Why Even the Supreme Court Can't Fix Your 401(k)

Traditional pension plans have given way to defined-contribution plans over the years, with the 401(k) being the most common retirement plan that businesses set up for their employees. Unfortunately, the way 401(k)s work puts many employers in the awkward position of acting as fiduciaries for their employees, and that has led to conflict and countless lawsuits from workers when things go wrong. Yet even though one case involving employees of Edison International (NYSE: EIX  ) could get a hearing at the Supreme Court, don't expect the decision to change the costs of 401(k) investing.


U.S. Supreme Court. Photo: Kjetil Ree via Wikimedia Commons.

The case and what it means
The facts in Tibble v. Edison International aren't all that uncommon. In picking investment options for its employees, Edison allegedly chose to offer mutual funds aimed at retail investors, rather than choosing nearly identical funds targeting institutional investors. The retail funds imposed higher fees on Edison's roughly 20,000 plan participants than the institutional funds would have, with the funds' expenses taken directly from their mutual-fund balances rather than explicitly charged to plan participants' accounts in a more transparent manner. As a result of the higher fees and a fee-sharing arrangement, Edison was allegedly able to reduce its administrative costs for operating the plan by $8 million.

Last week, the Supreme Court requested that the Department of Labor work with the U.S. solicitor general to file a brief setting out their take on the lawsuit. That request has employee advocates excited about the future prospects for the Edison case, because it's exactly the course the justices followed prior to taking on another retirement-plan court case involving Fifth Third Bancorp (NASDAQ: FITB  ) , which is scheduled for argument before the high court tomorrow.

Part of the Edison case will turn on a technical argument about statutes of limitations, potentially giving the Supreme Court the same out that lower courts used in rejecting some of workers' claims for being filed too late. On the merits of the case, appeals-court decisions on similar issues have tended to side with employers. In a case three years ago against Exelon (NYSE: EXC  ) , a court rejected an argument that the utility should only have offered low-cost institutional class funds, rather than also including some retail funds.

But even if the Supreme Court addresses the broader question of whether choosing higher-fee funds over identical lower-fee alternatives is a breach of the fiduciary duty that plan sponsors have to their participants, it still won't address the key problem with 401(k) plans: that your employer has so much control over the account in the first place.

The shift from pensions
401(k) plans represent a compromise between two extremes, but they do a bad job of finding the right balance. With traditional pension plans, employers were responsible for all of the decisions about investing; if they made bad decisions, they suffered the consequences, having to make additional pension-fund contributions to cover any shortfall. By contrast, IRAs and other outside accounts that workers have are entirely within their own control, and workers are responsible for making smart investment decisions with those accounts. Because IRAs give you full rights to invest in just about any type of investment available, you don't suffer the same limitations as you do with 401(k) plans.

401(k) plans split the difference, forcing the employer to offer prudent investment options but giving the worker all the power to divide money across those options. In some cases, employers can use their collective bargaining power to get better deals than workers could get on their own. But these plans have extra administrative and record-keeping costs, and one way or another -- whether through higher fund fees or direct charges to participants' accounts -- workers at many companies end up paying for them.

As policymakers consider reforms to employer-sponsored retirement funds, the real question is whether employers need to be part of the retirement savings process at all. Even though valuable benefits such as profit sharing and matching contributions can help with your retirement prospects, it's clear that employers are increasingly uncomfortable in their role as retirement advocates for their employees. Giving individuals the right to set up self-directed IRA-like accounts with higher 401(k)-like limits would put the fiduciary-duty issue to rest once and for all and give workers the full power to save on their own behalf.

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Tune in to Fool.com for Dan's regular columns on retirement, investing, and personal finance.


Read/Post Comments (9) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 01, 2014, at 11:04 AM, jdmeck wrote:

    No matter what, you will never make everyone happy.

  • Report this Comment On April 01, 2014, at 11:33 AM, Mega wrote:

    Having been part of my company's 401k committee, I'm disappointed by recent lower court decisions on this.

    Of course, it's best practice for the company to offer the funds with the lowest possible fees, and pay the administrative costs separately. That is we what do.

    But in my view the courts are seriously overreaching if they rule that companies have to pay administrative costs instead of passing it on to employees through a different cost structure. This is still fairly normal - how can courts criminalize normal behavior?

    There are many severe violations of fiduciary duty going on every day - this is not one.

  • Report this Comment On April 01, 2014, at 11:36 AM, Mega wrote:

    It's not like having the 401k plan you want is a god-given right. It's an optional part of a company's benefit package.

  • Report this Comment On April 01, 2014, at 2:57 PM, RxPro wrote:

    @Mega, exactly, you are more than welcome to review the 401k funds prospectus before agreeing to employment or before participating in the plan. Companies are often matching your contributions, giving you "free" money for participating, yet if they have a fund with a 0.5% higher cost the employees are able to take them to court?

  • Report this Comment On April 02, 2014, at 10:18 AM, WildHamm wrote:

    The fix to this is so simple yet those in power will never come around to providing anything but an overly bureaucratic, regulated solution. Eliminate the 401k altogether. Allow everyone with earned income to contribute to an IRA (Traditional or Roth) with maximums set to higher levels (i.e., $23,000 and $29,500 for those over 50). Lastly, allow employers to make matching and/or profit sharing contributions to your IRA.

    What would this do? Get your company out of making investment decisions for you. Save companies a ton in complying with regulations and maybe increasing their contributions to your IRA. Get the government out of it entirely, other than setting the yearly limits. Allow individuals to make decisions based on what’s best for them as opposed to what is best for the company or the plan administrator/advisor. Eliminate the retirement plan brokers and investment advisors from the process altogether. It let's individuals engage their advisors, should they want to or need to, versus those hired by the company.

    I’ve been through switching 401k plans and all the BS the intermediaries throw at you to justify their high costs. The true definition of a financial intermediary is “additional cost.” Good plan administrators and investment advisors know that 80% of individuals only need a minimum of three or four low cost index funds (total bond, total stock and total international), yet how many plans have these? Far too few, I’m afraid. Most are loaded with proprietary, high cost, poor performing funds. This is especially true of small businesses that have no pricing leverage.

  • Report this Comment On April 02, 2014, at 9:31 PM, mortakee wrote:

    I like your suggestion there Wildhamm and hope maybe some day they would execute on such an idea. Wise and keen investors can do more essential wealth building in a Roth IRA with greater control over the assets. I highly despise the limits of a 401k

    However, I likely see that idea ever coming to life simply because there would be a lot of tweaking needed down to the rules and regulations and the government would lose out on taxes from 401k distributions taken early on and during retirement. I ensure I maximize my Roth contributions each year and at least meet my employers match on 401k contributions so I'm not throwing away free money, and invest what is left over in a regular brokerage account for growth.

  • Report this Comment On April 02, 2014, at 9:55 PM, classic216 wrote:

    IRAs are better than 401ks for two reasons:

    1. More options to choose from

    2. lower fees

    Contributing to a 401k to the point of the employer match is a no-brainer.

    Contributing beyond the match could make sense for some people because it's a convenience factor - your money gets invested automatically without you ever having to see it or look at it.

    And a Roth IRA generally makes more sense than a Traditional IRA because half the country's population doesn't make enough to pay federal income tax....with a Roth you know for a fact that it's saving you money on taxes.

  • Report this Comment On April 03, 2014, at 9:05 AM, gskinner75006 wrote:

    Edison International should just end their 401k plan. Don't like it, don't work there. This business of running to your local street corner ambulance chaser every time your not happy with what someone is giving you needs to end. I'm not sure when we became a nation of such cry babies but it's getting embarrassing.

  • Report this Comment On April 03, 2014, at 10:36 PM, Lateralus88 wrote:

    I think the attitude of the employee taking what they get and liking it is a little off base. Once the company decided to offer the plan, they are bound by law to do so in the best interest of the employees.

    The argument of the case is that using the funds with the more expensive fee class was negligent because the company could easily have achieved the same goals at a much lower cost if they had done some basic due diligence.

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