Fiduciary Rule Commentary: Are IRAs the Problem or Solution?

By Kim O'Brien

The REAL REASON American’s Aren’t Saving: Are IRAs the Problem or the Solution!

As we continue our quest to uncover the real reasons behind the Department of Labor Fiduciary Rule - and arm ourselves with litigation arguments - we remain dumbfounded by the rule’s transparent and unbalanced regulation of IRAs over 401(k) plans.

Why the Department of Labor ignored problems with 401(k) plans and the marketplace, over which they have clear and present jurisdiction, is concerning.

The retirement crisis has been much documented and lamented over during the debate on a fiduciary standard. And it is true, Americans generally aren’t saving enough. But, why, has all the attention and negativity been directed at the IRA marketplace when so much is wrong with the 401(k) marketplace?

Last week’s column focused on the plateau of the 401(k) plan offerings and participation and we suggest that the negativity is because of the skyrocketing desire to roll money into individually owned IRAs.   This week, let’s take a deeper dive into factors that may impede America’s ability to save.

401(K) Fees

The Center for American Progress estimates that a typical worker -- earning the median income and paying the average 401(k) fees over their lifetime -- will be assessed a total of $138,336 in fees. And the costs explode for higher-income employees, who, assuming a starting salary of $75,000 at age 25, are projected to pay an estimated $340,147 over their lifetimes, thanks to the fee structure of the average 401(k) plan.

The department’s explanation of fees is worth a read. The discussion specifically addressing types of fees covers almost 1700 words and they address plan fees and individual participant fees.

According to the DOL, 401(k) plan fees and expenses generally fall into three categories:

• Plan administration fees to cover day-to-day expenses;

• Investment fees to manage the plan assets; and

• Individual Service fees.

They remind you that the net total return of your 401(k) is after these fees have been deducted. But wait, that’s not all. The department goes on to explain that there are MORE fees that are related to your own investment choices. And, they warn that the fees they describe “can be referred to by different terms.” They include:

• Sales charges 

• Management fees 

• Other fees

To help uncover and calculate these fees, they offer a 10-point “fees checklist.”

What do all these fees do to America’s savings?

The department offers its own example to help:

Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.

Based on the fees listed, consumers would be hard pressed to limit their fee exposure to .5 percent or even 1.5 percent without a substantive employer match. So, buyer beware - ask your own questions - complete the 10-point survey - you are on your own!

Impossible situation for most savers.

Not surprisingly, thedDepartment doesn’t address fixed annuities in this fee conversation. Why bother when almost no 401(k) plan offers guaranteed and insured retirement annuities? They do address variable annuities, however, and remind us that variables have investment management and administration fees for the subaccounts in addition to:

• Insurance-related, including: sales expenses, mortality risk charges and administrative; and,

• Surrender and transfer charges.

Other than fees for add-on benefits like long term care or income riders, these are the only fees charged in fixed annuities. Given a choice, rather than navigate the maze of numerous investment option fees, let alone calculate them, fixed annuity owners always know their “net total return.” It is provided to them each year by the insurance company and is known as their annuity value. Many even offer more frequent tracking features. And, if you prefer a quick answer just call. It’s like the year-end balance in a savings account. Annuity owners also are told what their annuity is worth if they keep it with the insurer and what their annuity is worth if they end their contract early (surrender charges). Simple AND transparent.

So, what does the typical 401k owner pay in fees? That’s hard to say. According to FiduciaryNew .com Joe Valletta, author of The 401k Averages Book, pegs the range from 0.87 percent for larger plans to 1.56 percent for smaller plans. It is unclear if these numbers include the fees charged for individual investment choices made by the participant. We suspect not!

The fiduciary-centric website warns that benchmarking services have trouble providing an accurate fee average as a baseline for consumers because there is no rigorous reporting structure for 401k plans.

That might have been a good problem for the department to spend its time on.

Consider 401(K) Performance

In an article published last year, The Motley Fool asks “Do workers get what they pay for” and reports that research strongly suggests that higher 401(k) fees don't translate into higher returns for plan participants.

A seminal 2009 study on the relationship between mutual fund fees and performance found "a puzzling negative relation between before-fee risk-adjusted performance and fees in a sample of U.S. equity mutual funds: funds with worse before-fee risk-adjusted performance charge higher fees."

NerdWallet.com tells us that only 24 percent of active mutual fund managers outperform the market index. What’s more, the typical 401(k) plan contains no offerings beyond mutual funds so where do you go for good performance? Sadly, there are few options in your 401(k) and if you’re are nearing retirement and want out of risk-based mutual funds, the DOL Rule makes it almost impossible for you to find a professional who can help you.

For those of us immersed in the justification for the rule, the department’s conclusion about 401(k) fees is too ironic for words. They advise (emphasis there’s):

When you consider the fees in your 401(k) plan and their impact on your retirement income, remember that all services have costs. If your employer has selected a bundled program of services and investments, compare all services received with the total cost.

Remember, too, that higher investment management fees do not necessarily mean better performance. Nor is cheaper necessarily better. Compare the net returns relative to the risks among available investment options.

And, finally, don’t consider fees in a vacuum. They are only one part of the bigger picture including investment risk and returns and the extent and quality of services provided. Keep in mind the importance of diversifying your investments.

Great advice, too bad it wasn’t followed for a rule making and their calculation of the so-called $17 billion in losses from fees in IRA mutual funds.

If the Department of Labor was truly looking out for retirement savers, why not spend more time and energy on fixing what is broken, instead of what is not?