As I’ve discussed in prior blog posts, 401(k) account balances for many Americans have recovered as a result of better financial markets and ongoing contributions. In tandem, the debate over 401(k)s has shifted—to the question of fees.

Critics share a common complaint: 401(k) fees are too high.* I’ve been asked this question in this way: Why aren’t 401(k) plans as cheap as a low-cost Vanguard index fund? The Vanguard 500 Index Fund, for example, carries a current expense ratio of 0.18%. By comparison, the median 401(k) plan, according to one study, costs about 0.70%—nearly four times as much.

Why the difference? There are four reasons.

First, 401(k) plans require a more complex infrastructure than a retail investment account. I won’t go into the details (that would take its own post), but 401(k)s offer a more complex—and expensive—array of administrative services than a typical retail investment account or IRA.

Second, most 401(k) plans offer higher-cost actively managed funds, along with a few passive choices. For example, 96% of the employers who have chosen Vanguard as their 401(k) recordkeeper also have decided to offer active funds. Having weighed the issue, employers choose to offer both types of funds.

Third, and more subtly, 401(k)s are subject to what economists call “economies of scale.” Large companies are able to spread recordkeeping costs over a large base of workers; they can also get price discounts on indexing or active management that come with “bulk” purchasing. In layperson’s terms, a plan with 10,000 workers will get lower prices than a plan with 100 workers. The same is true with the size of assets to be invested. So a big difference in fees across 401(k) plans is influenced by how big the plan is.

Finally, fees are influenced by the assets accumulated by participants. Suppose you have two 401(k) plans, both with 1,000 plan participants and both with the same services. Company A consists mostly of higher-paid, long-tenured engineers who have accumulated larger account balances. Company B, a chain of retail shops, has many short-tenured, lower-income workers with smaller balances. All things equal, to generate the same dollar amount in fees, participants at Company A will be charged a lower rate (on their larger balances), and participants at Company B a higher rate (on their smaller balances).

The dynamic nature of the job market only exacerbates this issue. Employees change jobs or retire and then roll over their savings to an IRA. As a result, the 401(k) system is always losing money to IRAs—especially large balances at retirement that, if retained, could drive down 401(k) costs.

So what’s to be done? Actually, a lot is already being done (a point often missing in some critical articles). A regulatory project has been under way to encourage greater fee-consciousness for several years. The government recently issued the final set in a series of regulations. The project mandates certain 401(k) fee disclosures to the government, employers, and participants. The initiative has the full support of the 401(k) industry—the mutual funds, money managers, banks, insurance companies, independent recordkeepers, consultants, and actuaries who make the system work.

Will better information mean lower costs? Certainly better information is a prerequisite for the tougher price negotiations. The new regulations can be thought of as a behavioral finance “framing” exercise in which human decisions are shaped by how information is presented. The new disclosures are certain to make everyone in the 401(k) system more fee-aware.

At the same time, there are limits to what regulators can do. The new regulations won’t eliminate economies of scale. They won’t eliminate disparities in incomes, tenure, and asset accumulation among plans. But they are certain to make price comparison shopping easier, and also highlight the enduring question of active versus passive management.

Which sounds like the right thing to do.

* The rhetoric can be heated. When discussing fees, critics sometimes use terms like “train wreck,” “disaster,” and “investment fraud.” For examples, click here or here.

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