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Lobbying for more options in your 401(k)

"My company retirement plan has a lousy set of fund offerings. How do I convince my employer to offer more (and better) options?"

One of our readers e-mailed with this question recently. For the benefit of other readers in the same boat, I thought I'd publish my response here on the Weblog:

The best possible outcome would be for your employer to add a "brokerage window" or "self-directed" option to your 401(k) plan (or your 403(b), if you work for a not-for-profit). Such an option would allow you to invest in funds offered by a brokerage firm selected by your plan administrator.

A couple of years ago, my wife's employer (a small college) added a brokerage window. The number of funds from which we could choose grew, literally overnight, from about 20 to hundreds. (And, of course, I immediately moved her retirement money from some slow performers into SMI's Upgrading recommendations!)

Getting your employer to make positive changes to your 401(k) will require convincing the benefits decision-maker that such a change is in the company's best interest. The folks at The Motley Fool offer a helpful guide on how to build a persuasive case. (They even include a sample letter to send to your company-benefits director!)

Fodder for your letter will come from your plan's Summary Annual Report, Summary Plan Description, and/or Fee Arrangement. Request a copy from your company's 401(k) plan point person. (It may be someone in your human resources department, or even the company CEO or CFO if you work for a smaller outfit.)

Buried in these documents is the dirt on the fees your plan charges — both the investment expenses and the plan expenses — and whether your boss covers administrative costs or if they are passed through to plan participants (that's you)....

"In a half hour, you can figure out what your expenses are," says Stop the 401(k) Rip-off! author [Google Books preview] and retirement-plan industry veteran Dave Loeper. "If you find out that you are getting ripped off, the next step is to complain to your employer without sounding like a complainer."

Since this topic can be touchy, your aim is to inform, not complain, Loeper says. Don't focus on the needlessly high expenses you're paying. Instead, note that you have calculated the expenses you're paying and are wondering if there are some lower-cost alternatives available. Judiciousness should be your default mode. You've got to convince your company that, in dollars-and-cents terms as well as employee-satisfaction terms, something needs to change.

This Morningstar article (free registration required) covers some of the same territory as The Motley Fool piece, but lays out additional options.

If adding a brokerage window is "a bridge too far" for your employer, you need a fallback position — namely, requesting the addition of several low-cost index funds. The Wall Street Journal reported a few weeks ago that more employers are adding index funds to their plans, so there might be a trend here your employer would be willing to follow.

But, as the WSJ notes, getting indexes added presents its own challenges.

The stodgy 401(k) world won't change strategies overnight. Fund companies won't easily relinquish their active-management fees, which tend to be higher than those charged on index-tracking products, especially at a time when rocky markets are pinching profits. And actively managed funds tend to do more "revenue sharing," which involves fund companies making payments to plan administrators.... (emphasis added).

Still, some big players are betting that the stars will begin realigning....

In a recent survey of about 150 employers by consulting firm Hewitt Associates, 17% of them said they are likely this year to replace some or all of their plan's actively managed investment options with index funds. That is up from 8% a year earlier....

Some smaller plans that don't have the purchasing power to access the lowest-cost index funds on their own are banding together in multiple-employer plans that take a passive approach.

(The WSJ also takes note of "a spate of recent lawsuits [in which] workers have claimed their 401(k) plans charged excessive fees and offered actively managed funds that failed to beat cheaper index-tracking alternatives." For an example, see here. This is probably not something you want to bring up in a confrontational way — you don't want to come across as adversarial — but the fact that some employees are willing to go to court reinforces that this is an important issue to workers and one employers need to be aware of as well.)

If you can get your employer to add even just a handful of index funds representing the major market categories (large companies, small-medium companies, international stocks), you could put together something similar to our Just-the-Basics strategy. Such an approach is likely to offer superior results to being invested in not-too-stellar pre-chosen funds.

Workers with limited fund options within their retirement plan will likely benefit from reading our research on how to choose funds in your 401(k) when your options are few (SMI web membership required). When we tested this simple approach a few years ago, its returns more than tripled the broad market's over the 8-year test period!

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