The recent news that the Supreme Court will be taking on a lawsuit involving a company’s 401(k) plan is sending shockwaves through the investment field.

Let’s start with the basics first.  A 401(k) plan, also known as a defined contribution plan, is a retirement plan administered by companies on behalf of their employees.  The employer selects the menu of investment options available to employees and also may offer to match an employee’s contribution to the plan.  The employee sets aside a certain percentage of their pay to contribute to their plan and selects investments.

As company pensions have declined, the 401(k) has become the primary retirement vehicle, with over $4.5 trillion in assets, as this chart indicates:

So, what is the lawsuit the Supreme Court is considering?  From the Wall Street Journal:

The court will focus on a narrow issue concerning the statute of limitations in the case, called Tibble v. Edison International . A ruling against Edison could trigger a wave of lawsuits against companies over the way they set up and manage 401(k) retirement accounts and similar plans, according to lawyers not involved with the case.

Tibble is one of 13 class-action lawsuits filed in the past eight years that have accused U.S. companies, including Boeing Co. and Massachusetts Mutual Life Insurance Co., of failing to act in the best interest of employees who participate in their 401(k) plans. The issues include failing to monitor excessive fees, favoring some high-cost retail mutual funds over lower-cost options and funneling employee savings into investment products managed by affiliate companies.

So, the crux of the issue is fees, and whether employers who administer these plans are acting in the best interests of their employees.  Unfortunately, as an employee you are held captive in that if you want to participate in a 401(k) plan, you are limited to selecting from the menu of investment choices offered by the 401(k) provider at your company.  I saw this issue firsthand when I left an employer and sought to rollover my 401(k) into an IRA (a common practice).  The 401(k) administrator charged hundreds of dollars to facilitate that transfer which seemed excessive to me.

This NY Times article personalizes the story by highlighting the plight of one of the early litigants in this case.  Here is how they described the issue of 401(k) fees:

At the heart of the suits are a raft of obscure fees and services that few employees will be able to discern. Unless employers absorb all of the expenses, you must pay the bills for plan record-keeping, administration and fund management.

Most fund expenses not covered by employers are deducted from plan assets — the money pooled for your retirement — and show up in an “expense ratio,” which is expressed as an annual percentage of what you have invested. If your plan charges 1 percent on $100,000 invested, you are paying $1,000 annually in fees.

To help your students learn more about 401(k) plans, I thought this news story would provide a great opportunity for your students to compare two 401(k) plans to get a sense for how the differ and the impact of costs on your 401(k) balance.

How about comparing Apple’s 401(k) plan to Facebook’s 401(k) plan, using a service called Brightscope.  You can ask students to answer the following questions:

• Which plan has a higher overall rating?
• Why do you think this plan is ranked higher?
• What are the largest funds invested in each 401(k)?  Are you surprised by this?
• How many investment options does each company provide?
• Who has the more generous 401(k) plan?  What do you think makes one plan more generous than the other?
• Which company has more assets invested in the 401(k)?
• Which company has higher average balance in the 401(k)?

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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