ICI Calls Out 401(k) Myths

Recent media reports on 401(k) plan losses, excessive fee suits, and the move many sponsors are making from defined benefit offerings to defined contribution offerings has fostered negativity about 401(k) plans.

The Investment Company Institute (ICI) has addressed the resulting myths about 401(k)s in a Q&A titled “10 Myths About 401(k)s—And the Facts.” The number one fact ICI reports is that the financial crisis is not causing Americans to bail out of their 401(k)s.

In its document, ICI notes that although losses in 401(k) plans in 2008 have been reported at around 27%, ICI’s study of 22.5 million defined contribution accounts shows that only 3% of plan participants had stopped making contributions through October. In addition, only 3.7% of plan participants had taken withdrawals from their participant-directed retirement plans, including 1.2% who had taken hardship withdrawals—a level of withdrawal activity in line with past years.

ICI points out that retirement-saving assets are down—in all forms of accounts—because the stock market is down, not because of any fundamental flaw in 401(k)s. In fact, ICI says, thanks to diversification and ongoing contributions, the average account fared better in 2008 than the S&P 500, which was down 38%.

The document says Americans of all income groups support 401(k)s, and 401(k) savers have not suffered any greater loss than other retirement investors.

ICI also notes that DB plans were never universal or risk-free. In 1981, before the creation of 401(k)s, not one in five retirees received any benefits from a private-sector pension, and for those who did, their median benefit was $6,000 a year in today’s dollars, the document says.

DB plan assets have fallen along with all other retirement assets, and DB plans expose workers to other forms of risk, such as the risk that the sponsor will freeze workers’ benefits (by freezing the plan, terminating the plan, or going out of business) or that a worker will lose or change jobs without accruing significant DB benefits. “For today’s typical worker—who will hold seven or more jobs in his or her career—DB plans can be a poor fit,” ICI says.

401(k) Fees

In its myth-busting Q&A, ICI contends that “the numbers bandied about by critics of the 401(k) system vastly exaggerate the fees that most plans charge.” The document notes that ICI and Deloitte Consulting LLP recently compiled a detailed survey of fees paid by 130 plans of various sizes and using various recordkeeping models and found that the median all-in fee—covering investment, recordkeeping, administration and plan sponsor and participant service expenses—was 0.72% of total assets in 2008 (see “Average 401(k) Fee is 72 Basis Points, Study Says). In dollar terms, based on the average account size, the median fee per participant was $346 a year. While fees vary across the market, 90% of all plans surveyed had an all-in fee of 1.72% or less.

In addition, ICI said its research shows that 401(k) investors concentrate their assets in low-cost mutual funds. The average asset-weighted total expense ratio incurred by 401(k) investors in stock mutual funds was 0.74% in 2007—substantially less than the industry-wide asset-weighted average of 0.86%.

ICI also notes that mutual funds follow SEC rules on disclosing trading costs, and fund managers have strong legal and market incentives to minimize those costs. “Mutual funds have more comprehensive disclosure than any other investment option available in 401(k) plans, and have strongly supported improved disclosure,” ICI says.

The ICI document is available here.