GAO raps 401(k) plan administrators for taking hidden payments from mutual funds they recommend

by Jim Sloan

If you've been wondering why your 401(k) savings account seems to lag behind other professionally run retirement savings accounts, a new report from the Government Accounting Office recently offered some clues.

According to the GAO, many firms that run 401(k) investments plans receive hidden payments from mutual funds that are a part of the savings account plan. As a result, even mediocre mutual funds may be included in your 401(k) plan simply because they paid to be there. You won't necessarily benefit, but your plan administrator certainly does.

Steering you toward investments

This conflict of interest goes even further in some cases, the GAO said. Some of these mediocre investments pay extra, providing the savings account plan administrator incentive to subtly steer you toward putting your money with that fund. The plan administrators legally can't blatantly endorse certain investments over others in the plan, but they can suggest strategies for investments that, if you follow it, will lead you to a specific fund or group of funds.

So if you thought your 401(k) administration was picking funds based on what is best for you, you may be mistaken.

"If left unchecked, conflicts of interest could lead plan sponsors or participants to select (investments) with higher fees or mediocre performance, which, while beneficial to the service provider, could amount to a significant reduction in (savings rates) over a worker's career," the GAO said.

Most of these "revenue sharing" arrangements between firms administering your 401(k) and the fund managers, record keepers and custodians who pay to be part of the program are never disclosed to those making the investments.

The cost to savings account investors

According to Forbes magazine, these conflicts of interest are hurting tens of millions of people saving money in the 401(k) plans. Forbes said that the percentage of private industry employees investing in 401(k)-style contribution plans increased from 36 percent in 1999 to 43 percent in 2008. The plans often include an "education" component that can be a veiled endorsement for a fund that pays the plan administrator.

"Participants who confuse investment education for impartial advice may choose investments that do not meet their needs, pay higher fees than with other investment options, and have lower savings available for retirement," the study says.

The GAO report also noted that 401(k) providers structure certain company plans in a way that they don't have to accept any legal responsibility for the plan.

How much is this costing investors? It varies and it's often hard to determine. But according to the GAO, studies have shown that returns for 401(k) plans tend to lag behind professionally managed, traditional pension plans by about 1 percentage point a year.

Recommendations for change

The U.S. Dept. of Labor has looked into "the potential for conflicted investment advice," the GAO said, but noted that efforts by the Employee Benefits Security Administration to get plan administrators to disclose the compensation they receive has been limited.

The GAO recommends:

  • That the Labor Department require service providers disclose their compensation in a consistent way from plan to plan
  • That the Labor Department revise standards that allow plan administrators to recommend investments in which they have a financial stake
  • That the Treasury Department require disclosure that investment products outside a plan usually have higher fees than funds within a plan

The GAO also recently took aim at the use of target date funds, which reset their asset allocations over time. The GAO would like those funds to disclose more information about the assets they hold. Some of these funds endured 31 percent average annual losses during the 2008-09 stock market selloff after returning an annual average of 28 percent in 2005, according to Reuters news service.

Disclaimer:This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.

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