By Robert Powell, MarketWatch
Last Update: 12:01 AM ET Aug 31, 2012
BOSTON (MarketWatch)Dont do it. Dont make any rash decisions when you next open your 401(k) statements and see how much you are paying in fees for this and that fund. Dont just sell those funds with high expenses and buy those with low expenses.
Instead, experts say you should take a deep breath when you see your 401(k) fee disclosures and consider this an opportunity to review your retirement plan in light of your entire portfolio.
I think the first thing participants should not do is panic, said Joshua Itzoe, a partner and managing director of Greenspring Wealth Managements Institutional Client Group. Fees have always been a part of their plan, generally in the form of mutual fund/separate account expense ratios. Unfortunately, having never seen these fees deducted as an explicit expense will likely take (plan participants) by surprise or at least create confusion for those who are paying attention.
Fred Barstein, the founder and executive director of the Retirement Advisor University, shares that point of view. First, participants should not overreact, he said. The fact is that most if not all pay some fee to subsidize some if not all of the employers cost to run a plan.
Create an investment policy statement
So, instead of deciding which funds should stay or go based solely on cost, the experts recommend taking the time to create an investment policy statement, a statement that will plot a course for all the investments in your household, including your taxable and tax-deferred accounts.
Participants need to focus on a proper asset allocation, a mix of stock and bond funds, to meet their risk tolerance and time horizon, said John Spach, a managing director of 401k Advisors and 403b Advisors.
And once you do that, then you can start making decisions about which funds should stay or go in your 401(k) plan. Consider, for example, how this might play out in real life. Lets say you do an investment policy statement and learn that you need an emerging growth stock fund, which we should note tend to have higher expenses than domestic funds. If you own an emerging growth fund in your 401(k), examine whether the fees are in line with the benchmark. If the fees are in line with the benchmark, theres likely no need to change anything. If the fees are above the benchmark, perhaps you might consider investing in an emerging growth fund outside of your 401(k) where you can purchase a lower cost alternative and not lose any diversification benefits. The point being this: If you have an IPS that dictates your asset allocation, owning the right fund might be more important than account its housed.
Ask the benefits department to explain
Chad Griffeth, the co-founder of BeManaged, also reminds us that its not unusual for plan participants to share in the cost of the plan, just as they do their health care. But this is a great opportunity to understand if your share is reasonable or not, as it can be difficult to define reasonable unless a peer-to-peer comparison is provided, said Griffeth.
His advice: Ask your benefits department to share their thoughts with employees. Plus, it could be time to get some information from an independent third party, like the plan consultant.
One of the most important aspects for participants is to understand their plan fees in context and how they compare and benchmark against industry averages, said Itzoe. If plan sponsors have been doing their job, theyve gotten out ahead of these issues and taken steps to engage and communicate with their participants in an honest, transparent and simple way, he said.
Others agree. Plan participants should not initially jump to conclusions regarding the fees and try to have all of the fees explained to them to better understand if in fact they are competitive or not, said Ray Mignone, of Ray Mignone & Associates.
In his practice, Itzoe finds that most people are reasonable about plan fees if they are treated with respect and honesty. For participants who are confused or who have questions Id encourage them to ask their HR department about their fees, how they compare and the due diligence process the company has gone through to evaluate the reasonableness of these fees.
Here are the questions Itzoe recommends asking:
- What is the required revenue for our provider to deliver record keeping and administration services?
- How does this compare to the market?
- When was the last time we went through a fee benchmark or RFP process to evaluate the cost of our plan?
- For the funds in our plan, are we eligible for lower cost share classes?
- Can we have additional low-cost index funds added to our plan?
- Are the fees in our plan for recordkeeping or adviser services primarily asset-based or fixed?
- Is there a way to negotiate a greater percentage of fixed fees to control costs as our plan grows?
- Do any of the funds in our plan provide revenue sharing to the provider?
- If so, is the revenue sharing being used to offset plan costs and are there excess amounts that can be used to lower the overall cost of the plan?
Low cost is low cost
By the way, dont think that the lowest cost funds are always the best ones for you. Funds with the lowest fees are not necessarily the best, though fees are certainly a factor affecting ultimate returns, said Barstein.
Another adviser agrees. Since many participants have never fully understood the fees associated with their 401(k) plans, their inclination when seeing the fee disclosures for the first time will be to move their assets into the lowest cost investment options, said Sean Deviney, a financial planner with Provenance Wealth Advisors.
In most 401(k) plans, this is typically a money market or short-term bond fund. This may not be the best investment allocation given the individuals age, time horizon to retirement and risk tolerance, he said.
Its important to understand the fees you are paying and that they be reasonable, but that should not be the sole determining factor when selecting your investments, said Deviney.
Whats the fee for?
Plan participants should not to treat their 401(k) disclosure statements like any other disclosure they may receive and ignore it, said Raymond Gay, AIF of Rogers Financial. Plan participants need to be aware of the costs associated with the management of their plan and investments, but they also need to be made aware of the services they receive for those fees, he said. It is important to remember that fees are associated with a service.
Dont stop contributing or withdraw your money
Dont let fees get in the way of you contributing to your 401(k) if that in fact is the best way for you to save for retirement.
Participants should weigh fees against the many benefits of a 401(k) plan including tax relief, matches by employers if applicable and the basic human fact that automatic payroll deductions have proven to be the most effective way for people to save vs. making the decision every pay period, said Barstein.
Gay advises against withdrawing money from your 401(k) because of fees. Participants should not overreact and make drastic changes to their portfolio or remove money from their 401(k) plan because of the new fee disclosure, said Gay. The fees are not new to their plan its only new in how they are being presented.
For his part, Spach expects a certain degree of outrage to come from the participant world as the fees and expenses of a 401(k) and 403(b) are finally communicated in a font size that everyone can see and read.
But before anyone stops contributing or significantly lowers their current deferral amount they need to stop and consider the following. Retirement plans are sophisticated platforms that provide services and reporting that everyone has come to expect and need, Spach said. Nothing is free. Employers are being held at an extremely high level of administration and they need the help and services of organizations to keep them from harms way and to provide the best possible investment options at the lowest possible fees to their employees.
One more challenge that awaits 401(k) plan participants is that the actual fee disclosure notices they will receive might not be very helpful and might create even more confusion, according to Itzoe, who reports reviewing more than 40 such disclosure for clients and others. In my opinion, one of the shortcomings of the final regulations is that the notices only require an actual dollar amount to be shown for every $1,000 invested, he said. This is very burdensome because the participant has to determine how much money they have in each fund they own in their account, divide that amount by $1,000 and multiply by the per dollar cost.
Itzoe lays out this example: If Fund A has a 0.95% expense ratio and Fund B has a 1.20% expense ratio, the actual dollar shown for each fund is $9.50 and $12.00 respectively. Assuming the participant has $10,000 in each fund, they would need to divide each amount by 10 and multiply by the two dollar amounts shown. In this example, the result would be $95 for Fund A and $120 for Fund B for a total of $215. By dividing this amount by their total balance of $20,000 they would have a weighted average expense of 1.08%. The math is pretty simple but how many people are actually going to do this? Itzoe asked.
A better approach, he said, is this: Weve tackled this issue for a number of clients by putting together a very simple spreadsheet that only requires the participant to enter their balance for each fund and it automatically calculates their fee in dollars and percentages and benchmarks their percentage fee against plans of comparable size.
Dont ignore those fees
You would not be alone, by the way, if you didnt pay any attention to your 401(k) statements. Two-thirds of Americans with defined contribution plans or IRAs say they spend less than five minutes perusing their retirement plan disclosures, and 20% say they rarely or never read the disclosure paperwork, according to a new LIMRA survey.
With the implementation of the Department of Labors new fee disclosure rule, LIMRA wanted to gauge participant sentiment throughout the process, said Alison Salka, corporate vice president, LIMRA Retirement Research. Not surprising, almost nine out of 10 participants either didn't know the fees they paid or didn't think they paid any fees for their employer-sponsored retirement plans.
Dont be among the nine in 10 who think ignorance is bliss.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. . Follow his tweets at RJPIII.
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