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

The highest court in the nation is considering taking a case on fees in your retirement plan, but regardless of the decision, you'll still have to be wary of your employer.

Apr 1, 2014 at 10:25AM

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.

Supreme Court
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.

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

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Exelon. The Motley Fool owns shares of Fifth Third Bancorp. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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