(March 2, 2001) 401(k)s: Far More Dangerous Than IRAs |
401(k)s and IRAs are America's most popular retirement
plans. It seems most employed Americans have one or the
other and many of us have both. Like all investments, each
of these vehicles has risks. Virtually no attention has
been paid, however, to the substantially greater risks
401(k)s are as different from IRAs as debit cards are from credit cards. Debit cards, in case you didn't know, offer almost none of the protections that credit cards carry. When you pay for something by debit card, your money gets immediately withdrawn from your account. If something goes wrong with your purchase, God help you in your attempt to get a refund. I recently spent two years fighting with Charles Schwab & Co. to credit my account for two tickets to London on Virgin Atlantic, a certain Mr. Robinson (Mrs. Robinson accompanied him, I presume) charged using my Schwab VISA debit card. When you purchase by credit card, all sorts of protections kick in. Most importantly, the card issuer gets involved in resolving the matter between you and the merchant.
Like most debit card users, 401(k) investors have unwittingly exposed themselves to problems IRA investors will never encounter. These additional risks can be broken into four categories: investment risk, record-keeping risk, employer-business risk and regulatory risk.
Investment risk may seem the most obvious but is actually two-fold. First, there is the risk that you may make the wrong investment selection. You may choose to put your money in a value fund and suffer when value is out of favor. You might be too conservative and put all your money in a money market fund and miss out on great stock market performance. You may choose poorly. While an IRA investor may also choose the wrong fund in which to invest, he is free to choose from any fund out there. A 401(k) investor generally does not have this freedom of choice. The second aspect of investment risk, peculiar to 401(k)s, is the risk that your employer makes a bad choice in determining what investment alternatives to offer employee participants in the plan. One outrageous scenario, which has conflict of interest written all over it, is the mutual fund or financial services company that only offers its employees only its own mutual funds. Often these funds are not the lowest cost, best performing funds available. One or two of the funds may be terrific but it is highly unlikely that the employer's funds are the best in every asset class. The fiduciaries involved with the 401(k) plan are supposed to consider all the alternative funds and do what's best for the participants of the plan, but it just doesn't seem to happen that competitor's funds make it into the plan. Even financial services companies with poor performing funds and high sales loads find ways to justify offering only their funds in the employee 401(k) plan.
The risk that errors in record-keeping will arise over the course of an individual's lifetime is huge. My wife and I participate in three 401(k)s and in every single one, we have uncovered significant errors. It has been estimated by experts in the field that errors in 401(k) statements are widespread. Our experience would confirm this. 401(k) record-keeping is exceedingly complex. When you have thousands of employees, a dozen investment alternatives, participants' contributions, sponsor's matching contributions, changing pension laws, anti-discrimination rules, early retirements, layoffs, mergers, bankruptcies, dissolutions and understaffed and sometimes untrained benefits departments, the potential for error is tremendous. Errors are probably more prevalent in small plans, which lack access to software and consulting services necessary to ensure accurate records.
My wife discovered soon after she enrolled in her 401(k) that several of her salary contributions never made it into her account. I, on the other hand, found that when I moved from one state to another in the middle of a year, my employer's record-keeping system treated me as a new employee and withheld the maximum allowable contribution for the year, a second time.
Over the course of your lifetime, you may receive hundreds of 401(k) statements. An error may occur in one statement and, if unnoticed, be repeated. With each passing year, the monetary value of that error may grow. So, it is important to ask to receive statements regularly and examine them closely, as best you can. In our opinion, however, it is unlikely that the average participant would be able to ferret out many possible miscalculations.
Employers are trying to shift responsibility onto their employees to ensure the accuracy of these statements by adding disclaimers such as, "It is the employee's responsibility to verify the accuracy of this statement and notify us within 30 days of any inaccuracy." Most debit card issuers have the same policy; credit card issuers do not. The very fact that these disclaimers are appearing on 401(k) statements should tell you something. Hopefully, these disclaimers will not be upheld by the courts because, as mentioned above, it is virtually impossible for an employee to verify the accuracy of his statements.
What if you find an error? Be careful before you assert your rights. Given how often most Americans change jobs, chances are you will no longer be an employee of the company that made the error when you discover it. It is unclear whether the Employee Retirement Income Security Act (ERISA) protects current employees from harassment and threats by the employer. If you are no longer an employee, the employer may retaliate against you for catching his error. Since all retirees and many plan participants will no longer be employees, this is a major ERISA oversight. Don't be surprised if, when you confront your former employer with an embarrassing and costly error, you are responded to angrily. Nobody likes to have their mistakes brought to light. And if you left your employer on bad terms, things could get really nasty.
401(k) investors are also plagued with risks related to their employer's business. When an employer goes bankrupt, voluntarily closes or merges with another company, guess what happens? The 401(k) plan often gets forgotten. For most companies, the company's 401(k) plan is unrelated to the company's core business and its trustees are not experienced in pension matters. For example, the physician's group that employed my wife had physicians as trustees. When the corporation folded, the physician/trustees hired a retirement services firm to administer the distributions. The trustees thought that was the end of their fiduciary responsibilities. The result was that it took my wife two years and countless phone calls and letters, to finally have her assets rolled over. During the two-year period, it was virtually impossible for her to obtain information about the status of the plan's termination.
Finally, 401(k) investors are subject to far greater regulatory risk. What is the difference between investing in the Fidelity mutual funds and investing in a 401(k) that invests in the very same Fidelity mutual funds? There is a big difference when it comes to prospectus or "summary plan description" delivery; sending of benefits statements; redemption or distribution rights; and compliance monitoring.
When you invest in a mutual fund, you get a prospectus. If you lose your prospectus, you can easily call Fidelity and get a replacement. When you invest in a 401(k), you should receive a "summary plan description." Many employees never get them. If you lose your summary plan description, you may have a difficult time getting another copy. The entire human resources department of a small company may consist of just one person who may not have copies ready to send out.
Mutual funds are required to send shareholders a quarterly statement and annual and semi-annual reports. Believe it or not, 401(k)s are not required to automatically provide benefits statements on a regular basis. You have the right to request a statement annually, but beyond that, it's up to your employer.
How about when you want your money back? Mutual fund investors call the fund company and their shares are redeemed immediately, as is required under the federal securities laws. Mutual funds also must provide daily pricing of portfolios. When you request a distribution of your 401(k) assets, it may take years. I am told that employees who leave their jobs on unpleasant terms frequently experience longer delays in getting their distributions. Some plans do not price their portfolios daily, weekly or even monthly. Participants in these plans may have to wait until the next valuation date for a distribution amount to be determined and longer still to have it processed. Obviously, mergers, bankruptcies and other factors regarding the employer's operations may impact on distribution timeliness. While awaiting a distribution, the value of the employees account will fluctuate, for better or worse.
Every mutual fund company is inspected by the SEC every few years for compliance with the federal securities laws. Any problems investors experience may be directed to the SEC or the National Association of Securities Dealers, Inc. There are established rules and arbitration procedures for dealing with investor complaints related to brokerages or mutual funds. No government agency regularly inspects 401(k) plans to ensure that assets are protected and participants are being treated fairly. The Pension and Welfare Benefit Administration shares jurisdiction over these plans with the Internal Revenue Service. Officials of the PWBA tell me that because there are so many 401(k) plans out there, they act on "predication" only. That is, if they have reason to believe there is wrongdoing, they'll look into it. That's not very reassuring for participants. If there is a problem with your plan, it's up to you to find it and report it to the agencies. Practitioners in this field agree that even when a participant reports a 401(k) error to these agencies, they are generally "useless."
Unless you are able to convince the PWBA to get involved in your case, you'll probably have to hire an ERISA trained attorney to pursue your claim and they don't come cheap. So, unless you've lost a lot of money and have a lot more to pursue your claim, you may be in a regulatory Twilight Zone for quite some time.
Don't get me wrong. There are compelling reasons to participate in 401(k)s. The amount an employee can set aside is far greater than in an IRA. The employer's matching contribution is a tremendous benefit. But, as is often the case in investment matters, the risks related to new investment vehicles unfold only slowly over time.