Effect of Fees on Rates of Return
A report on the Towers Watson analysis included a discussion on the effect of plan expenses on rates of return. The previous analysis focused on returns based strictly on income performance.
The report noted that DB plans typically report income net of investment expenses. However, expenses for 401(k) plans, including administrative costs, are typically deducted from investment returns. As a result, Towers Watson said, Form 5500 data does not reflect differences in returns for DB and DC plans arising from embedded non-investment costs in the investment income component—especially for mutual fund investments.
In 2008, 38% of plan assets in 401(k) plans were invested in mutual funds, compared with only 12% in DB plans. Mutual funds for 401(k) plans had an average weighted expense of 66 basis points in 2008. With 38% of 401(k) plan assets invested in mutual funds, a reasonable assumption is that these fees reduce rates of return by 25 basis points.
According to Towers Watson's 401(k) fee data, roughly one-third of mutual fund fees are actually bundled administrative costs, so 401(k) returns lose an average of 8 basis points due to bundled administrative costs incorporated in investment fees. Between 1995 and 2007, asset-weighted median returns were 1.07% higher in DB plans than in 401(k) plans, and adding 8 basis points to 401(k) plan returns for implicit bundled administrative costs results in a net difference of almost exactly 1 percentage point.
Rebecca Moore