The rules governing America's most popular retirement vehicle are about to change, and that could mean huge savings for millions of workers building nest eggs for the future.
Spurred by the U.S. Labor Department's effort to force plan administrators and investment companies to disclose the cost of 401(k) retirement plans, companies are looking to reduce fees and offer new investing choices.
Under current rules, it is difficult—if not impossible—for many 401(k) participants to determine how much they are paying in fees. The fees, which vary by type and size, aren't typically disclosed in annual statements to investors. Because of the extended time frame involved in retirement accounts, a small percentage change in an annual fee can make a big difference in the investment performance.
Analysts and companies in the industry say the increased disclosure will allow companies to negotiate better deals and employees to request more cost-efficient plans. Already, the prospect "is putting downward pressure on fees," said Lori Lucas, leader of consulting firm Callan Associates Inc.'s defined-contribution practice.
The Labor Department had hoped to roll out the rules by Jan. 31. A department spokesman said it would likely happen within a few weeks.
Fidelity Investments, ING U.S., Manulife Financial Corp.'s John Hancock unit and BlackRock Inc. in the past few years have rolled out low-cost index mutual funds alongside their higher-fee actively managed funds.
On Jan. 10, Charles Schwab Corp. introduced a new 401(k) product consisting only of inexpensive index funds.
Employers, for their part, are shopping around their retirement-plan business more aggressively. Fidelity Vice President Beth McHugh said the firm is seeing companies "doing more due diligence to make sure they're comparing what they have with what's available out there in the marketplace."
Kevin Crain, head of Bank of America Merrill Lynch's institutional retirement business, said his firm had a record number of requests for proposals in 2011.
401(k) plans have grown in prominence since an Internal Revenue Service regulation in the early 1980s allowed workers to contribute their own money to the accounts on a tax-deferred basis. By 1990, 401(k) plans had about $900 billion in assets; by 2011, the figure had swelled to $4.3 trillion.
Yet until now the industry has been opaque, critics say. The new disclosure rules are "going to give employers more control and leverage to negotiate lower fees," said Pamela Hess, director of retirement research at Aon Hewitt, a human-resources consulting company.
The Labor Department's long-awaited rules will require that mutual-fund firms and other 401(k) administrators disclose to employers details about the fees they are charging to run the plans. Administrators, in turn, will have to disclose the costs to the workers investing in the plans.
The deadline for the disclosures to employers is expected to be April 1, though that could be pushed back, say industry experts. And 60 days after that disclosure, employers would have to provide detailed information to participants about fees, expenses and investment performance.
Some companies have taken steps to improve disclosure.
Putnam Investments has been producing a full breakdown of administrative and investment fees since 2010. Lincoln Trust Co. of Denver has developed what it calls a "personalized expense ratio" so participants can see the cost easily, said Tom Gonnella, Lincoln's senior vice president of corporate development.
M.A. Mortenson Co., a Minneapolis construction company, is preparing to send employees in its 401(k) plan a special mailing and also include fee disclosure in their regular account statements and annual statements, said Annette Grabow, manager of retirement benefits for the firm's several thousand employees.
Experts said the increased focus on fees should benefit workers. "The fee disclosure regulations may very well turn out to be the most important change in the history of the 401(k) plan," said Mike Alfred, chief executive of retirement-plan research firm BrightScope Inc., in San Diego. Workers enrolled in plans "are likely to win big," he said.
Savings of as little as 0.5% a year of assets could make a big impact on workers' nest eggs. Over a 30-year career, an extra 0.5% annual fee can slash a worker's savings at the time of retirement by 10%, according to Vanguard. A worker who saved $10,000 a year in a fund with expenses of 1% would wind up with $829,000, $91,000 less than a worker paying 0.5%.
The prospect of increased scrutiny on fees is prompting employers to change their investment lineups to offer more low-fee funds. In a survey last November of 600 employers, 67% had tweaked their investment lineup, compared with about 10% in most years, said David Wray, president of the Plan Sponsor Council of America in Chicago.
Index funds appear to be the most popular choice. Among the 401(k) plan sponsors that made changes to their investment lineups in 2011, the vast majority increased the proportion of passive funds on the menu, according to a recent report published by Callan Associates.