How to Boost Returns in Overpriced Retirement Plans
It’s amazing that people will spend months researching and pricing a new appliance –- something they’ll only use for a few years – yet neglect to check the costs of their retirement plan, something they’ll need for rest of their life.
Your retirement contributions constitute a major purchase. Using your semi-annual statements, which you should be receiving soon, start to compare and lower the expenses in your plan. You’ll reap a double benefit: an increase in the amount invested and enhanced returns.
Wayne Lenell started scrutinizing his retirement program when he became finance director of the Catholic Diocese of Rockford, Illinois, which has a $20 million defined-contribution plan (similar to 401(k) plans) for 3,000 employees.
His money was also in the plan, so he had a vested interest in finding out whether he was getting the best-possible performance.
“There was no reporting, no comparison to (return) benchmarks, and we didn’t know if we were getting a good deal or not,” Lenell said.
The Detective Work
Lenell wanted to improve his retirement program, so he hired Tom Muldowney to vet the plan. Muldowney is an independent, fee- only financial planner and managing director of Savant Capital Management in Rockford.
Muldowney discovered that the diocese was paying too much in expenses and getting poor returns from an insurance company product called a Guaranteed Investment Contract or GIC. Muldowney then recommended some low-cost, diversified funds for the plan.
The changes saved the diocese $400,000 a year on its plan based on 1 percent fewer annual expenses and 1 percent more in returns. While that doesn’t sound like much, that’s $12 million over 30 years.
“We cut costs by 25 percent when we moved from GICs to index funds and get quarterly reports and comparisons to (fund performance) benchmarks,” Lenell said.
All told, Muldowney says no funds within the diocese plan charge more than 0.30 percent a year – an attainable goal for any retirement plan. Adding Muldowney’s annual advisory fee of 0.40 percent per fund, the Rockford plan still costs less than 1 percent a year to run. Compare that with 1.62 percent for the average retail stock mutual fund and the savings translate into higher returns over time.
Your Plan’s Costs
You can clearly pay too much for your retirement program. Seemingly small differences in expenses make a huge difference in retirement. Compare, for example, a $1 million portfolio at three different expense levels, compounded at 5 percent return over 30 years and withdrawn at age 60 at a rate of 4 percent a year:
The highest-cost fund, averaging 2.3 percent a year — similar to expense levels seen in broker-sold variable annuities and other insurance products — leaves you $642,018 at age 90.
A middle-tier expense level of 1.3 percent — close to the average retail stock fund — produced $862,050.
The lowest expenses — at 0.30 percent, similar to index or institutional-class funds — netted $1.16 million. That means you could gain about $518,000 if you reduced your investment expenses by only 2 percentage points if all other factors are equal.
John Ameriks, senior investment analyst for the Vanguard Group, the second-largest mutual fund company, observed that “expenses are a big deal while you’re accumulating (retirement assets) and a bigger deal while you’re drawing assets down in retirement.” Ameriks calculated the above examples for me based on a study he did on retirement expenses and returns.
While cost savings are easily achieved simply by moving into less-expensive funds within your retirement program, most employers are reluctant to make changes and may not even be aware of the high costs of their 401(k)s.
Brent Glading, a fee-only consultant with the Glading Group in Montclair, New Jersey, has talked to large retirement plan administrators across the U.S. and found that “not one plan sponsor (employer) had a clue as to what was going on with expenses. Most said they weren’t paying anything.”
As a former Merrill Lynch 401(k) plan salesman and currently a specialist in ferreting out and reducing 401(k) expenses, Glading works with employers to show them how much profit plan vendors (the companies managing the program) are making, which ranges up to 500 percent. Then he negotiates with vendors to return some of that profit back to the plan to improve returns and lower costs.
Want a Rebate?
Glading said he recently was able to garner a $1,200-per-employee rebate on a $150 million plan at a commodities trading company. He couldn’t name the company because it wanted to remain anonymous. He says that’s usually the case with his clients since employers don’t want to appear as if they were overcharging their employees. That creates a liability issue since employers are legally responsible for obtaining the lowest-cost, most-diversified funds for their 401(k)s. “Nobody realizes they can get these rebates,” Glading says. “Few chief financial officers know they can do this.”
Employers, though, have a growing awareness that their 401(k)s may be overpriced. A recent survey of more than 140 large employers representing almost 2 million employees by benefits consultant Hewitt Associates Inc. in Lincolnshire, Illinois, found that “70 percent of plan sponsors were concerned about the total cost of their 401(k),” and many have taken steps to reduce expenses.
What to Seek
Employers may be lax on policing costs because they can get employees to pay many of them. Pam Hess, a Hewitt consultant, said that less than one-half of employers she surveyed “have attempted to calculate total plan costs.”
Yet dramatic savings are possible depending upon the size of the plan assets – the larger the plan the more institutional- class discounts are available – and the type of funds within the program.
Hess says a typical 401(k) large-stock growth fund charges an average 1.58 percent annually in expenses. A similar separate account would average 0.56 percent a year. The lowest-priced large-stock growth fund would charge 0.14 percent annually. Better yet, an S&P Index fund is available for as low as 0.02 percent.
Contact your plan administrator or trustees to get an audit, fee reduction and rebate. Tell them to contract with an independent fee-only adviser (someone not on commission, with no connection to vendors). Then enlist the support of company executives to broaden your low-cost, diversified fund selection.
Remember that executives have their money in the plan, too. And once they take action, it’s payback time – for everyone.