The Problem with 401(k) Plans

By James Kwak

Apparently my former professor Ian Ayres has made a lot of people upset, at least judging by the Wall Street Journal article about him (and co-author Quinn Curtis) and indignant responses like this one from various interested parties. What Ayres and Curtis did was point out the losses that investors in 401(k) plans incur because of high fees charged at the plan level and high fees charged by individual mutual funds in those plans. The people who should be upset are the employees who are forced to invest in those plans (or lose out on the tax benefits associated with 401(k) plans.)

In their paper, Ayres and Curtis estimate the total losses caused by limited investment menus (small), fees (large), and poor investment choices (large). Those fees include both the high expense ratios and transaction costs charged by actively managed mutual funds and the plan-level administrative fees charged by 401(k) plans.

What really annoyed people in the 401(k)) industry (that is, the mutual fund companies that administer the plans and the consultants who advise companies on plans) was Ayres and Curtis’s charge that many plans are violating their fiduciary duties to plan participants by forcing them to pay these fees. Various parties connected with a plan (e.g., the named fiduciary, the administrator, the investment adviser) have fiduciary duties, which include duties of prudence (doing a reasonably diligent job) and loyalty (putting the participants’ interests first). Overpaying for investment management and administrative services would seem to constitute a breach of these duties.

The response of the industry has been one of righteous indignation and blanket assertion. For example, Drinker Biddle huffs, “In our experience, most plans are well-managed.”  401(k) plans provide different “services,” so different plan-level fees are appropriate; and high fund fees are OK because “it is commonly accepted that the use of actively managed funds is prudent.”

Just because lots of rent-seekers say so doesn’t make it so. Investment management is pretty close to a commodity business. Even if markets for illiquid assets aren’t that efficient, and even if publicly traded securities markets are a little inefficient around the edges (and I have no problem with rich people putting their excess cash into hedge funds trying to exploit those inefficiencies), paying money to gamble on fund managers is not something that companies should be encouraging their employees to do. There’s no good reason not to just provide a lineup of cheap, big index funds with low costs and low tracking error.

Plan administration is a commodity business, too. I’ve been in 401(k) or 403(b) plans at four companies (one of which changed administrators partway through), my wife has been in plans with two different administrators, and apart from fund choice I don’t recall any differences between them (and I’m pretty attentive to these things).

So yes, most plan sponsors and administrators are violating their fiduciary duties, as I argued in a paper (summary here). Not that they should stay up nights, at least for now. The courts have for the most part endorsed current behavior, probably “reasoning” that if everyone’s doing it, it must be OK. But anything Ayres and Curtis can do to draw attention to the problem of high fund fees and plan fees will help move us closer to the day when workers don’t have to pay for their companies’ poor choices.

26 thoughts on “The Problem with 401(k) Plans

  1. 401k plans are just another example of the masters of the universe getting the government to rig the rules so that they can make gobs of money at the expense of economic mortals. I personally would like to put my 401k in plain old US savings bonds, or plain old bank CDs, with no fees or management. But of course that is impossible, because if I did that then the financial companies couldn’t skim from it.

  2. @ AndyfromTucson
    Although your employer (and especially the “planner” who gets the use of that money, often an insurance company such as Met Life) will try to talk you out of it, I believe that you can transfer part of the money (the vast majority of it over time) to a Roth IRA or traditional IRA (depending on your age and individual tax situation). If you make 1 transfer (rollover) per year (which I believe is the current limit) you can still take advantage of the employer matching in your 401k and yet transfer the majority of your money where you have more choices how to invest and lower fees (say for example at a discount brokerage such as Fidelity or TD Waterhouse)

    Best way might be to consult an CPA or a CFP (Certified Financial Planner) before you make any moves. Here is one good link for info on transfers or the better word is “conversions”:

    Also a “heads up” post on how exactly a lot of these schemes work, and that’s exactly what many 401k’s are, SCHEMES:

    A 50 minute documentary that explains very well how the fund companies (including ETFs) fleece and/or bilk people with fees:

  3. Also, if you have the time, it’s a very long paper and takes time to read, but if you want an in-depth view, Jennifer Taub’s academic paper “Able But Not Willing: The Failure of Mutual Fund Advisers to Advocate for Shareholders’ Rights” is the best explanation I have ever seen on this topic. YES, it is long, but if you want to know what is REALLY going on, this is the one to read (just click the dark blue button in lower right after the link jump):

  4. What is the big surprise. Dave Loeper of Financeware has been documenting and writing about this for a decade. What does the DOL or anyone else do about the ‘problem’; absolutely nothing. So don’t hold your breath!

  5. Gilligan walks in as the skipper is starting a fire.

    Gilligan, go get some wood for the fire.
    We don’t need a fire skipper.
    Never mind that, go get some wood for the fire, Maryann saw a boat out there.

    I don’t see a boat skipper.
    Of course you don’t see a boat, but Maryann saw a boat out there,
    now will you go get some wood for the fire.
    Skipper can you see Maryann?
    No Gilligan, how can I see Maryannn when she’s not even here?
    The same way you see the boat out there.

  6. My company’s plan is sponsored by Fidelity. What if you did not allow sponsors to offer their own plans? Would Fidelity push you into a high fee plan from another vendor (unless they were getting a kickback, but you could eliminate those too)? If Fidelity could not offer their own funds, would they still sponsor programs? If not, then they are saying that offering their own funds is why they sponsor programs.

    BTW – I am in Vanguard index funds, < 0.1% fees.

  7. 401k is another wall street scam. They want to take SS money to continue boosting the ponzi-scheme.

  8. Just another dumb article by another dumb writer who thinks he is an expert because he has participated in a 401k plan.

    One of the main problems with 401k plans is that authors such as this and all the other “experts” spend all their time bashing savings plans, bashing the industry, bashing the advisors.

    The end result is that individuals do not participate or do not participate at the level they should. I am sure the author will find some way to blame everyone else for that, too.

  9. Great article. This is such a pernicious problem. The fees seem small or “reasonable” on a yearly basis, but the cumulative effects of the fees is enormous. They cut large swaths through retirement savings.
    Then, when people retire, an investment advisor recommends they roll over their 401k savings to an IRA. Why? The advisor tells them the fees will be lower. The advisor then recommends an annuity, which has hidden upfront fees of 5-8%, hidden yearly fees and long surrender penalties. The fee fest needs to end. The question is what will make that happen? The Labor department and state insurance departments are captive. The SEC?

  10. It’s none of the above honey. We have to many industries which operate solely to their customers in public, but to thier own benifit in private, behind closed doors. And since we were not there behind closed doors, we can not possibly know what they were doing behind those same closed doors. Or can we?
    The solution will come from a God that most people do not believe in, The Time Police!

  11. I should apologize, I referred to TD Ameritrade as TD Waterhouse above. Many years ago they were known as Waterhouse and even though I know the difference I’ll be damned if I can ever get myself to express it correctly. Kind of like the old Oakland Raiders/LA Raiders thing. I know it clearly in my head, but I’ll be making the same mistake a month from now.

  12. Thank you, James. Great post and grateful for the link to your paper on the same subject in .pdf format.


  13. I agree that fees for defined contribution funds are way too high and far too opaque. However, equity markets driven by index funds would not be healthy – price signals would become meaningless. Passive equity investing is part of the problem not the solution.

  14. “…the use of actively managed funds is prudent.” That’s about as wrong as you can get; years of experience and research have shown that over the long run index funds best actively managed funds hands down.

  15. I have a CFP that charges .9% (point nine percent) fee for managing my IRA. Is that a good deal? What options do I have?

  16. finally someone spelled it out I am a strong believer in everyone opt out of the forced 401K and let the investment community get what they have coming to them

  17. Roll over your 401K to a broker account and trade Index funds yourself. Read up on public chartlist at under the author David Larew think tank charts daily commentary of market direction and trade the market wave buy index low and sell high (top swing). Also read up Tony Caldaro on market cycle Elliott wave, it guides you from the beginning of the Bull market cycle to the end and the beginning of the Bear market. You could never miss the market swings, getting 15 to 25% return is not unusual doing it yourself. I have been doing it for 15 years.

  18. Or you could just do what I do, and hit the casino and figure out your best odds from there. Oh craps, I just won again.

  19. This has been my experience as well. At my job, the company kicks in 2% of your annual salary BUT the sponser of the plan charges 2% or more to run the plan. Effectively, giving the employees nothing. I have removed my money from the plan but none of the other employees even CARES to understand how their money is being assessed….. I wonder who to blame anymore — is it the greedy plan sponser OR a passive, irresponsible 401k investor who is relying on the ‘trust’ of others to be fair with them?

  20. It’s not just the fees of the 401k’s but it’s the 401k problem in and of itself. The concept that millions of American workers are to take control of their own retirement investments is a little crazy. Even if we assume that a good majority, say 80% of participants, do a good job running their 401k – doesn’t that mean we still have millions of our fellow citizens (and their family members) who are going to be in serious financial trouble? And the problem is that we now know it is way less than 80% that are doing well with their 401k. The whole concept to move us to investing in our own little account and the whole proud, strong, independent American is a bogus line. We were much better off when the society had large scale, structured retirement accounts sponsored by employers. And as Gen X moves closer to retirement in the coming decades we will truly see the failure of the 401k fiasco.

  21. Hey, let’s just throw those stupid Hu Mans into an anti-gravity environment. Let’s see how they adapt. I’m investing in that.

  22. As a retired private industry CFO, one thing I regret was not influencing the deceptive 401K presentations by investment companies that showed how you could become a retired millionaire if you participated in the 401k and got an 8-12% average annual return. To compound the damaging effect of this optimism, the effect of inflation was rarely adequately considered and poorly planned for.

    I think that government and politicians promote free spending, no savings, higher debt behavior so that you don’t notice that we are losing ground to better governed nations. Further, individuals are foolish enough to believe in prosperity as an American entitlement without hard work and savings.

    Don’t worry, be happy.

  23. As a retired private cfo you must also be familar with the phrase that, it is easier for a camel to walk thru the eye of a needle, than it is for a rich person to make it to heaven. So it seems that you have made your choice. As for the individuals, it’s easier to fool someone, than it is to convince them they have been fooled, and that’s just what we do here. So I would be worried if I were in your shoes, the question from there is, about what?

  24. The end of the defined benefit era has not been good. As companies no longer have to manage pensions, they increased CEO pay sky high and used those retained earnings for M&A and other shenanigans. I think the stock market run-up in the 1990’s could be partially attributed to the death of the pension plan.

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