With the recent volatility in the stock markets worldwide, concern over the future of many people’s retirement accounts are at the forefront. Volatility as defined in the stock market means to many of us that sleeping well at night is elusive. In the past two days I have had a few calls from my clients not to express concern but to offer a heartfelt thanks. You see, the folks who decide to buy annuities from me join a long list of those who are not affected at all by market risk or market volatility. Like so many people, my clients have joined the long list of people choosing safety and security as the primary direction for their important retirement income funds.
Education is the key to learn how to avoid or minimize risk. As a group, we Baby Boomers are also becoming more educated about the retirement system that have been in place most of our working lives. I am of course speaking about the most popular retirement vehicle of all: 401(k).
It may be a surprise to many of you, but just until recently, the fees and expenses in a 401(k) were craftily hidden. New laws that have increased transparency and made fees and expenses easier to find and understand, many participants fail to take the time necessary to understand and learn about them. Government regulators and other have been making loud and boisterous sounds about disclosure and a purer form of transparency and yet, truly understanding what fees a 401(k) member pays is still cloudy. It is cloudy because so many small fees and expenses are subtracted in way to many areas of the system.
401(k) fees are in 3 main categories: investments, administration and services.
Administration is just that, fees and expenses for accounting, member reporting, tax reporting, and compliance with federal reporting standards. Some companies cover the administration fees and expenses for their members, others do not. Specific service charges can be associated with loans against your 401(k). Investment fees can be confusing and difficult to fully understand. An annual statement should explain what you pay in investment fees.
Investment fees can vary widely depending on the company selected to manage the actual investments offered in the 401(k). An example would be the fees associated with a fund that is actively managed compared to a fund that follows a specific index, such as the S&P 500 Stock Index. The difference in fees associated with the actual investment options can be huge, possibly 3-4 times different. Additional fees charged by the fund could also be for expenses incurred by the fund manager when assets are bought and sold, these fees could also be additional sales charges.
Some funds will also charge a fee known as the 12 b-1 fee. In reality, this fee is nothing more than a trail sales expense paid to the brokerage firm. The interesting thing about these delayed sales fees is they are annual, the fee is paid every year. These fees (and all fees) have a direct influence on what your retirement fund actually earns. The higher the fee, the lower the net return.
In some plans an agreement is present: revenue sharing. This means that the actual mutual fund will “kick” back additional compensation to the overall account manager. These agreements are not universal in existence, they are determined on a plan by plan agreement. What is not always disclosed is that these agreements are in existence.
Fees associated with 401(k) s is no small issue, they represent billons of dollars expensed annually and subtracted from the participant’s retirement accounts. The math is simple, if billions are paid in fees, billions are not there for the benefit of the plan participants.
New laws aimed at this disclosure of expenses are in place but it requires action on the part of the participant and many do nothing. Asking for clarification and help in this area is essential to being fully informed. .
A recent study compiled by the firm, FeeX, found that the bigger the company the lower the fees associated with the 401(k) plan. The differences are significant, big company plans (more than 100,000 participants) averaged a mere .27% annual fees compared to smaller plans with fewer than 1,000 participants with fees averaging about .78%.
The game changer is with smaller firms with employees of less than 25, fees can be very high at this level. The reason? Simple. Lack of education, lack of involvement from the employer and lack of discussed disclosure. Handing out the paperwork and signing up employees can be a dangerous and expensive game. Education is the key, ask question and dig as deep as possible, the difference to the participant can be huge over a working career.
In today’s low interest rate environment, more money is needed to fund a long and secure retirement for an employee. A recent report by the US Government Accounting Office found that more than half of people age 55 and up don’t have any money saved for retirement. Plus, about half of those people do not have a pension plan, leaving them with little income outside of Social Security.
One possible solution for retirement funding management is to outsource the financial responsibility to an insurance company. By doing so you are guaranteed a fixed rate of return or a fixed monthly retirement income. The choice of an annuity is the preferred path to outsourcing.