The Supreme Court's Misplaced Ruling on 401(k) Plans
Last month, the Supreme Court effectively expanded employers’ responsibility for the performance of the funds in their 401(k) plans, ruling that employers must regularly monitor the investment options in their plan and remove funds with high fees or poor returns. The ruling’s goal, protecting retirement savers from high fees and poor performance, is both admirable and desperately needed.
More than half of all workers now rely on 401(k)s for retirement, yet high 401(k) fees are still costing savers dearly: an average two-earner household that saves consistently throughout their working life can lose as much as $155,000 in fees by the time they retire. All told, high fees are costing savers a whopping $25 billion a year, draining precious dollars from account balances already lagging dangerously behind the amounts needed to provide secure retirements.
However, the court’s ruling heaps further responsibility for the investment performance of 401(k)s on the wrong party: the firms actually responsible for investing 401(k) assets—the financial services industry—should be accountable for the performance of their investment products, not employers. Why? Because the law making employers liable for retirement plan investments, ERISA, is outdated: it was passed in 1974, before the 401(k) even existed, and was intended to protect participants in defined benefit pension plans, whose investment management was often done in-house.
Now, the 401(k) plans offered by most employers (and IRAs, their individual counterpart) are more like pre-packed products or services, more similar to a health insurance plan or even a carton of milk than the defined benefit pensions of old: off-the-shelf products sold to employers and individuals. And just as we don’t expect an employer to personally inspect the quality of every carton of milk sold in its cafeteria or examine the record of every doctor covered by its health insurance plan, we shouldn’t expect employers to verify the performance of every fund in its retirement plan, a daunting task beyond the resources of many employers, particularly smaller ones. It would be fairer and more sensible to hold the “producers” of 401(k) plans accountable for their quality, just as we hold health insurance companies or dairy producers responsible for the quality of their products.
Thankfully, efforts at the Department of Labor and in New York have recognized the need to update these outdated regulations and hold financial firms accountable for the performance of retirement investments. The Department of Labor’s proposed rule requires that financial advisers who sell retirement funds to any client, whether a company or individual, put those clients’ interests before their own profits.
This rule recognizes that the primary reason that investors end up in high fee funds or plans is because of conflicted advice from financial advisers, many of whom often receive higher commissions from placing investors in higher-fee funds. The new rule would prevent this practice, leading to lower fees and better investment options for retirement investors, saving them billions.
A similar effort to rein in investment advisors is underway in New York, the epicenter of the financial services industry. Here, legislation introduced by Assemblyman Jeffrey Dinowitz would require that investment advisors in New York State not bound by fiduciary standards must disclose to potential clients that they may not be giving advice in their clients’ best interests, and may recommend higher-fee investments that earn them and their firm higher profits at the expense of their clients. This proposal, championed by New York City Comptroller Scott Stringer, would apply to a wider variety of financial advice than the Department of Labor’s proposal, covering all advice dispensed by financial advisors in the state, not just advice on retirement investments.
Both proposals would, if enacted, likely result in significant savings for individual investors, as companies and individuals would to gravitate to lower-fee investments, which in turn leads to higher returns for investors. However, the rules would likely also lead to lower profits for financial services firms, who unsurprisingly have been lobbying hard against the proposals.
The ultimate success of the rules remains to be seen, but the fact that they’re even being discussed shows that the voices arguing for significant reforms to the current 401(k) system are beginning to be heard.
