Many Americans are paying high fees in their 401(k) plans for insurance they don’t need, and their employers often are unaware, some observers say.
BOSTON — Many Americans are paying high fees in their 401(k) plans for insurance they don’t need, and their employers often are unaware, some observers say.
The culprit, the observers say, is a fee for mortality-and-expense risk that is part of the variable annuities often offered to 401(k) plan participants.
The fee is designed to protect investors from market declines. If there is a big sell-off in the stock market and a participant dies, the contract from the insurer typically provides for replacing what the participant invested and giving it to beneficiaries.
Big savings
But one financial planner said that the annual M&E fees sometimes can be 1.25% or higher.
“That’s huge,” said Joe Baker, a certified financial planner at ALCUS Financial Group LLC in Mount Pleasant, S.C.
Although paying M&E fees might have made sense for someone who began investing just before the stock market tanked in 2001 and who died soon after, it doesn’t make sense for the vast majority of retirement plan investors to pay such a big fee every year, he said. Most 401 (k) participants eventually roll assets into individual retirement accounts and never use the benefit, Mr. Baker said.
In one audit, his firm reviewed a plan for a small construction company in which each participant paid 2.31% on average of their account assets annually. ALCUS recommended a new plan — with virtually the same range of investment options, plan features and online benefits, minus an M&E fee — that charged participants 1.28%.
For a participant with a 401(k) balance of $100,000, the savings by just switching plans would be more than $1,000 a year, Mr. Baker estimated. If invested at 7% annually for 20 years, the savings would mean an additional $45,000 for the participant, he said.
The VA industry, however, defends the fees.
Although variable annuities within qualified plans typically have higher costs, including M&E fees, than straight mutual funds, the difference is about 0.9 percentage points on average, according to Michael DeGeorge, general counsel at NAVA Inc. in Reston, Va., formerly the National Association for Variable Annuities.
“The difference is not as great as some people may believe it is. However, that 90 basis points or so does provide a number of important insurance benefits that are not going to be available if someone invests just in mutual funds,” Mr. DeGeorge said.
The death benefit ensures that beneficiaries get the full amount the deceased invested if the market drops, and many annuities also offer living benefits that provide additional principal protection during an investor’s lifetime. Variable annuities also offer the option of converting retirement plan money into an income stream guaranteed for life, Mr. DeGeorge said.
“Group annuities offered within qualified plans often have lower expenses than individually owned annuities,” he added.
Although the stock market historically has made money for long-term investors, few expect to die suddenly, which is why the peace of mind annuities offer makes sense, Mr. DeGeorge added.
But not everyone agrees.
If investors are worried about market risk, they would likely be better off getting term life insurance at a cheaper rate or investing in more-conservative asset classes, according to Mercer Bullard, founder and president of Oxford, Miss.-based Fund Democracy Inc., which advocates for mutual fund shareholders.
The vast majority of 401(k) participants don’t need M&E insurance, he said.
It also makes little sense to use a variable annuity — which is a tax-deferred vehicle — in a retirement plan that itself is tax deferred, Mr. Bullard said.
“Variable annuities have long been the last refuge of excessively priced products, and it is very common, unfortunately, for those kinds of products to find their way into tax-deferred employee benefit plans,” he said.
It is so common, in fact, that Mr. Bullard, who also is a securities law professor, is subject to them in the plan offered through his employer, the University of Mississippi Law School in Oxford.
“You are subject to the options that your employer has provided to you, so I’m stuck with what are essentially insurance products which are more expensive than they otherwise would be,” he added.
The small employers with which ALCUS works often don’t even realize that their employees are getting a raw deal, Mr. Baker said. When a big financial company tells a small employer that it can offer it a 401(k) for about $950 a year, as was the case with the construction company, the employer often jumps at the chance, he said.
Documents for 401(k) plans can be thick, and executives at small businesses — who typically wear many hats — don’t always read them, Mr. Baker said.
“Most of the time, the employer[’s] or the plan sponsor’s costs aren’t too bad,” he said. “But when you look at where a lot of the fees are hidden, it’s on the employee side.”
Although the problem isn’t exclusive to small plans, when it comes to them, “the abuse is aggravated, because small plans are more expensive to operate, so the additional fees that you are going to pay in these funds will be even higher,” Mr. Bullard said. A plan provider might charge an employer $1,000 a year to run a plan, when a competitive price really would have been $5,000, he said.
“That $4,000 will somehow find its way from the employees’ pockets into the provider’s pocket,” Mr. Bullard said.
Meanwhile, David Loeper, chairman of Financeware Inc., a Richmond, Va.-based firm that offers investment management services and online tools to support financial advisers, said the firm cut its combined 401(k) plan costs by about 75% this year by switching from an
annuity-based plan offered by The Principal Financial Group Inc. of Des Moines, Iowa, to one offered by Employee Fiduciary Corp., an independent record keeper in Mobile, Ala.
The new plan, which isn’t annuity based, charges Financeware, which has $1.8 million in plan assets, $25 a year per participant and offers access to 33,000 funds. Financeware had been looking for a new vendor for six years, Mr. Loeper said.
Terri Hale, a spokeswoman for Principal, said the company doesn’t have any M&E risk charges in any of its retirement plans, including those funded with annuities. While noting that Principal doesn’t comment on specific client situations for confidentiality reasons, she said that some providers may seem less expensive, because they don’t provide the same level of service.
Mr. Loeper said that while the Principal plan that his firm used didn’t have a specific breakout for M&E expenses, he suspects —though he can’t prove it — that the yield quoted on a guaranteed contract option offered through the plan was net of M&E costs. The biggest cost differences between the two plans, however, were expense ratios, administrative costs and commissions, he said.
“If you are a small company and have less than $1 million, it’s almost all sold by insurance companies,” Mr. Loeper said. “So it was hard to find somebody that would service us and wasn’t playing the same games.”
