Employee retirement plans have drawbacks as well as advantages. Several new rules from two departments of the federal government—Labor and Treasury—are designed to reduce some of the drawbacks and provide new opportunities.
Here’s a closer look at how your retirement plan is about to change and what you can do…
An AARP study last year found that 71% of 401(k) participants are unaware that they are paying any fees at all in their 401(k) plans, even though those fees can have a major impact on their retirement nest eggs.
Example: Paying an extra 0.5% in annual fees throughout a 30-year career can reduce the amount in a 401(k) at retirement by 10%, according to the fund company Vanguard.
The Labor Department has issued new rules that start within the next few months that are meant to make it easier to figure out how much you’re paying in fees and expenses in 401(k) plans and in 403(b) plans that are covered by the Employee Retirement Income Security Act (ERISA). Here are some of the fees you’ll be hearing about…
Administrative fees are what you pay just to participate in your 401(k) plan. These include recordkeeping and accounting expenses, among other costs. Although employees at large companies often are not charged these fees, employees at smaller companies typically are. An employee at a company with 10 employees might be charged an amount ranging from $50 to $200 per year.
What’s new: Any administrative fees imposed on plan participants now must be revealed in the annual disclosure statement. When plan providers debit these fees from participant accounts, they also must be clearly listed in the “account activity” section of the next quarterly statement.
What to do: If you’re charged significantly more than $50 per year (perhaps $100 if you work for a company that has fewer than 10 employees), encourage your employer to explore lower-cost 401(k) providers. Suggest that your coworkers make the same request.
Asset-based fees are what you pay to invest in specific mutual funds (or other investments) in your 401(k). They are a percentage of the amount invested and can vary significantly. When insurance companies manage 401(k) plans, they typically impose a “wrap charge”—sometimes called an “asset charge”—of as much as 1% or 2% annually on top of mutual fund fees. That charge often has not been disclosed to plan participants.
What’s new: The fees and expenses charged in each investment now must be clearly disclosed in a chart for easy comparison. Annual expenses also must be listed both as a percentage and as a dollar figure per $1,000 invested. Any wrap charges must be included. Shareholder fees, such as up-front sales commissions and redemption fees, also must be listed.
What to do: Try to avoid investments that impose annual fees in excess of 1%. (It’s reasonable to adjust that down to 0.5% for bond funds…or up to 1.5% to 2% for foreign stock funds.) Index funds should charge much less. Unfortunately, 401(k) plans typically offer very limited investment options, and there might not be any options appropriate for your goals that fall below these fee levels. If so, request that your employer seek out a 401(k) provider offering lower-cost investments. Also, check whether your 401(k) offers a “brokerage window” that allows you to invest in mutual funds or other investments that are not specifically included in the plan. If so, you can use this window to invest in lower-fee investment options.
Warning: You generally cannot arrange automatic contributions through a brokerage window, so you will have to make each share purchase yourself. Some 401(k) providers charge either a flat fee or a per-trade commission for using the brokerage window. Find out if yours does.
Individual service fees are charged when you take advantage of optional 401(k) plan services, such as borrowing money from your account or requesting a check via overnight mail.
What’s new: These fees now will be summarized in a straightforward table.
What to do: Refer to this table before requesting any special services.
In decades past, it was common for traditional pensions to provide retirees with a check each month for as long as they lived. Now most retirement plans are 401(k)s, which offer no guarantee of income for life. And even retirees who still have traditional pensions often opt for the flexibility of a lump-sum payout rather than monthly checks.
That lack of guaranteed retirement income—together with longer life spans, low bond interest rates and recent declines in the value of homes—has greatly increased the odds that retirees will outlive their savings.
The Treasury Department has proposed rules to reduce that risk…
Longevity annuities would be allowed in 401(k)s and IRAs. Longevity annuities provide an income stream that starts when the buyer reaches a fairly advanced age—usually 80 or 85—and continues for the remainder of the buyer’s life (or the life of the buyer and his/her spouse, in the case of a joint-life longevity annuity). These can be a lot more affordable than an immediate annuity that begins making payments soon after your initial investment.
Example: A 65-year-old might have to pay $277,500 to purchase an annuity that pays $20,000 per year starting immediately…or just $35,200 for a longevity annuity that pays out $20,000 per year starting at age 85, according to a report issued by the President’s Council of Economic Advisers.
Trouble is, it currently is difficult or impossible to purchase a longevity annuity in a 401(k), 403(b), 457 plan or IRA—they run afoul of required minimum distribution (RMD) rules that force investors to begin taking money out of tax-deferred accounts starting at age 70½.
What’s new: The proposed rules would exempt assets invested in longevity annuities from RMD calculations—as long as the annuity costs no more than 25% of the account balance…and as long as the cost of the annuity is no more than $100,000…and starts making payments no later than age 85.
What to do: A longevity annuity might be a viable option in certain cases—say, if you’re healthy and come from a long-lived family. But that doesn’t mean you should jump at the one offered in your 401(k).
While the plan provider might have used its market power to obtain better annuity terms than you could obtain on your own, it also is possible that you could find a better longevity annuity on the open market, outside your 401(k).
Compare the costs and monthly payments offered by several insurers before making any choice. Consider the financial health of the insurance company offering the annuity, too. If this company goes out of business, the value of your investment could be severely diminished—protections for annuity investors in the case of insurance company insolvency vary by state but often do not exceed $100,000, which might be much less than what you expected your longevity annuity to provide. (See www.Ambest.com and www.StandardAndPoors.com for ratings of insurers.) Married people should strongly consider a joint-life longevity annuity, which makes payments until both spouses pass away.
Be aware that today’s low interest rates mean longevity annuities currently are relatively expensive. There’s something to be said for delaying a purchase or seeking out another way to ensure that you don’t outlive your retirement savings, such as delaying the start of Social Security benefits, which increases your monthly checks by 7% to 8% for every year you delay from age 62 to age 70.
Those with traditional pensions will be allowed to take two forms of payment. Currently, employees with old-fashioned pensions are offered a choice upon retirement—either monthly payments or a lump-sum payout.
What’s new: The Treasury proposal would make it simpler for employers to offer the option of taking part of the pension as a monthly check and part as a lump sum, something that currently is difficult and rare.
What to do: Taking part of your pension as an annuity for safety and part as a lump sum for flexibility could make some sense. But it’s wise to hire an actuary to examine the plan’s lump-sum offer first to make sure that it is as large as it should be. There’s a lot of money on the line, and it is very hard for the average person to gauge whether he/she is getting a good deal. Unfortunately, the lump sums offered by pension plans sometimes are significantly lower than the present value of the monthly pension checks surrendered to acquire them.
Source: Peter Philipp, CFP, CFA, who specializes in employee benefits and investment management for businesses and individuals at Cambridge Investment Research, Inc. Based in San Francisco, he is an instructor in wealth management with the UC Berkeley Personal Financial Planning program. www.CambridgeSF.com