By Mark FolgmannHopefully 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.
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.
By MARK FOLGMANN
We’ve spent the last six articles unpacking the problems and concerns with the small business 401(k). Today we will take a closer look at what an ideal plan would look like so that you may compare your plan with an ideal plan. For my money an ideal plan would revolve around three issues - which would be plan design, cost and overall investment experience. The overall goal should be to create a plan that would allow for the greatest chance of a successful retirement for each and every employee.
We start with plan design because this puts all the triggers and measurements in place to assure success. This starts with a fiduciary process in which an Investment Policy Statement is created with the rules of the plan. This document would specify what our investment strategy is, and why we include certain investments and how and why investments are replaced. It would also point out what we measure success against with regard to indexes such as S/P500 or Russell 2000.
Next we would create an Investment Committee, whom along with a Fiduciary Advisor (RIA) will implement and monitor the process. We would also suggest automatic sign-up and annual increases in salary deferral till an employee reaches a benchmark of 10, 12 or 15 percent. Add in a Roth option because tax-free is the name of the game when possible.
Cost is the next areas of focus within a plan. Start with transparency, if you don’t know who is getting paid and how much – you have a problem.
The only control you have over your plan is the cost and most don’t know what they are paying. I would expect your overall cost within your plan to be south of one percent, and this should include everyone including the advisor. A well-crafted plan should have about .30 percent (or less) for investment cost, .30 percent (or less) for recordkeeping and custodial care and .40 percent (or less) for a fiduciary advisor.
In order to get your investment cost less than .30 percent you will have to utilize low cost institutional class index/passive mutual funds. Since there is no academic proof that high cost actively managed funds outperform the market over long periods of time, we believe the best strategy is to match the market with the lowest cost.
The typical plan I review has all in cost of 2.5 percent or more with many of these fees buried in hidden cost. Once you know who is getting paid and how much, you can monitor and make annual decisions on who needs to stay and who needs to go - this is the plan sponsors fiduciary responsibility. Normally these funds or investments are institutional classes such as Vanguard or Dimensional Funds who do not pay advisors to market them. An annual check-up on all plan cost keeps everyone on their toes.
Lastly we must deal with investment experience of the participants. As stated in an earlier article, the average investor during the boom 1990s only experienced 3.9 percent annual growth from their funds while the market return was over 10 percent a year. Therefore, we should allow professional money managers to create model portfolios and let the employees pick their portfolios based on their individual situations.
The current market has shaken the most sophisticated investors and most are now in agreement that we are not trained to manage our own money.
Last but not least is the use of Institutional Funds vs. retail funds. You want your retirement money commingled with professional money managers, not the typical retail investor who does the wrong thing at the wrong time (all the time). Professional managers are not driven by fear and greed; they are driven by asset allocation and rebalancing. Over time this has a significant impact on the overall investment experience.
A friend of mine Josh Itzoe, author of “Fixing the 401(k)” recently wrote a white paper available on my Web site, which estimates the cost of not having a “Fiduciary Advisor” at $450,000 per participant. You can read the full article at www.arkadvisor.com under the 401(k) section. If you oversee a 401(k) and would like a review of your plan, you can reach me at (231) 668-4118 or mark@arkadvisor.com. Next time we will look at a case study to demonstrate what an inferior plan can cost you over time.
Mark Folgmann is president of Ark Advisors LLC in Traverse City. He has more than 25 years of experience within the financial service industry. This is the seventh in a series of columns discussing topics related to 401(k) planning.
By Mark FolgmannThe profitability of the 401k industry depends on the magnitude of fees it can extract from plan assets, not on how well it protects and enhances the retirement income security of plan participants. Conflicts of interest run rampant in the Financial Service Industry and it begins with the advisors or brokers pay. Rarely is it disclosed that different investments pay different commissions or fees to the broker and even different mutual fund share classes provide different income to the selling agent. This is what creates the conflict when we have the broker picking or advising what funds or investments to include within our 401ks and receiving different compensation as a result. People tend to do what they get paid to do and the greater the pay the more they make the recommendation.. I see this in the insurance industry quite often when the agent suggest whole life insurance which cost and pays much more over term insurance which is less expensive and probably better for most people. Advisors will want you to believe they have a special skill for identifying and choosing outstanding mutual funds to be included in your 401k when in reality these mutual funds have bought their spot with “pay to play” money and may even throw in a free trip for the salesman (advisor) if he sells enough of their product.
Many people think their 401ks are free because most of the fees are never disclosed and sharing the fees generated by a common practice called Revenue Sharing. The 401k may only offer the most expensive mutual fund share classes which generate enormous fees which in turn are used to pay for record keeping and advisor servicing fees. Since the employees participating in the 401k never see the fees deducted, it appears the services are free when in reality they are being charged so much they would be better off not participating in the 401k and instead funding a private IRA with a low cost Vanguard Fund. This is not the case if you are receiving matching by your employer. I have recently reviewed 401ks that are charging employees 35 times more in fees than they would pay at Vanguard for equal if not superior investments.
By Mark FolgmannA Fiduciary is someone who occupies a position of special trust and confidence. The sponsor of your 401k holds this position and their sole purpose is to protect and secure your families retirement income. This responsibility involves many parts such as selecting advisors, cost analysis, evaluating conflicts of interest, implementing a fiduciary process and ensuring a successful retirement outcome. Unfortunately many fiduciaries are not fulfilling their duty and are incorrectly assuming their advisors are sitting on the same side of the table and sharing the risk.
You must start by asking your advisors if they accept fiduciary responsibility, in my opinion this is the most important question you will ever ask your advisor. Most firms and advisors operate under the suitability standard and that does a great job protecting the advisor and his firm but does not protect you the client. Fiduciary advisors must act in their client’s best interest so make sure you get confirmation in writing. You can learn more by visiting www.focusonfiduciary.com. Employees depend on their plan fiduciaries to be knowledgeable and implement a process that will protect their family’s retirement income. Based on the current status of our 401k plans we need a wake-up call to plan sponsors. Remember the interest of the financial service industry is diametrically opposed to the American worker whose retirement funds they have been entrusted to invest. Every dollar of cost reduces your retirement account by an equal dollar. Plan sponsors can learn more by registering for our February 25th NMC class from 1-4pm “Understanding your 401k” at 995-1700.
Next time: What the financial service industry does not want you to know (conflict of interest)
By Mark FolgmannProbably not the best time to bring up fees in your 401k since many account values are already down 40 or 50%. In order to get maximum recovery when the economy improves it’s imperative that you pay attention to cost within your plan. As I ask people what their cost are within their 401ks I usually hear that there is no cost or my employer pays the fee. This simply is not true; you always pay virtually all the cost. The industry is masterful at hiding and concealing these fees a lot like the line in the Wizard of Oz when they say “Pay no attention to that man behind the curtain.” At last count there are 14 ways to hide fees and those fees can eat as much as 50% of your retirement balance over a 40 year career.
This seems to be impossible but remember two things, first fees come out each year whether you make money or not and second the compounding effect is one of the most powerful forces in the universe. A 25 year old saving $400/month with $200/month employer matching would accumulate $2.8 million by age 65. This illustration assumes a 9% portfolio growth rate and zero investment/plan cost, neither very likely, the typical small business plan (plans with assets less than $20million) I review has total carrying cost of 2.5- 3.5%. If I run the same illustration assuming a 2.5% total cost/yr in fees the accumulated balance at 65 becomes $1.37 million, which is a reduction of 52%. Now it is unrealistic that we have a plan with zero cost but we would make a lot of progress if we first understand that there is a cost and we as participants are paying the bill. Once we realize we have a problem we can determine exactly what it is costing. I say that with tongue in check since it’s extremely difficult to find all the fees since currently there is not a requirement of full disclosure. My personal belief is your complete plan cost should not exceed 1% and you should have a goal of .75% or less and this should include all fund expenses, record keeping and advisor fees. Your employer has fiduciary responsibility to review plan cost and make sure they are reasonable and competitive.
The Department of Labor is currently working on increased requirements demanding full fee disclosure that should take effect later this year. Many 401k plans with high fees are scrambling to replace current plans with lower cost plans prior to the new disclosure rules taking effect. You can visit my website at www.arkadvisor.com for a 30 minute free video on Hidden Fees under the 401k Pension Consulting Page and as always to can e-mail question to me at mark@arkadvisor.com. Our next article will be addressing Fiduciary Responsibility for employers.
