By James Kwak
Ted K. points out (and comments on) Stephanie Fitch’s article in Forbes on Wal-Mart’s 401(k) plan. The crux of the matter is that Wal-Mart seems to have done a lousy job creating a good 401(k) plan for its employees. Until recently, it had ten funds, only two of which were index funds; the other, actively managed funds all had high expense ratios (the ones Fitch quotes are above 1 percent).* More shockingly, the expense ratios paid by plan participants were the same as the expense ratios paid by individual investors in those mutual funds. It didn’t even pool its employees’ money together to get institutional investor rates. The irony, of course, is that Wal-Mart is the world’s best, most powerful negotiator when it comes to getting low prices for the stuff it sells, yet it exercised no negotiating power in getting low prices for its employees — even though it had $10 billion in assets to swing like a club.
One allegation of the current lawsuit is that Merrill Lynch, which administered the plan, may have chosen funds for the plan because of (legal) kickbacks it was getting from the fund managers. In other words, Merrill was pushing specific funds onto Wal-Mart employees because it was effectively getting sales commissions for those funds. This is classic banking behavior, of course, but it’s a bit of a mystery to me why Wal-Mart would put up with it; since it’s just as easy for Wal-Mart to create a good 401(k) plan for its employees as a bad one, why did it create a bad one? (I don’t actually think Wal-Mart would actively go out of its way to screw its employees if it didn’t benefit it some way.)
I say it’s classic banking behavior, because of course banks will try to sell you products that give them bigger profits; it’s their interests they have in mind, not yours. The basis of the lawsuit, however, is that Wal-Mart violated its fiduciary duty to plan members under ERISA. Unfortunately, the fiduciary duties under ERISA seem (as far as I can tell on a very cursory reading) to be pretty flimsy, having to do mainly with disclosure. In other words, you can create a lousy plan for your employees; you just have to tell them all about the plan so they can figure out that it’s lousy. (And in any case, since most employees are effectively captives of their employers, there’s nothing they can do about it, anyway.)
401(k)s are in many ways a feeble substitute for traditional defined-benefit pensions. Among other things, unless you get an employee match, it’s all your money — your employer isn’t contributing anything. The tax deduction you get from a 401(k), like all tax deductions, is valuable in direct proportion to your marginal tax rate and the amount you are able to put aside, meaning that it is extremely regressive. But still, it’s a modest benefit for working people (and a better benefit if there’s an employer match). However, like all investments, the tax benefits can be rapidly swallowed up by fees.
One hundred years from now, people will look back and say we were all suckers for paying expense ratios of over 1 percent to fund managers who generally fail to beat the market. Unfortunately, we will all be dead before then, and in the meantime we’ll be paying those fees.
(This is what Wal-Mart had to say about the issue: “We are proud to provide a high-quality, innovative retirement plan to help more than one million of our Wal-Mart associates prepare for the future.” Reminds me of something Google recently said.)
* I don’t think having a small number of funds is bad in itself. Too much choice can be counterproductive, especially if some of the choices are bad; it’s better to have three cheap funds than to have three cheap funds and seven expensive ones.
The Baseline Scenario 
Maybe some executives from Walmart were taken on a real nice holiday and got to hang out with some famous people and got their kids helped into Harvard. That’s how it works where I live.
They most likely get a break on the administration fees (which can be considerable, especially with lots of low balance accounts) in exchange for letting Merrill screw their employees with high expense fund options.
Bingo. They almost certainly made the decision based on Wal-Mart’s bottom line.
Wal-Mart is not alone; my own company’s 401(k) plan offers limited options and all of them have high expense ratios (except the S&P 500 index fund). This sort of decision makes no sense unless it is somehow cheaper for the company.
I always thought this was common knowledge and standard practice… Not that that makes it any better, but singling out Wal-Mart in this instance is not entirely fair.
Employee-paid plans often have high fees even on index funds. It’s not uncommon to see an S&P 500 fund with an 85-basis point expense ratio. It ought to be criminal.
This is general illustrates the weakness of the 401k system. There’s actually something worse–the 403b. With the 403b, there are even fewer fiduciary duties. In fact, most “plan administrators” purposefully make no effort in selecting vendors so as to avoid getting sued.
The only options end up being those provided by the most aggressive players, those who can get the biggest fees for all the effort expended. That would be people like AIG peddling super-high-cost insurance products like variable annuities, where you pay extra fees for a tax benefit that is redundant (because 403b is already tax deferred). ANd you are often stuck in these products because of ruinous redeption fees.
Who gets hurt by 403bs? Teachers, hospital workers, people at nonprofits. Thanks, insurance industry.
There’s really no reason why savers need to incur the massive administrative costs of hundreds of thousands of 401k and 403b plans chasing the pretty same group of maybe a few hundred mutual funds. States or the Treasury–or maybe even the Social Security system–should offer every employer a “safe-harbor” collection of funds that have fees negotiated down by the massive bargaining power that would be possible. You would have lower fees, portability from job to job (without having to do “rollovers”), lower administrative costs per beneficiary, and better choice.
529 plans have already started us down this road. Australia does it with “superannuation.”
But of course, the insurers and mutual fund cos would fight it tooth & nail.
I think it’s ridiculous that workers should have to put their hard-earned savings into a company-defined 401K to begin with. We should have the right to put any or all of the maximum-allowed 401K contribution into any retirement investment vehicle at any institution we please, from a retirement savings account at our local bank to an active trading account at a discount brokerage firm. Why in God’s name should we have to wait to leave a company to have control over our contributions. The fact that we are REQUIRED to have wall street firms manage our 401K contributions via high-fee mutual funds while we are employed at a company is the biggest and least-acknowledged example of how wall street controls congress. It makes me want to puke.
Well, I think you guys have all covered it. 401k plans are another Wall Street racket. Why are they the way they are? Let’s see: lobbyists, Congressional pandering to campaign contributors? Just be greatful Clinton and Bush didn’t succeed in turning Social Security over to Wall Street.
“Just be grateful Clinton and Bush didn’t succeed in turning Social Security over to Wall Street.”
Exactly! They were all so sure that would be the best way to secure a healthy retirement. Can you imagine the bigger mess we’d be in now if it were allowed.
I can basically sum up Congress and our economic policy makers in one phrase:
So many Ivy league educations. So many ineffectual clowns.
Proof that government is better than private enterprise. The federal employee Thrift Savings Plan has an expense ratio of .019% Yes, that is a 0 after the decimal point. It offers 5 or 6 cash, bond, and equity index funds options, plus several Lifecycle funds. Several of the funds are managed under contract by Blackrock. They Feds obviously negotiated a good deal, because the Blackrock managed funds have the same .019% expense ratio. This is what you get when you have administrators whose job it is to aid employees, not the to see how much the company can get away with. I have also worked with several non government 401K plans. They basically don’t care about the employees, but I think the reason is not really as nefarious in one sense as the article suggests. My experience has been that decisions on what to offer and how it should be administered at what costs are trusted to amazingly low level employees who have no idea what they are doing and who can be bought for a hot dog.
People won’t look back 100 hundred years from now saying we were suckers for paying 1% fees. They will say we were suckers for investing our dollars in public companies with no real governance allowing the management to legally filch from the shareholder large amounts of money.
Is it really that the federal government is such a good negotiator and cares so much about it’s employees?
Count me in the cynical camp that expects to see a fee that is not passed on to the plan participants. Somebody has to pay for the record keeping etc, and I don’t think that it is Blackrock out of the goodness of their heart (or whatever passes for one in a financial firm). I would have gold plated benefits too if I didn’t have to worry about a profit/loss statement and just cared about keeping the workers happy.
I don’t understand why the contribution limit for IRAs ($5,000 in 2010) is so much lower than the contribution limit for 401(k) plans ($16,500 in 2010).
The 401(k) plan does offer some advantages, including an easier method to essentially dollar cost average into the market at each paycheck. But, I think I would rather contribute to an IRA so that I could select the funds that I want at a discount brokerage. Companies have reduced or eliminated their matches, which makes investing within a 401(k) (as opposed to an IRA) less appealing.
I understand the cynicism, but the general consensus around town (in DC, where I live), is that the TSP is run efficiently (as is the health program, FEHB). The Federal Retirement Thrift Investment Board, which runs the TSP program, is an independent Government agency. The five members of the Board and the Executive Director are required by law to manage the TSP prudently and solely in the interest of the participants and their beneficiaries. That explicit fiduciary duty alludes to what JK says in the article as something private plans apparently lack. Money in the TSP and earnings on that money cannot be used for any purpose other than providing benefits to participants and their beneficiaries and paying TSP administrative expenses, which are low, as I mentioned. The Board has contracted with a number of private sector companies to provide record keeping services for the TSP, which include maintaining the accounts of TSP participants, processing requests for benefits, and providing call center support. I imagine that a lot of other expenses are pushed onto the agencies, but these are not passed on to the employees.
See my further comment, posted below.
Pitiful. My spouse’s choices include 1 and 2 star funds. If you want small cap or international you get a very poor performer with an outrageous expense ratio. And this is a plan sponsored by one of the largest banks in the country. We always joked the funds paid kickbacks because why on earth would anyone otherwise choose them.
Simple – look for payoffs to the plan’s Walmart administrators.
James,
In the 4th paragraph, it seems you might mean “employer match” rather than “employee match”.
Considering Wal-Mart has been nailed over and over again for their mistreatment of employees, singling them out on yet another issue is exactly the right thing to do in my opinion. They’re a huge employer that pays very poorly for most of their workforce, and fought pretty actively against giving them benefits in the past. Unless you shine a light on their behaviors, they won’t change.
Social Security is a Ponzi scheme. Watch it and Medicare go completely bankrupt when the boomers start retiring next year, and the rest of us that have been paying in will get nothing out when we retire.
401K plans and health insurance are two components in the “unacknowledged” employment contract that helps employers hold employees hostage
. . holds employees hostage or offers them security, it’s all the same in the end — any form of “security” holds us hostage.
Thanks James for an interesting and useful article.
This is a general problem with so many corporate 401K plans: they really rip the captive participants off with exorbitant fees.
This is also true for some Solo 401K plans hawked to freelancers and independent contractors (cough, ADP, cough, cough) …
Of course, one advantage (to government) of 401Ks and Individual Iras over large defined benefit corporate plans, on a macro level, is that, when mismanaged or underfunded, these accounts do not socialize their losses by becoming the responsibility of the taxpayer.
“Mistreatment of their employees. . .” Maybe you guys are going a little overboard. No one’s falling into lard vats and boiling to death here.
Yes, of course, 401k plans are not as generous as the fat, old pension plans, but they’re not that bad. The problem is that so few people start putting money into them in their 20s as they should. And yes, stock markets can go down, but I think we’ve all learned some healthy lessons in the last 18 months. Oh wait, maybe not since I guess many did not learn the lesson back in 2000.
Posts like these remind how much I can dislike this blog. I’ll keep reading it because there are so few channels with such rigorous analysis of the issues, but surely it’s healthy for individuals to bear some of the burden for their own retirement.
The 401k losses may not socialized, but feeding, clothing and medicating the destitute pensioners does remain the responsibility of the taxpayer.
I think the post was not about 401k versus old pension, but that the employer needs to do some work to make the 401k work well. If you have high expense ratios, saving early won’t save you. Wal-Mart doesn’t want to do the work on their 401k and let the banks screw their employees instead.
Most traditional defined benefit pension plans are overseen by a group of employee representatives elected or at least ratified by the employee-beneficiaries. The job of the overseers is to provide some kind of check on the tendency of Companies maintaining the plans to screw the employees in pursuit of revenue (i.e., bonuses).
401(k) plans have no such oversight board. Hence, yet another way in which defined contribution plans are a worse deal than defined benefit to the employees.
The ERISA law could be amended to mandate employee oversight. This would not solve all the problems, since not many employees have the expertise for meaningful oversight, and the elections/ratifications can be rigged by the company. Again, financial services lobbying efforts would have to be overcome.
In the words of Paul Krugman, “We’re Doomed”.
15 years ago my employer paid all the administrative costs of setting up and running my 401-k.
10 years ago they dumped that cost onto the employees in the plan.
5 years ago they started selling the right to rape their employees with fees.
This isn’t news unless you weren’t paying attention. This could so easily be fixed if the government allowed us to roll 401-ks into IRAs while still employed. Of course they won’t but have you ever wondered why they won’t?
Oh. Since there is no actual torture going on, the idea that employees might be mistreated is gratuitous hyperbole.
Also -it’s healthy for people who have no clue about how finance works, might be working two jobs to make ends meet, have family responsibilities and a home to maintain to also have to follow the stock market and take responsibility for getting their meager accounts skimmed by high rollers.
Yeah – if that’s the way you think, why do you read here?
Holy Moloch on a Unicorn
JzB
Geesh, those fees are criminal (or should be). Why more companies don’t just use vanguard is something I’ll never understand. Although I have to imagine that most Walmart employees would be better served by contributing to a Roth IRA administered by a company of their choice over Walmart’s 401k plan, at least for the first $5k of savings a year (assuming that they are far enough away from retirement to make savings from tax free earnings worthwhile over the upfront tax-break in a 401k).
Oh, so its NOT OK for the crooks on Wall Street to control our 401Ks, but it IS OK for the crooks in Congress to keep control of our Social Security contributions?
Any sensible person would choose to invest every dollar of their payroll taxes in the equity market rather than the required portfolio of Treasury bonds. Think about it: the private sector is WHAT GENERATES THE WEALTH to pay the interest on the Treasury bonds (via taxation).
I can’t get over how many people miss this simple relationship. In the end, if there is no “equity premium” (stocks outperforming T-Bonds), there is no economy, no market AND NO GOVERNMENT.
Ben burbles:
They do. It’s called Social Security. Bismark invented it.
You don’t pay any fees to people who, if they really could beat the market, would be a lot richer than they are, and you aren’t risking retiring into a market collapse.
Of course, whether those are features, or bugs, depends on where you sit. To banksters, and their apologists like Ben, they’re bugs.
How could it be a surprise that Wal-Mart would design a so called benefit that would not actually be of use to their employees?
Ben is rather clueless if he thinks employees are all going to be little warren buffets while overpriced funds slowly steal away what little return they have.
If you want to talk about bad retirement plans, I’ll point you to a city 403(b) that was MANDATORY back when I had a part-time coaching job at a city school. It was run by Great West. I got essentially no choice and no information about costs or returns. I was enrolled on hiring and the money came right out of my paycheck. When I left the job, I had to call Great West because their website was useless and inaccessible, but the first office I called didn’t have the right piece of paper to mail me. After talking to multiple offices for a period of a few months, I finally got someone to mail me the piece of paper, which I had to mail back. This happened within the last few years. I was amazed at the total lack of web access or other easily-accessible information and the dependence on systems that must date to the ’70s. Also I made basically nothing on the investments (at least they didn’t lose any of it).
Still more recently, when I had an employer 401k with ADP, the fees were ridiculous but everything was opt-in, fully disclosed, web-accessible, and easy to operate. It was a good deal for me because of the match. If it hadn’t been a good deal, I wouldn’t have signed up for it. Wal-Mart employees are in the same position, although they ought to get more of the benefits of economy of scale – but is anyone not sophisticated enough to understand the plan really getting paid enough that a 401k is relevant to their retirement planning?
Aside from dividends, you get money from the market by selling stock. Who would buy all the stock that boomers would have to sell?
Ben – you’re a wanker
Before y’all canonize the TSP plan, consider that it has a woefully small number of choices, and completely ignores major asset classes – like REITs, for example. Gov’t employees would have gladly paid even outrageous fees for the opportunity to include this asset class during its years of marvelous outperformance in the last Bull Market (and in the current one). Ditto for global resources, and ditto for individual styleboxes – the performance differentiation of individual smallcap and midcap stylboxes over the overly-broad Completion Index (TSP “C”), for example, has been very, very large in many time periods – and easily capturable, if only the choices were there.
Give me complete coverage of all styleboxes and major non-stylebox asset classes, complete with fees, and you can keep your low-fee, limited-choice menu…and I’ll beat your pants off every time.
Of course, the ideal would be complete coverage with low-cost index funds – and that’s how I design plans for clients.
correction to prior post – reference to TSP “C” fund should’ve been TSP “S” fund.
Soc Sec is a Ponzi Scheme, but it is legal and enforced and even when things are at their worst it will be able to pay 75% of promised benefits, which frankly I’m planning not to need, but still will be enough to keep poor and unlucky people from eating dogfood. Calling it bankrupt is just ignorant propaganda. As for Medicare, it’s Admin costs are about 3%, far below public insurance, and the ‘fraud and waste’ people wail about is less (per $ spent on benefits, and in total) than public insurance companies. I’m not saying either program is perfect, but for god’s sake learn something before spouting nonsense and encouraging people to cut off their nose to spite their face.
I also would prefer to invest those funds myself, but most people would be really good at blowing their entire retirement. Also, I think the real issue was to avoid Gov’t investing in companies, picking winners and losers and having other nasty effects in the open market. The thing about social security is it’s about as secure a system as can be divised to prevent senior poverty – it has been resoundingly effective at accomplishing it’s goal – and that’s why it’s the third rail, even if it could produce better ‘returns’ over the long run. Just my 2 cents.
@billshrm: May I humbly suggest that you have no idea what you are talking about? Every study has shown that differentiation of the type you propose leads to worse financial outcomes for employees, not better. That is why the TSP wisely has rejected entreaties from people like yourself, most of whom have a vested interest in pushing over-priced mutual funds with high expense ratios on employee plans. And BTW, if complete coverage with low cost index funds really is, as you say, the “ideal”, then you should be very happy. That is precisely what the TSP offers today.
James, great article, I love this topic. My wife has an account via her employer and Edward Jones that just rapes the participants, excuse the explicit imagery. She literally cannot invest for less than about 3%, but in most funds she’s paying 5-7% up front. I went through the prospectus and found 13 different fees of various types, they get you coming and going. We invest in the money market account, just enough for matching, and I’m going to try to xfer it out when it hits a few thousand dollars (anyone ever try this while still employed? theoretically, I think it can be done.) In contrast, my employer has an awesome plan, I pay on avg .35% combined between the plan fees and fund fees, with over a hundred (!) funds to choose from. I really don’t understand why they arent all that way.
“The irony, of course, is that Wal-Mart is the world’s best, most powerful negotiator when it comes to getting low prices for the stuff it sells, yet it exercised no negotiating power in getting low prices for its employees — even though it had $10 billion in assets to swing like a club.”
Seconding antiani, when the world’s experts at screwing their buying prices do *not* bargain even half-way intelligently, it’s due to corruption.
You raise a good point. (Still, when I look around at the sheer numbers of homeless and destitute, support from the taxpayer looks anything but mandatory.)
By contrast, large corporate pension funds that are insured by the federal government (because the pension funds pay insurance premiums to the government) do become mandatory responsibilities when the corporations fail, bungle, cheat, mismanage etc. The beauty of this arrangement is that said insurance premiums are insufficient, but the government must still pick up the tab.
Social Security and Medicare will not go completely bankrupt. Benefits, however, will have to be trimmed substantially and taxes increased because of the aging population.
“the private sector is WHAT GENERATES THE WEALTH to pay the interest on the Treasury bonds (via taxation).”
Such ignorance. You think that government does not create wealth? Was there no value in rural electrification? Was there no value to the Interstate Highway System? Was there no value in defending the country in the world wars and against terrorism? Was there no value in the creation of public schools and universities?
You have your head so far up your a$$ that I’d bet that you can see daylight!