John F. Wasik: Pressure is on to lower 401(k) fees
The days of the overpriced 401(k)-type retirement plan are numbered. The word is out. Congress will soon hold hearings on program expenses, and the U.S. Labor Department will issue guidelines on making fees more transparent.
Meanwhile, the market has responded to employees who are being gouged on retirement-plan expenses.
Enter the bargain 401(k), a stripped-down version of the old-style plan that was loaded with middlemen's fees and with too many costly mutual funds.
In what I call the bare-bones 401(k), or BBk, costs are kept to a minimum because they are stocked with either index or exchange-traded mutual funds. That means maximum diversification at the lowest-possible price.
You won't find the new BBks offered by insurers or huge brokerage houses, though. They are typically offered by registered investment advisers or independent fiduciaries, professionals who disclose all of their fees and rarely make money from commissions.
While they must battle for acceptance and defeat the conventional wisdom that only brand-name financial powerhouses can provide a decent 401(k), they can boost your total return through massive reductions in expenses.
Mutual funds have been a commodity for a long time, especially the index variety, and they should be priced accordingly. But that hasn't been the case in 401(k)s, where fund companies charge employees more than 1 percent a year when they only need to be paying 0.20 percent annually, or much less.
Parker Payson, for example, co-founder of Employee Fiduciary Corp. in Mobile, Ala., offers an EF Smart Plan that includes funds charging as little as 0.19 percent annually. It's based on the highly regarded Thrift Savings Plan, which is used by the U.S. government for 3.2 million federal employees. Funds in that program cost as little as 0.06 percent annually.
Elegant in its simplicity and rock-bottom cost, the government's thrift plan offers index funds covering U.S. stocks and bonds, international equities and real estate. There is also lifestyle portfolios that will package funds for you based on projected retirement age.
Unlike most plans that are dominated by actively managed funds, Payson moves participants into passive index or lifestyle products. He charges employers a flat fee for administration and gives them a pie chart showing how costs were devouring employee assets under conventional plans. He estimates he can cut expenses by as much as 90 percent.
"The amounts that are being siphoned out of participant returns are unconscionable," Patton says. "Some 50 percent of the total return can be pulled away by fees."
While boosting your return through lower annual expenses, the BBk won't eliminate all middlemen fees. You still need to pay someone to administer your plan, set it up and do the necessary paperwork.
Yet there's no reason for your retirement plan to be such a greedfest for brokers, fund companies and administrators. Here's a sampling of some of the charges that may be deducted from your retirement assets:
Wrap, mortality and commission expenses. Only in 401(k)s, 403(b)s and 457 programs structured as variable annuities or sold by brokers, these charges could cost you more than 2 percent of your kitty, every year.
Commissions and fees for sub-transfer agents, administration, compliance, 12(b)1, finders, account servicing and distribution. These expenses are often hidden in what you pay for each fund in your plan, but are negotiable and can be paid on a flat-fee basis instead of a percentage.
Internal costs. Actively managed funds have higher turnover, meaning more portfolio transaction fees are charged to you. Exchange-traded or index funds eliminate most of these costs.
The BBk removes most of these fees and discloses all costs openly. You save because more of your retirement money is being invested and not paid out to third parties.
Why should you be picky about retirement-plan costs. Even small increases in your total contributions make a huge difference when the U.S. savings rate is a negative 1 percent, the lowest point since 1933. Keep in mind that with its many warts, the 401(k) is the only retirement plan for most employees, serving 47 million people.
Matt Hutcheson, an independent fiduciary and founder of Tualatin, Oregon-based Gemini Financial LLC, which offers a low-cost retirement plan, says "most plans considered to be low-cost can consume up to 3 percent of employee assets per year, and more in many cases."
At the very least, approach your employer and ask him or her to do an independent fee analysis of your plan. Most programs can trim costs and put more money in your pocket. Then, tell your employer it's time to go bargain-hunting for a bar-bones retirement plan.
John F. Wasik, author of "The Merchant of Power," is a columnist for Bloomberg News.