Are Low-Cost Funds Coming your Employer’s 401k Plan?

On February 24, 2015, the Supreme Court heard oral arguments in a case that could alter the selection of mutual funds in your employer’s 401k plan for the better.  At issue is whether a claim is barred by ERISA’s statute of limitations against an employer plan sponsor that allegedly breached its fiduciary duty of prudence by offering higher-cost retail-class mutual funds in its 401k plan, even though identical lower-cost institutional-class mutual funds were available. In this case, Edison International, the defendant plan sponsor, is seeking to uphold the lower courts’ decisions that this claim is barred by the six-year statute of limitations in the Employee Retirement Income Security Act (ERISA), because it was not timely filed.

The plaintiffs contend a plan sponsor has a duty to re-evaluate periodically investment options in its 401k plan, an obligation not bound by a statute of limitations that might restrict questioning the initial decision to add an investment option, such as a high-cost retail class fund.  Interestingly, a coalition of employer groups — the ERISA Industry Committee, American Benefits Council, U.S. Chamber of Commerce, Business Roundtable and National Association of Manufacturers — filed a friend of the court brief defending use of retail mutual funds in 401(k) plans in the case:  Glenn Tibble el al. v. Edison International et al.  A decision is expected by summer 2015.

The significance of this case is that plan participants and the courts may see how fees really matter in investment performance. Often there is a meaningful difference between the fees of the retail and institutional classes of the same mutual fund. For example, the Vanguard 500 Index Fund is a common choice in many plans offering Vanguard funds. According to the Vanguard site, the retail class has a fee of 0.17% and it has no minimum investment. The institutional class for the same fund has an expense rate of 0.04% for a lower difference of 0.13%.  Of course, the institutional class has a minimum investment of $5 million, which is the reason for the lower cost.

Remember fees are automatically deducted from the fund’s return. So funds with lower fees have better returns than those with higher fees. Were the Supreme Court to side with the employee plan participants in this case, employer plan sponsors are likely to look to shuffle their investment offerings to obtain lower-cost funds.  This reshuffling to include lower-cost mutual funds would be welcome by 401k plan participants, because it would likely boost their earnings and return.


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