Supreme Court 401(k) ruling latest shift in favor of retirement savers

Doing the right thing by retirement savers – could it be the new black?

The U.S. Supreme Court ruled this week that employers have a duty to protect workers in their 401(k) plans from mutual funds that are too expensive or perform poorly. The landmark ruling – which was unanimous, sends a strong signal to employers to improve their plans – and it comes just as the Obama Administration prepares a landmark of its own by issuing rules requiring that financial advisors put the interest of customers ahead of their own.

The high court ruled in a class action case brought against Edison International, a large southern California utility company. The case was brought on behalf of 20,000 retirees and workers at the company by Jerome Schlichter, a St. Louis attorney who has made cause of suing 401(k) plans in order to get them to shape up. The case was sent back to the lower court for final resolution.

“It’s hard to say how sponsors will react, but certainly the law has always been that fees must be reasonable,” Schlichter says. “If there is a fund that is significantly less expensive than another comparable fund, the plan fiduciary must determine that cheaper is better.”

The message here isn’t that all 401ks are bad, or too expensive. Costs have been falling but they vary widely across the industry.

Most workers do not know they bear the lion’s share of costs yet fees make a huge difference in returns over time. The U.S. Department of Labor estimates that a 1 percentage point difference on a current account balance of $25,000 will reduce total accumulations by 28 percent over 35 years, assuming average returns of 7 percent and no further contributions.

The Edison battle centered on the 401(k) plan’s use of retail-class mutual funds when less-expensive institutional shares were available. The difference between those classes typically is 25 basis points, according to John Rekenthaler, vice president of research at Morningstar Inc.

The court decision will put pressure on large plans to cut costs further but will not have much impact on smaller plans, he says. That is because big plans have the buying power to negotiate better deals with fund providers – and because large corporations are much more attractive targets for litigation.

In particular, he expects more big plan sponsors to push for better deals than institutional funds by demanding “separately managed” versions of funds that offer specialized attention but also cut management fees to the bone.

Learn more in my column this week at Reuters Money.

Photo: Wikimedia Commons

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