How To Rid Your 401(k) Plan Of Costly Conflicts

Are there conflicts of interest within your 401(k) plan?

Unless an independent auditor reviewed it, you would never know, but that doesn't mean you can't weed out some bad funds.

According to a recent study, mutual fund companies that act as trustees for plans tend to favor their own funds. If they perform badly, they tend to look the other way and leave them in the plan.

Ultimately, this conflict is an albatross for 401(k) investors. Bad funds tend to stay in the plan and it hurts retirement savings.

How much return is sacrificed by these conflicts? The study says from 3 to 3.6 percent annually. And that's before sales charges and middlemen fees are subtracted.

A long-time critic of 401(k) plans, author/adviser Dan Solin, lambasts plan trustees for ignoring these persistent conflicts:

"Initially, you have to wonder about the judgment of plan sponsors who permit mutual fund families to serve as trustees of 401(k) plans. This is akin to having the fox guard the hen house. How likely is it that these "trustees" will conduct a thorough and objective analysis of investment options and determine that funds managed by unrelated fund families should have a prominent presence?

Clearly, there is a conflict of interest between the obligations of the trustee to select "suitable" investments for the plan and its economic interest in profiting from the inclusion of its own proprietary funds."

There's no reason why 401(k)s have to maintain these embedded conflicts other than to perpetuate Wall Street's greed. There are a few simple steps you can take to improve your plan:

1) Demand that an independent fiduciary review the plan and suggest changes. These professionals are not beholden to any fund company or Wall Street broker and are legally required to act in the best interest of plan participants. They can overhaul a plan, suggest that the trustees dump the junk funds and reduce costs.

2) Dump most actively managed funds and replace them with index mutual funds or exchange-traded funds. Funds with embedded conflicts are there for a reason: They make money for the fund companies. The more they trade and incur expenses, the lower your return. You pay their freight. Index funds have rock-bottom costs and rarely trade. Check out my recent list of the best exchange-traded funds for 401(k)s.

3) Dump any "proprietary" or insurance/brokerage-company funds, especially those layered with "wrap" fees. These are often the most expensive funds offered and don't compensate you for the high fees with high returns.

4) Demand that your plan administrator audit the plan for expenses and performance. By law, the people running the plan are mandated to operate your 401(k) for your benefit, not the fund companies. Conflicts can — and should — be eliminated. If they fail to act, you can sue them.

For example, three participants in 401(k) plans are suing Fidelity Investments, alleging "fiduciary self dealing." The mutual fund giant stated that "our practices are in compliance with ERISA and Department of Labor guidelines. We operate with the best interests of clients and customers as our top priority." More than a dozen suits have been filed since 2006.

It's important to ask questions and build alliances within your company. Are executives in the plan? Then they have an incentive to improve it. Get them on board. At stake is every participant's future financial well being, but the time to act is now.

 

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