August 6, 2013

Is It Time for Financial Planners to Advise Against 401(k)s?

There were two excellent comments to my July 30 blog: “What Should 401(k)s Cost? What Do They Cost?” As the title connotes, I was writing about the recent 401(k) controversy sparked by Yale law professor Ian Ayres’ letter, suggesting that more than 6,000 retirement plan sponsors may be violating their fiduciary duty by overcharging their participants. 

The first comment was made anonymously, but that doesn’t detract from its poignancy: “Some good points in the article but then it should give pause to why so many advocacy groups push for auto-enrollment into 401(k) plans. It has been known that some plans basically stink and yet workers are being forced to contribute at least 3%, and many groups purportedly speaking for the consumer are requesting that the number be raised.” 

Seemingly a lifetime ago, as a senior editor at Worth magazine back in the early 1990s, I used to give talks to groups of investors about personal finance. Among other suggestions, I advocated always investing in 401(k)s when available, and at least maxing out the matched contributions. Even back then, I knew fees in many plans were high, but never ran the numbers to see how high. Now I’m beginning to think I may have been wrong: As this no-name comment suggests, the high level of fees in many retirement plans might outweigh the benefits of tax deferral. 

The second comment came from Robert Schmansky, a financial planner and NAPFA member, who also contributes to NAPFA’s “The Fee-Only Planner” blog on Forbes.com. Mr. Schmansky takes issue with one of the sources of the data on high 401(k) fees: “Demos is a political institution that claims to be doing economic research...and it ignored the reason fees were high in order to promote a political agenda. The fees are high because of regulation of 401(k)s, not in spite of their call for more of it.” 

In his June 26 Forbes blog, unfortunately titled “Your 401(k) Isn’t That Bad, Schmansky goes on to call out Demos for basing some of its fee analysis on the difference in costs between actively managed funds and index funds.  He refers to a 401(k) analysis from Vanguard’s Small Business division, which showed “…the weighted average of the total fees for the plan came to 0.63% per fund.” Comparing that cost to Demos’ calculated managed fund average of 0.78%, Schmansky concludes “the 0.63% may be different, but not as much as the piece leads us to believe.” (The “piece” referred to is an analysis by Robert Hiltonsmith of Demos; Hiltonsmith was quoted on a PBS Frontline documentary called “The Retirement Gamble” which has stirred the retirement planning pot.)

It’s fair criticism, which illustrates that by using the Vanguard S&P 500 Index expense ratio of 17 bps, Demos is cooking the books. But that’s not to say that Mr. Schmansky is a 401(k) advocate, which his much better blog of July 11, 2011, “Get Rid of the Workplace Retirement Plan,” shows.

“When you really think about workplace retirement plans,” he wrote, “what sense does it make that your employer, who may be in the publishing industry like Forbes, or may manufacture widgets, decides what you invest in, and is held accountable for you? Our retirement system is broken and it isn’t improving because we don’t have freedom of choice. Employees are captive to plans where indifferent employers, poor custodians, high-cost plans and a government and insurance lobby that think they know what’s best makes our decisions for us.”

Pretty strong stuff. But at least to my mind, Schmansky is on to something here. The problem is this, I think: How can we get Washington’s attention to turn a battleship the size of the 401(k) industry? Professor Ayres took a big first step with his letter to plan sponsors. And data from organizations such as Demos—for all its flaws and hidden agendas—helps to focus public attention on the issue of high fee, as well.

Perhaps the financial planning profession could weigh in too, by routinely analyzing the long-term impact of total costs and fees in client 401(k)s, and recommending their clients opt out when tax deferral isn’t worth it. Maybe if advisors start advising against 401(k)s, the investing public will get Washington to wake up.

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