Low-Cost Funds Coming Soon to Your 401k Plan Thanks to the Supreme Court

On May 18, 2015, the Supreme Court ruled that companies offering 401k plans have a duty to select low-cost investment funds for the plan and to monitor the investments continuously and remove imprudent ones.  This ruling is a huge win for 401k plan participants.  I expect that within the next several months, employers offering retirement plans such as 401k, 403b, and 457 plans will review their plan offerings and shuffle their line-up to include low-cost funds.

In this case, the Court decided that a claim was not 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. The Supreme Court ruled against Edison International, the defendant plan sponsor, who sought to uphold a 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 opinion can be found here.  Indeed, the court stated that a “fiduciary is required to conduct a regular review of its investment with the nature and timing of the review contingent on the circumstances.”

As I noted in a previous post, the significance of this case is that the Supreme Court could recognize that fees really matter in investment performance. In fact, Justice Breyer writing for a unanimous Court stated that “expenses, such as management or administrative fees, can sometimes significantly reduce the value of an account in a defined contribution plan.”

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.

So be on the watch for news from your employer announcing changes to its 401k plan offerings to include low-cost mutual funds in light of the Supreme Court’s ruling.

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