of 403bwise, and Steve Schullo, a teacher in the Los Angeles Unified School District, teachers are beginning to appreciate the high costs of many 403(b) plans and learning to ask a lot of hard questions. |
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| A recent wave of lawsuits is shedding even more light on high fees charged to teachers', nurses',
and other employees' defined contribution plans. Such defined contribution plans include 403(b) plans (teachers and not-for
profit employees like hospital nurses) as well as 401(k) (employees of for-profit corporations) and 457(b) plans (employees
of state and local governments). These lawsuits fall into three basic categories: |
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Suits against employers for selecting over-priced investment options (typically mutual funds) for their
employees' retirement plan assets, mainly on behalf of 401(k) plans. |
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Suits against insurance companies who service all types of defined contribution plans claiming that the
insurer took kickbacks from mutual funds in exchange for featuring mutual funds in the insurance company's plan platform,
on behalf of 401(k), 403(b), and 457(b) plans. |
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Suits against insurance companies and certain unions claiming that the insurance company paid the union
to endorse the insurance company's investment products, on behalf of teachers' 403(b) plans. |
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| A common theme in all of these lawsuits is that employees are paying higher fees than they
should be (and thus have less money for retirement) because employers (and in a couple of cases, unions) are not choosing
(or endorsing) the best options for employees (members). The total fees for some plans are close to 5%, meaning that
employees must earn 5% just to break even (more than 5% if you take inflation into account). In years when the market is
down and investments lose value, the mutual fund managers and insurance companies still take their fees, making it that
much harder for employees to realize meaningful returns. Given the choice between high fees and the proverbial money under
the mattress, the mattress may not look too bad, especially since the mattress won't penalize you for cashing out like
many annuities do. When you consider the basic features of defined contribution plans — whether 401(k), 403(b), or 457(b) — the reason for employers' lack of diligence becomes obvious: employers select the investment options, but it's not their money at risk. In defined contribution plans, employees pay the fees and bear the risk of the investment options selected by employers. The contrast with traditional pension plans is stark. With a traditional pension plan, the employer's money is at risk because the employer is liable for the benefits that it has promised. Thus, when investing assets in a traditional pension plan, employers are vigilant about fees and investment decisions because it's ultimately the employers' money at risk. Thankfully, the tide is beginning to turn. We expect the lawsuits described above will have three salutary effects: |
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Putting employers (and unions) on notice that if they fail to act in the best interest of employees when
selecting (or "endorsing") products and investment options for defined contribution plans, they risk being sued. |
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Putting insurance companies and other investment providers on notice that they risk being sued if they fail
to fully disclose their fees and fee-sharing arrangements. |
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Educating employees about the true costs of defined contribution plans. |
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| Coupled with greater scrutiny of plan fees by Congress, the U.S. Securities and Exchange Commission,
and the U.S. Department of Labor, this new round of retirement plan litigation signals a pro-employee change in the defined
contribution plan industry. |
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