The 401(k) System: Great for Wall Street, Bad for Retirees

Here’s a question that you probably don’t want to answer honestly: What fees are you being charged by your 401(k) plan?

Don’t feel bad if you haven’t got a clue, because that puts you in the majority. An AARP study a few years back found that 65 percent of 401(k) account-holders didn’t know they were even paying fees.

This ignorance is no small thing, it turns out, because such fees take a huge bite out of our retirement savings over the long term. According to a new Demos study by my colleague Robert Hiltonsmith, the ordinary American household “will pay, on average, nearly $155,000 over the course of their lifetime in effective total fees.”

That is serious money, especially given that many Americans haven’t stashed away nearly enough for retirement. How do financial firms manage to steer such a big slice of our nest eggs into their own pockets? By hitting us with a blizzard of costs that are difficult to identify and track. A typical 401(k) plan charges administrative fees, asset management fees, and trading fees. Investors even pick up the tab for "marketing fees," paying for all those pesky fund brochures and indecipherable financial statements that your 401(k) provider constantly sends to you.

In a perfect marketplace, the fees for retirement plans would be kept low by fierce competition among plans to provide the best service at the lowest cost. But, as noted earlier, most investors aren’t paying much attention to fees and, in any case, financial firms make it as hard as possible to calculate the real costs of these fees. Mutual funds are not required by law to disclose their trading fees, except in those arcane financial statements that most people just throw out. In any case, it’s not so easy for you or your employer to move to a different retirement plan -- which makes real competition even scarcer.

So what happens in a marketplace when buyers lack information and can’t easily exercise consumer choice? Sellers can charge whatever they want. And this is pretty much the case in the 401(k) marketplace, according to the Demos study. Wall Street is making a killing off of investment fees even as alarm bells are sounding everywhere about how so few Americans are saving enough for retirement. And beyond the rare push by regulators to rein in fees -- like when Eliot Spitzer went after the mutual fund industry nearly a decade ago -- government is doing very little to stand up for the little guy.

Beyond the familiar story of Wall Street greed, high costs for retirement plans are baked into America’s incredibly inefficient 401(k) system, which revolves around individual accounts. “Because 401(k) savers’ assets are spread between thousands of essentially-identical or similar mutual funds,” the Demos report notes, “many savers, particularly those in smaller 401k plans, are unable to benefit from efficiencies—lower costs—from what economists call ‘economies of scale.’”

The 401(k) system is a fantasy for Wall Street because it forces every employee to deal with a middleman and gives the Schwabs of the world a piece of the action. But this system stinks for everyone else.

In contrast, workers get a much better deal from old fashion pension plans in which they contribute through their paycheck to a big pool of retirement savings which are centrally managed -- without any middlemen and the costs of handling individual accounts. Of course, though, such plans are becoming a thing of the past. And that’s too bad. In the era of the 401(k), Wall Street profits have surged while retirement security has plunged. In fact, about 40 percent of workers don’t have access to a 401(k), and many of those with such plans haven’t saved much.

An earlier Demos study, also by Robert Hiltonsmith, found that the median balance in a 401(k) account for employees between the ages of 45 and 54 was just $67,000. Workers on the cusp of retirement didn’t have much more: $98,000.

One reason for these low balances is that investors have been hammered by two stock market meltdowns in the past 15 years. As I have explained elsewhere, both these meltdowns were partly caused by risky speculation by Wall Street insiders. In other words, saving for retirement is not only getting hard because financial firms are gouging us on fees; but also because this same rapacious industry keeps blowing up the stock market through their greedy behavior.

Wall Street has been screaming its head off about the Dodd-Frank law passed in 2010. In fact, though, reformers haven’t gone nearly far enough. The financial services industry still needs to be more heavily regulated and, ultimately, downsized to become a smaller, less profitable sector that serves the American public instead of bilking it.