401k – A Case Study

By Mark Folgmann

Hopefully you caught 60 Minutes on CBS last week, they had a great segment on all the hidden fees within our 401ks. Katie Couric also picked up the story and did a follow-up on Tuesday. It’s great to see the problem is getting more press on a national basis. We approached a random local company and asked if we could review their plan for our article. We wanted to pick a local company to illustrate that almost all plans are filled with problems and fees that are not disclosed. The company employees over 100 employees and has in excess of 7.5 million dollars in their plan invested with a bank.

This plan was review by the bank recently and the disclosed fees were approximately $39,000 for investment expenses and $6,000 in administrative cost for a total of approximately $45,000. These were the obvious fees and once we started reading all the fine print we discovered revenue sharing fees, additional fund access fees, transaction/brokerage fees and custodial fees. Do you ever wonder why all the questionable fees are in the fine print? By the time we added it all up we were over $120,000 per year in total cost. Our analysis showed that even though the majority of the plan assets were invested in low cost Vanguard funds the bank was charging outrageous fees on top of the Vanguard management fees to allow access within the plan. Virtually all investment choices other than Vanguard were paying kick-backs to the bank to be included in the investment line-up. This pay to play philosophy creates huge conflicts of interest for the plan sponsor. Great funds do not have to pay to play and they stand on their ability to generate excellent returns with low cost. Imagine the bank charging employees 300-600% more that the Vanguard managers charge, just to include them in the fund line-up. This plan prices out at about 1.75% of plan assets with virtually all the cost being asset based, meaning the percentage remains constant on future plan growth. I believe there is another .5 -1% that even I can’t find; most experts agree that overall plan cost are usually in excess of 2.5% per year. If you recall from previous articles I stated that most plans should cost less than 1% of total assets and large plans like this one should be closer to .75% of assets. Overall this would save the employees between $60,000 and $120,000 per year in unnecessary fees. This cost should be able to be obtained while using an advisor that accepts written fiduciary responsibility; which the bank will not. Lastly there was not an Investment Policy Statement in place which acts as the plans guiding principles. It allows for a fiduciary process so the plan sponsors can make smart ongoing decisions regarding the investments within the plan. This statement would have driven different decisions to eliminated most of the conflicts of interest within this plan.

Just wanted to remind you employers out there that we are conducting another “Understanding you 401k” class at NMU on Thurs 5/14 @ 2:00pm. Call the college for details.

“To 401k or Not”

By Mark Folgmann

I was planning on a case study this week but due to a long tax season and timely questions from my daughter-in-law I decided to put off the case study till next time. We have an excellent local plan to use in our 1st case study and would like to review another 3-4 over the next month. Please call my office if you would like your companies plan reviewed and you have the authority to provide us with all the specific details.

Over the weekend she came to me and asked about an article from a few weeks ago when I stated that many employees are better off not participating in their 401ks especially if they don’t receive matching on their savings. I thought it would be a good idea to explain further so we ran the numbers on her plan (which is one of the worst I’ve reviewed) and compared her end results with a Roth IRA funded through Vanguard. She is 24 years old and we funded her Roth IRA for 41 years at $3,000/year without any increases. We also grew her account by 9%/year compounded with .20% annual fees through Vanguard and 3.00% annual fees through her 401k. The advisor on her plan is using “C” class shares which are about the most expensive share classes in the entire industry.

I’m sure you can guess what account outperformed. The Vanguard Roth IRA value at age 65 was $1,207,140 and the 401k account value at age 65 was $531,664. Just imagine, a 55% increase in retirement value and retirement income all because of one choice. My calculation ends at 65 and we all know that her money will work for another 25 or 30 years after her retirement date. I won’t even show you how much would be lost to fees on account balances that large because you would not believe it possible. End result could be loss of 70-80% of retirement income because of one ill informed decision when she was 24 years old, all caused by the lack of fee disclosure. It’s a shame that most can’t even get the information to make an informed decision about how and where to save for retirement.

There are two distinct advantages to her 401k at this point. #1 is payroll deducted savings and this is a big one. Money is deposited before it gets in her hands and this assures it gets into the retirement account (very important but not worth $675,476) and #2 higher contribution limits within the 401k. It’s very complicated and hard to make good choices about your retirement accounts without knowing all the fees and rules of the different accounts. With all the choices available both pretax 401k and Roth 401ks (not all 401ks have updated for Roth contributions) regular IRAs, Roth IRAs and Spousal IRAs if you are married it can be a quite daunting task without professional help. You also have income restrictions on your individual IRA accounts which could eliminate your deduction if your household income is too high. These decisions should be based on savings amounts, household income, fees attached to accounts and timeframes. These factors should be evaluated by an unbiased 3rd party and second opinions are very important so you don’t make costly mistakes.