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Retirement Planning: Justifying Fees, Part One January 26, 2009

Posted by retirementwithaplan in retirement, social security and pensions.
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Let’s begin by asking the same questions that Richard Glass posed in a paper dated September 2008. He wrote: “Underlying the current spate of lawsuits over 401(k) fiduciary misconduct (particularly fee levels, revenue sharing, self-dealing, and active versus passive management) is a simple question: Are participants getting their money’s worth for the fees they pay?”

012609nts_crzMany of us 401(k) plans and an equal amount of us have seen loses the likes of which we have never before witnessed. For some of us, this is simply too much to handle. These folks were not well versed in the risk and the nuance of investing and their subsequent defeatist attitude is part of the question. For some of us, those loses caused us to re-think our allocations, re-balance our portfolios and otherwise run for the most conservative offering(s) available in the plan. Some of us are simply upset that we are continuing to pay fees for something that we feel should have been better managed.

In other words, we have fiduciary angst. A fiduciary acts like a gatekeeper and if they are responsible, they do their job by tempering excesses and reigning in risk and fees. Keeping costs manageable is key to the overall success of any retirement plan. Those costs eat away at gains and exacerbate losses.

In your plan, these folks have to monitor the performance of the funds they offer. Mr. Glass writes: “If active management’s value proposition is found to be on “shaky grounds”, then fiduciaries will have to redefine the 401(k) plan’s overall value proposition to participants. Even if the value proposition of
active management passes with “flying colors” (and there is much evidence to conclude that selecting consistently “good” performing active managers without the benefit of 20/20 hindsight is fraught with problems), it will still be prudent for fiduciaries to reevaluate how their 401(k) plan is designed and then communicated to employees. After all, what good are the best funds when participants’ accounts are “bare cupboards”?”

A fund’s performance is always difficult to predict. And although you can approach your fund selection with a certain criteria, low fees, tenured managers, and good comparables to similar types of funds, the standard by which those carrying the fiduciary responsibility with directing those choices does not exist.

And if it did, what would it look like?

Should it be based on skill or luck? How can you judge an actively managed fund and the fees they charge? Do you determine fair value by comparing them to indexes?

The plan’s run into several problems. First is participation. Fully 40% of the people involved in a defined contribution plan contribute 3-6% of their incomes. These same people have high post-retirement expectations but no real grasp on the reality of such a calculation. Those same people do not account for inflation’s effect on those plans. Almost 42% of the folks questioned about their retirement responded that they simply don’t think about it. Even now, after the market has melted. Non-participants may even feel vindicated for their inaction.

Although it is unclear whether the fiduciary thinks so, but plan participants generally assume that ERISA guidelines (long-term promises, lifelong retirement income, government insurance, a central pool of assets, and required
employer contributions) apply to the 401(k). In fact, lawyers worry that a judge, deeming the possibility that they should be all of those things, might rule in favor of many of the pending lawsuits headed towards the court system.

ERISA, or the Employee Retirement Income Security Act is designed for pensions. In the act Mr. Glass points out that , “ERISA designates employers as the focal point of its regulatory scheme for two major reasons: (1) to secure the defined benefit promise for workers and (2) to protect the government’s interest in the financial health of these plans.”

According to the act, the Department of Labor states “the Employee Retirement
Income Security Act of 1974 (the Act) provides, in part, that a fiduciary shall discharge his duties with respect to a plan with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” Should your 401(k) have similar constraints?

Not necessarily. What they should do instead is educate. Each plan participant should know what they might have for retirement if they continue on their current course of investments, how their post-retirement life will look, and how to improve those standards.

I want to leave you with this quote by Julius Stone as we move on to part two of Justifying Fees. Keep in mind, the fiduciary can make some changes that will benefit the employees, the future of those retirements and ultimately, their own legal standing in the matter. Because if they don’t, the consequences could be dire for the current incarnation of the 401(k).

“Where the law is silent or unclear the judge must decide the case as if he were a
legislator, still sounds strange to us, even after a century of demonstration… that this is what in fact happens daily in our courts.”

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