Farrell: Are employer 401(k)s cheaper? It all depends

Q: Is it true that an employee’s company cannot profit by their 401(k) and cash-balance plans, and thus are less expensive investments than what would be found on the open market — and thus a good incentive to keep one’s funds at the company at retirement? Thanks for your comments!

ALAN

A: You would think your observation holds, but it isn’t necessarily true that an employer’s plan is the cheapest, most cost-effective option. Unfortunately, as with most answers to questions about retirement savings plans, the answer is, “it all depends.”

Companies don’t profit from 401(k)s and similar retirement savings plans. They’re a cost to the company, but management finds the expense well worth it in the competition for talent. (It’s to management’s benefit to have a retirement plan, too.) Some employers have extremely efficient and thoughtfully constructed retirement savings plans, a financial boon to their employees. (Having looked at your retirement savings plan, you can count yourself among those in a good one.) However, not all employer-sponsored plans offer their employees a menu of good investment choices at a low cost.

For example, the Government Accountability Office (GAO) reports that the average sum sponsors of small plans pay for record-keeping and administrative services is 1.33 percent of assets annually. The comparable annual figure for large plans is 0.15 percent. The total fees paid on a plan are critical to investment performance. The GAO calculates that a 45-year-old with $20,000 in a 401(k) would have $70,555 at age 65 with a 6.5 percent return and paying 0.5 percent in fees. Hiking the fee by just 1 percentage point shrinks the nest egg at retirement to $58,400. Calculations like this are behind the new rules requiring better fee disclosure to plan participants. The realistic hope is that the total cost of plans will come down with improved disclosure.

Anyone nearing retirement will want to research both the cost of their employer’s plan, evaluate the investment options it offers and, most importantly, learn about the options offered by the plan for taking the money out. They’ll want to compare that information with transferring the money into a “rollover” IRA. Sometimes, the best choice is to stay put, especially if the employer-sponsored retirement plan allows for participants at retirement to put some money into an annuity, creating a pension-like guaranteed income.

Nevertheless, there are good reasons for stashing the savings in a rollover IRA in many cases. You’re no longer limited to the investment options chosen by the employer-sponsored savings plan. The money is under your control. You can shop around for the lowest-cost investment choices, such as broad-based equity index funds. You can look for a good annuity and put some of the money into it. As a general rule of thumb, the IRA option typically gives savers more investment choice and flexibility.

That said, your question highlights a troubling aspect of the employer-sponsored retirement savings market with 401(k) and comparable plans. The process is too complicated. I wish the rules were simpler and more standardized, making it easier for participants at retirement age to decide whether the best course is to stick with their employer’s plan in retirement or move the money into an IRA. You can’t assume in this business. You need to research your options.

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