In May 2012, the Department of Labor released its final fee disclosure rules.
The rules were designed to create greater transparency around the fees that plan sponsors and participants are paying in retirement plans. They also exposed the multiple profit centers of providers who offer proprietary funds and quantified the financial impact these have on total plan costs.
Since then, plan sponsors and participants have been inundated with disclosure documents and notices describing in great detail the fees in their 401k plans. Shows such as “Frontline” and many other nightly news programs have warned consumers about the perils of paying plan fees.
These charges have been made out to be the primary scapegoat for why people do not have enough money for retirement.
Based on having worked with more than 175 plan sponsors over the last 25 years, plan fees often are the least important variable in determining retirement plan readiness.
The single most important variable in saving for retirement is time.
Almost regardless of income, someone age 25 needs to save about 6 to 8 percent of his income at a 6 percent rate of return (in addition to projected Social Security benefits) to replace 80 percent of his income at age 65. This number jumps to about 13 to 16 percent of his income if he starts saving for retirement at age 35.
For those who started saving later in life, working an extra two to three years can increase retirement savings by 15 to 20 percent on average because of compound interest.
The second most important factor is the contribution rate of both the employer and participant. Someone who increases his contribution from 4 percent to 5 percent will have 25 percent more money saved for retirement, all other factors being equal. Going from 4 percent to 6 percent would be a 50 percent increase.
Unfortunately, many employers have reduced their contribution to retirement plans because of the dramatic increase in health care costs. Reversing this trend would have a profound effect on overall plan success.
Asset allocation is the next factor.
Virtually all of the headline stories about retirement plans focus on the individual who lost half his account just before he was ready to retire. This is a perfect example of someone who I believe was invested totally inappropriately based on his age. Another example is the new employee who invests in the guaranteed account so as not to lose money, thereby costing himself hundreds of thousands of dollars in lost earnings at retirement.
Numerous studies have shown that people who invest in a diversified portfolio on average earn 1 percent to 2 percent per year more than people who pick their own funds. Compounded over time, this is a huge difference. The longer you have until retirement, the greater the impact.
Finally, there are plan fees. All other factors being equal, lower plan fees will result in more plan assets in retirement.
It is a simple math problem. If overall plan fees were lowered by 20 percent from 1.00 to .80 percent, it has one-fifth the impact of increasing contributions or enhancing returns by 1 percent.
In combination, increasing employer and participant contributions, starting to save earlier or retiring later, choosing a more appropriate level of diversification and lowering fees are the solutions to the estimated $6.6 trillion overall shortfall in retirement savings in this nation.
This is why auto-enrollment, auto-escalation and defaulting to a qualified default investment alternative are growing trends in our industry.
Advisers who are retirement plan specialists realize that this is a multifaceted problem and that the most important measurement is overall results, not just price.