When asked about contributing to a company’s pension plan, my standard answer was always put in enough to receive the company’s matching percentage. Never turn down free money, it’s like receiving a yearly bonus of 2% or 3% of your annual salary.
However be aware of fees that are hidden in the fine print. Make no mistake, these fees do matter. They may seem tiny, barely noticeable but they can eat away your future. A one percent reduction in fees can add an additional 10 years to your retirement income. If two people have the same 7 percent return over time but one pays 1 percent in fees while the other pays 2 percent, the latter will run out of money 10 years earlier.
For nearly 30 years, the pension plan industry wasn’t legally required to explain exactly how much it was charging investors. Sadly, a recent industry survey showed that 67 percent of Americans believe they pay no fees in their 401(k) plan. In a recent survey in Canada, 36% of Canadians claimed that they paid no fees and 11% were unsure.
In a muddy but legal arrangement, a high percentage of plan providers accept payments from the mutual funds they offer in your 401(k) plan. This is called revenue sharing or, more aptly, paying to play. Naturally, the list you have to choose from includes the funds that pay the provider the highest amounts, rarely the best performing and certainly not the lowest in cost.
Additionally, many providers restrict low-cost funds to plans that exceed a certain amount of assets, meaning that employees of smaller companies are forced to invest in funds with higher fees. Since the providers don’t make much of a profit on the lower-cost funds they do offer, they will usually charge a significant markup. For example; you could be paying a 1 percent annual fee for an S&P 500 Index fund when the actual cost is .05 percent. That translates into a 2,000 percent markup.
“Last year the Obama administration announced that hidden fees and backdoor payments were costing Americans $17 billion per year. And that’s not counting the excessive “out-in-the-open” fees that are draining our retirement accounts. The Department of Labor is also sounding the alarm. “The corrosive power of fine print and buried fees can eat away like a chronic illness at a person’s savings,” said Labor Secretary Thomas E. Perez.
A company pension plan is a wonderful savings vehicle when it’s efficient. The problem is that many of these plans are plagued with a variety of additional hidden layers of fees. These added layers have seemingly arbitrary labels, such as “asset-management charges” or “contract asset charges.” They often add up to 1 percent or more and are buried in the fine print of plan disclosures.
New regulations for advisors
Beginning in April 2017, a financial professional who makes investment recommendations to you about your 401(k) or IRA will be legally required to provide advice that is best for your situation, not the funds that provide the most compensation to the advisor. “The advisor will now be required to disclose their conflicts of interest.” This new fiduciary standard will only apply to retirement accounts, and advice provided about other types of taxable investment accounts will not be held to the same standard.
Employers need to wake up and take their role as pension plan sponsors more seriously. It’s in their power to dramatically impact the future quality of life for their employees.