Tom Zgainer delves into possible pitfalls of 401(k) plans
Imagine giving up 50% or more of your future nest egg to excessive fees. This is precisely what is happening when you utilize a traditional 401(k) plan (which represents 95% of the plans in existence). Seemingly, small percentages have a massive impact when you look at how they impact your account growth over time. Just 1% in excessive annual fees can add up to hundreds of thousands, even millions, of lost retirement dollars.
Fees matter, and their impact can be devastating.
Have you ever been told your plan is “free?” Many 401(k) providers will market their plans as essentially “free” because there are no explicit checks being cut for recordkeeping, administrative fees, etc. But we all know there is no “free lunch” in this world.
If you encounter a “free” plan, ironically, you could be in an extremely expensive plan. The fees are simply being subtracted from your retirement savings, which can act like a hole in your boat! Make no mistake. Just because you may not be cutting a check for your plan, you still may be cutting into your future nest egg.
Figure 1 is a real-life example of two identical plans with the same growth rate, same ongoing contributions, but with different fee structures (0.65% versus 1.68% annually). All things being equal, the additional fees erode more than a million dollars in potential retirement savings.
Layers upon layers of fees are hidden in plain sight.
The traditional providers have been pushing the same old 401(k) plan for 30 years, but in 2012, the law finally required fees to be fully disclosed. The good news is that the curtain was pulled back. The bad news is their layer cake of fees is hidden in 30-50 page fee disclosures that the average person has no chance of deciphering. This is evident by the fact that 71% of Americans think they pay NO 401(k) fees. Nothing could be further from the truth.
Not only do providers make money by kickbacks from mutual funds, they are also happy to layer on additional, seemingly arbitrary fees that can double or even triple the cost of your plan. If that weren’t enough, many will also hit you with a one-time sales charge (aka commission) on every single dollar that goes into the plan. It’s an expensive and entirely unnecessary toll for the “privilege” of saving money.
Here are the charges that should raise red flags.
- Contract asset charge/Asset management charge — a layer of fees charged on the entire balance of your plan. This is over and above the cost of the investments.
- Required revenue — an almost comical line item, this is a fee charged to smaller plans where the providers insist they aren’t making enough.
- Sales charge — a one-time commission that subtracts 3% to 6% from every dollar you deposit.
- Surrender charge — many insurance company providers have figured out a way to have your 401(k) held within a “group annuity.” This means they can penalize you with hefty surrender charges if you decide to switch plans to another provider.
The mutual funds in your plan menu are often chosen for all the wrong reasons.
The vast majority of 401(k) providers make huge sums of money from kickbacks from the mutual funds in the plans they sell. This payment for “shelf space” is a legal but opaque process called revenue sharing. The net result is what we call “menu stuffing” — stuffing your plan’s fund menu with the funds that are most profitable for the provider. Worse yet are the providers that stuff the menu with their own more profitable name- brand funds.
Odds are that your 401(k) plan is packed full of expensive “actively managed” mutual funds that are hoping to beat the market by being the best stock pickers. The problem is that although they may have a hot streak, the studies overwhelmingly show that in due time, they will often lag the market. So you are usually overpaying for underperformance.
What’s the alternative?
A great number of Nobel laureates and investment legends such as Jack Bogle and Warren Buffet would recommend that most investors use low-cost index funds. Index funds simply track a basket of leading stocks like the S&P 500, for example. David Swensen, the Chief Investment Officer responsible for growing Yale’s endowment from $1 billion to $24 billion, warns us, “When you look at the results on an after-fee, after-tax basis, over reasonably long periods of time, there’s almost no chance that you end up beating the index fund.”
Most plans do not offer access to low-cost index funds because they can’t receive kickbacks (aka revenue sharing) from these ultra-low-cost funds. Many small or midsize plans will be told they don’t qualify for index funds because their 401(k) is not large enough. (Translation: “We wouldn’t make enough money off of you if we granted you access.”) Or worse, if they do offer them, they charge an outrageous markup. One plan we reviewed offered index funds with a 3,000% markup from its normal retail price. That’s like buying a $30,000 car for $900,000. All clients of America’s Best 401k have access to same low-cost index funds regardless of the size of the plan. No commissions, no kickbacks, and no markups.
Many of the biggest providers have been named in lawsuits for excessive fees and self-dealing.
There has been a flurry of recent lawsuits against 401(k) providers. The primary reason is for excessive fees and the use of proprietary products. Interestingly, it’s not just the customers who are suing, but many providers have been sued by their OWN employees for their own in-house plan. Providers were caught with their hand in the cookie jar by peddling their own, more expensive name-brand mutual funds and, thus, profiting from their employees’ retirement savings.
Business owners beware!
You have a legal obligation to make sure the fees in your plan are both fair and reasonable. As the plan sponsor, the Department of Labor states that the fiduciary obligation falls on you to make sure the plan is set up for the sole benefit of your employees. Nothing external can influence the decisions you make for your plan, including a relationship with the existing broker. More importantly, it’s your legal duty to periodically benchmark your plan, so a side-by-side comparison is a task that is in your best interest to perform. America’s Best 401k will provide a complimentary benchmark at your request.
The traditional model is being disrupted and rapidly becoming a dinosaur.
The 401(k) industry is ripe for disruption. Much like Uber has the transportation industry on its heels, our company is seeking to transform a decades-old industry that is riddled with conflicts of interest and often puts profits ahead of people. They have seemingly forgotten that it’s YOUR money, NOT theirs. America’s Best 401k is a next generation solution that eliminates brokers, levels the playing field with transparency, and provides a combination of high-tech and high-touch interaction for our clients.
Your next step: Get a complimentary side-by-side plan comparison
Most of our prospective clients are astonished when they see the results of their side-by-side plan comparison. In many cases, the immediate savings is more than $10,000 in the first year alone. But the real impact is what happens over 10, 20, or even 30 years. Below is a chart showing a 401(k) with $1 million in total assets. Here we show our average plan cost versus two other common providers. Note that although fees vary from plan to plan, we often see fees that are even higher from these two providers as well as other major insurance companies and national payroll companies. Assuming the plan is growing at 7% and has modest contributions of $60,000 per year, there are millions in potential savings being left on the table if a switch is not made immediately.
These savings will go right back into the pockets of you and your employees and make sure your money will last as long as possible into retirement. By sending us your fee disclosure form (to firstname.lastname@example.org), which we can help you locate, and by taking 15 minutes to review the results, we hope to show irrefutable evidence why a switch is in your best interest.
Take control, start here: http://americasbest401k.com/fee-checker-medmark.
Tom Zgainer is CEO and founder of America’s Best 401(k) and has helped thousands of companies repair or rescue their retirement plans over the past 15 years. You can learn more at http://americasbest401k.com/fee-checker-medmark.