What Does Your Retirement Plan Really Cost?by
Are you shopping for a new 401(k) plan for your employees this holiday season? For many employers, the impetus for switching providers comes from new fee-disclosure rules that took effect in July 2012. The rules require providers to detail all costs associated with their 401(k) plans. The idea was to improve transparency by preventing providers from hiding fees, thereby helping employers shop for the best options to their employees.
But the disclosure rules don’t apply to the proposals from retirement plan companies soliciting business.
That’s a problem, because employers could be steered into buying plans that cost more than they were led to believe, says Brandon Bellin, a senior associate actuary for Securian Retirement, a division of Securian Financial Group, based in St. Paul, Minn. Many employees—and employers—don’t fully understand how much difference a small increase in fees makes over a lifetime of saving for retirement, he explains. For example, consider what happens to an individual who earns $50,000 annually and defers 10 percent of her salary into a retirement plan earning 8 percent. Over 30 years, what might seem to be a small, 1 percent fee increase adds up to $100,000 in lost retirement savings. “[Employers] who are unaware of the hidden revenues and fees associated with a particular retirement plan provider’s proposal put themselves at risk if they move their plans to that provider,” Bellin says.
Below are a handful of questions Bellin suggests you ask to ferret out a retirement plan’s true cost. He acknowledges that because Securian sells retirement plans, he’s not a disinterested party. But he says a paper (PDF) he wrote recently about revenue models in the retirement plan industry helps explain why employers should heed his advice.
Where do you make your money? Some companies charge explicit fees that can be evaluated and compared across different plans. Small business plan providers, however, often rely on making money through something the industry calls revenue sharing, Bellin says. These are amounts paid by investment funds to retirement plan providers who offer their funds in the investment options available to employees.
Are there any conflicts of interest? For instance, if the provider is affiliated with a particular mutual fund, that company’s funds may generate higher revenue for the provider, who will have an incentive to promote them. Or the initial pitch may feature low-cost investment options that look like good values, but later, “the provider may suggest a ‘better lineup’ that pays higher revenue sharing [to them] and drives up plan costs,” Bellin says.
How do expense ratios compare across investment options? Oftentimes, retirement plans default to proprietary “target-date” funds that automatically move employees’ savings into more conservative investments as they get older. But despite the fact that many of these funds use low-cost, passive index funds as investment vehicles, they often charge fees closer to those of funds with active managers. “In these cases, investment management expenses can be unreasonably high,” Bellin says. “It’s a way [for them] to make more money without being too explicit about it.”
Will managed accounts be offered in your plan? For an additional fee, some plans allow employees to purchase professional management services for their assets, called managed accounts. “These fees can be substantial and may exceed the actual cost of providing managed accounts,” Bellin says. Some retirement companies may use such managed accounts to help subsidize the plans’ administrative cost. “When managed accounts are offered, they should be considered part of the total cost” of the plan, he says.
The bottom line: Before choosing a new retirement plan provider, try to get a side-by-side comparison of several providers’ plans, how much they will charge in fees, an explicit accounting of any fees that might be hidden, and what the total bottom line is for each provider. The other option is to simply avoid providers that get different levels of revenue from different investment funds. “That way it’s transparent and a lot easier to see than having the money hiding in various places,” Bellin says. “And the employer will avoid the situation where some participants pay more towards plan expenses than others based on which investments they are using.”