Saturday, April 19, 2008

401(k) Plans, Admin Costs, and Due Diligence

Most working folks in 21st Century America have pension plans with 401(k) in the title. Defined Benefit Plans, those old-style pensions where you started collecting a monthly check right after you were awarded a gold watch, are pretty much o-ver.

What everyone now gets is the opportunity to put aside part of their paycheck into a tax-deferred pension saving account, and if they're lucky, get some kind of matching contribution from the company (which is delighted to provide a match because it's way cheaper than the check-a-month pension system they used to fund.)

But here are some wrinkles you need to know, as they apply to all 401(k) plans across the country ...

By and large, 401(k) plans are more expensive than a low-cost mutual fund like Vanguard or even T. Rowe Price. Why? Because a 401(k) Plan has a layer of expenses on top of the various mutual funds it offers:

* It needs to carry insurance to protect trustees.

* It needs to pay legal counsel (lawyers) to keep the Plan up-to-date with federal and state pension laws, and assist in responding to complaints that might come up.

* It must perform due diligence (reviewing administrative performance and fund performance as required by government regulations). This often requires the assistance of outside financial advisors, often at additional cost.

In TAG's case, this has meant -- at one time or another -- changing administrators and switching funds. Some years back, our original administrator dropped the ball on several occasions so the trustees (half of them corporate, half of them union) set about finding a new administrator who might do better. We approached several different companies, whittled the field down to three, and then had each do full-on presentations, finally choosing the one that offered the most bells and whistles at the highest quality for the lowest cost.

Now, when a 401(k) plan has a large asset base, the extra costs for individual participants are pretty minimal. A plan is probably using an administrator that employs economies of scale, for instance a cheaper, sub-advised version of a retail mutual fund, or lower administrative fees, etc.

With mutual funds, most 401(k) Plans desire an array of asset choices -- without having so many that the average participant is confused and bewildered. (We offer a couple dozen options, which is probably on the high side).

The other thing that 401(k) plans like (and need are well-performing funds. This doesn't mean that each account hits a home-run in absolute terms very year, but that it performs as well or better than funds like it.

So, if you have say, a large company international fund, it better be doing as well as similar large company international funds, and it had better be keeping pace with its benchmark -- which would be a large company international index.

To this end, every three or four months, we sit down and review each of our 401(k) funds (escept for the indexes) and check on style factors (is the fund still a large company domestic growth fund, or has it morphed into something else?), its risk/return factors (is it riskier than the market index to which it's linked?)?), and how does it stack up to similar type funds?

We score each fund based on the above, and if one of the Plan's offerings falls to say, a 6 out of a possible 10, it goes on our "watch list." And if it keeps earning a low score for three or four quarters, we jettison it and replace the thing with a higher scoring fund.

This is part of due diligence (see above), and every 401(k) Plan must do it.

What makes fund reviews an ongoing adventure is, every actively managed fund will falter at one time or another, but you you don't want go replacing funds helter skelter. So, you wait to make sure it's down for the count, and not just for two or three months.

I tell 401(k) participants that, if the time comes when they've been out of the industry for three months and they have the opportunity under Plan rules to move their 401(k) money, they should consider doing so because:

1) They'll probably be able to snag outside funds that have lower costs than similar accounts in their 401(k) Plan, and

2) They'll have a much bigger choice of investment options.

But I think the biggest service 401(k)s perform is that they make it easy to put savings away for retirement, and wrap up the procedure in a tax deferral.

And a 401(k) pension plan is better than no pension plan at all.


Jason MacLeod said...

Hi Steve,

On March 10th you posted about possibly changing the 401k plan's administrator. Two names I remember being mentioned were Vanguard and New York Life. Has anything more happened with that? I am impressed with Vanguard's general offerings - T. Rowe Price also is well known for low-cost, high-performing funds. Is the plan management coming up for review? Are you still looking for feedback?


Jason MacLeod

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