Is that gift horse 401(k) plan you have a good deal? Have you examined its teeth?
Maybe it’s time.
The issue here is simple. This gift horse is one you may have to ride until you retire. When 401(k) plans got their start 30 years ago they were imagined as a supplement to pension plans. Today they are the main deal for retirement saving.
Workers now have the unwelcome task of saving for their old age. If they don’t save enough, retirement may not be possible. Ditto if they make poor investment decisions.
With that in mind I called Brooks Hamilton, an early advocate of 401(k) plans who pioneered ways to improve them. The Dallas attorney and I spent so much time talking about 401(k) plans over the last 25 years that we co-authored a 2001 National Center for Policy Analysis paper on how to “reinvent” 401(k) plans so more workers could retire in security, not despair.
Good progress has been made since then, but thousands of plans are still cookie-cutter creations designed by the financial services industry, for the financial services industry. Hamilton believes there is still plenty of room for improvement, even in some of the best plans.
While most companies focus on the company match—- how much cash the employer adds to the amount you save—- Hamilton measures plans on a broad three point scale: plan design, employer contribution and plan expenses.
When I asked why, he said: “I could take you to a terrific company here in Dallas that makes an enormous contribution—- independent of workers—- to their 401(k) profit sharing plan. It’s amazing.”
“That isn’t enough?”
“Not nearly. It’s like catching a long pass in football and forgetting to run for the goal. The company admires its contribution so much; they forgot to go for a touchdown. All that money goes into expensive funds. But they aren’t performing for the employees. In 2014 the plan as a whole got a return of 4.55 percent.
“In the same year the Morningstar moderate allocation fund average returned 6.21 percent. The low-cost Vanguard Balanced Index got 9.48 percent. So the plan is great for its employer contribution, but they can do a lot to make it still better for employees.
“Getting a low plan return on a menu of expensive funds isn’t unusual. It’s common. Recently I looked at the form 5500 (a document that plan sponsors file describing their plan) for a major media company in New York. The plan average return for 2014 was only 2.8 percent—- compared, again, to the 6.21 percent Morningstar average of the moderate allocation funds. Moderate allocation is broadly representative of 401(k) plan asset allocations.”
So fund expenses have been declining—- particularly for 401(k) plans of large companies—- but it’s clear that much of the financial services industry didn’t get the memo. This is particularly true for smaller organizations. Recently, for instance, a friend sent me the “participant annual fee disclosure notice” for the (small) firm he works for. The cost of the plan was $2 a month per participant plus the expenses of the underlying investments. Here are some examples of the markups:
- T. Rowe Price Blue Chip Growth Portfolio, 1.90 percent in the plan. Direct from T.Rowe Price the expense ratio is 0.71 percent.
- Fidelity Asset Manager, 1.72 percent in the plan. Direct from Fidelity, 0.65 percent.
- Vanguard REIT Index, 1.47 percent in the plan. Direct from Vanguard, the investor shares cost 0.26 percent. Expenses of the ETF shares are 0.12 percent.
“It’s sad.” Hamilton said, “But everyone should take a look at the latest class action suit filed by Schlichter, Bogard & Denton, LLP. It shows the kind of self-dealing that some financial services firms still think is fine.”
The complaint shows that the Reliance Trust Company, Insperity, Inc. and a variety of related companies, assumed fiduciary responsibility for $2 billion in multiple plans. They bundled them without passing on any scale savings. Then they offered their own brand new, untested and expensive funds and used other high cost investments at every opportunity.
The suit reads like a blueprint to squeeze every possible dollar out of a 401(k) plan without actually stealing the entire plan. Very depressing, if you care about people’s retirements.
Is there any good news?
Yes. There are lots of good plans out there. But even good plans can be better.