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Fee Deals Can Hurt Retirement Savers

Trisha Brambley was surprised when she got a call from the chief financial officer of a local company asking for help so candidly.

“He wanted me to tell him what he was paying for his 401(k) plan,” said Brambley, president of Resources for Retirement Plans Inc., a consulting firm in Newtown, Bucks County.

Typically, she is arguing that executives don’t understand their retirement plans’ finances.

Brambley scoured contracts and disclosure documents looking for costs, such as wrap, 12b-1, and subtransfer agent fees. “It took me about a week to figure it out,” she said, declining to identify the client.

Determining retirement-plan costs is as daunting for employers as choosing investments is for employees. What employers don’t know can hurt the retirement savers, said Ted Benna, an industry leader and a plan administrator in Williamsport.

“IBM brings in its plan costs around twelve-hundreths of a percent for everything,” he said. “I’ve seen plans on the other end that are paying” 3 percentage points in annual fees.

Low fees put more money to work faster. Retirement savers socking away $200 a month for 30 years and earning an average annual return of 10 percent would accumulate $440,000 at IBM’s plan costs, or almost double the $244,000 they would amass subtracting 3 percentage points from annual returns.

Despite the importance of fees, many corporate-plan sponsors aren’t interested in reducing retirement-plan costs, said Brent Glading, managing director of the Glading Group, a Montclair, N.J., consulting group.

“We tell them we can save them millions” of dollars, Glading said. “Once they learn it goes back to the employees, they don’t care.”
But most employers get price breaks themselves from plan providers that are designed to make the provider’s offering more attractive.

The Securities and Exchange Commission and New York Attorney General Eliot Spitzer are investigating who pays whom for what, to make sure that the plans’ investment choices aren’t being determined by undisclosed financial incentives.

“Plans with $10 million in assets and up generally are not paying the dollar cost” of administration, Benna said. “They are being passed on to plan participants.”

Revenue-sharing, as these arrangements are called, isn’t automatically bad, said Pamela Hess, a defined-contribution consultant for Hewitt Associates Inc. “There are cheap expense-free offers, and there are expensive expense-free offers,” she said.

But because the deals are rarely disclosed, employees face an even tougher task trying to determine what they are paying.

Retirement-plan costs weren’t always this convoluted. Plan sponsors, which are employers providing tax-advantaged investment vehicles for their workers typically pay for three services:

  • Trustee services, in which a bank or trust company accepts responsibility for the money.
  • An administrator to handle daily chores, such as keeping account records and operating Web sites.
  • An investment manager to put the money to work in stocks and bonds.

Investment management, typically paid by participants, accounts for 70 percent of plan costs, while the trust services account for 10 percent and administration 20 percent, according to Hewitt. The last two are often paid by employers.

When retirement plans offer mutual funds, participants pay for investment management by absorbing the same expenses and fees paid by the fund family’s regular, or retail, investors.

The arrangement builds in a level of double payment. For example, ABC Fund keeps account records for its retail investors, and adds that cost to its fees, which 401(k) savers pay, even though their records are kept separately.

What’s more, a retirement plan often collects participants’ transactions during the day, consolidates them, and presents them to the fund family as if it were a single, large account.

In a revenue-sharing deal, the plan provider offers to split investment-management fees in some way with plan sponsors to help defray administration costs.

Fred Reish, a Los Angeles lawyer specializing in pension law, calls it “the good side of revenue-sharing. It enables a small company to offer a very sophisticated 401(k) plan.”

But the equation changes as plans grow in size. Participants in sizable plans “should be paying significantly lower fees,” Hess said.

Enter the dubious side of revenue-sharing. Massachusetts regulators are investigating a payment of $40,000 made by Putnam Investments to a New York union local that the fund family described in internal memos as instrumental in landing a $100 million plan.

Putnam said the payment was legitimate and commonplace in the plan industry.

Reish said: “When something isn’t disclosed, it looks suspicious.”

The payments are legal as long as employers use the money on direct plan expenses, he said. Employers have no obligation to disclose them.

Worse than undisclosed payments, in his view, is the neglect many employers exhibit toward their plans. “They end up getting taken advantage of and paying ridiculous fees,” he said.

Brambley, the Newtown consultant, totes up plan costs and compares them to plans of similar size. She compares investment choices as well, to gauge what participants are getting for their money.

“It is like a shell game,” she said. “There is something like 70 different forms of compensation.”

Employers “should shop the plan every few years,” she said.

Employees need to get involved, too, Hess said. “They should definitely ask questions, make comparisons of fund expenses, and push the plan sponsor to do better.”