Too Many 401(k) and IRA Investors Know Too Little About Their Fees

It's so hard to make a buck. Will we Baby Boomers ever be able to retire, even with a 401 (k)? Here's another eye-opening article about management fees.

SmartMoney Posted 09/11/12

by Glenn Ruffenach

Question: How much time do you spend with the retirement-plan disclosures you receive from your 401(k) or individual retirement account?

Answer: Probably little more than the time you've just spent reading these two sentences.

A new study from Limra, a Windsor, Conn., research and consulting firm, found that two-thirds of Americans with defined-contribution plans or IRAs spend less than five minutes scrutinizing each disclosure statement. About 20% say they rarely -- or never -- read the documents.

The research is tied to new rules from the Department of Labor, which require providers of 401(k)s and related savings plans to disclose additional information about fees, expenses and associated data in quarterly and annual statements. The goal: to help workers cut the cost of maintaining their accounts and building a nest egg.The Limra study is an effort to gauge employees' understanding of the new rules - and it highlights not only how little time most workers spend with their retirement-plan documents but also how little they know about their plans' fees. Excessive fees, of course, can make a big difference in the eventual size of a nest egg. The Department of Labor offers the example of two 30-year-olds, each with $25,000 in a retirement account. The first account has an expense rate of 0.5%, the second has a rate of 1.5%. After 35 years, with identical investment returns of 7% (and no additional contributions), the first account would grow to $227,000 -- but the second would total just $163,000.

Among the key findings:

• Half of participants in defined-contribution plans said they have no idea how much they pay in annual fees and expenses.

• Almost four in 10 surveyed workers (38%) believe they don't pay any fees or expenses.

• Only about one in eight (12%) participants in defined-contribution plans could offer an estimate of what their fees might be. The most common estimate: 1% of the account balance. (Limra cites a 2011 Deloitte/ICI study, which found that the "median defined-contribution-plan participant is in a plan with an all-in fee of 0.78% of assets, based on plans included in that study.")

Will retirement-plan participants make use of the new disclosures? Reaction might well be "muted" at first, Limra states. That's because surveyed workers indicated they aren't really sure what to do with the information when they get it.

When asked how they might react if they learn that the fees in their retirement plan are higher than average, 31% said they didn't know; 24% said they would move current assets into funds with lower fees; 21% said they would with speak with their employer about trying to reduce fees; and 16% said they would do nothing.

William J. Bernstein "Money" Interview : The Worst Retirement Investing Mistake

If you've looked at my obssesive reading list ,you know I'm a fan of William J. Bernstein's investing books. Here's a new Money interview with Mr. Bernstein.

by George Mannes | Money – Tue, Sep 4, 2012

William Bernstein has a gift not only for grasping the complex but for helping the rest of us get it too.

He spent the first chunk of his career as a neurologist practicing on the coast of Oregon but cut back on his work hours in 1990. A few years later he focused on a new fascination: investing.

He launched an online journal (a sort of proto-blog) called efficientfrontier.com and wrote "The Intelligent Asset Allocator," the first of several books. (He has also written for MONEY.)

Now he's an investment adviser for a handful of high-net-worth clients. Bernstein's writing often explores academic financial theory, but he manages to turn it into practical, plain-English advice.

His latest obsession, resulting in the short e-book "The Ages of the Investor," is what economists call the life-cycle theory, which dictates that your asset allocation should be tied to your earnings power throughout your career.

Bernstein, 64, spoke with senior editor George Mannes; their conversation was edited.

There's a debate going on now among economists about how much exposure people should have to stocks. What made you weigh in?

It's almost like a political issue. There's a "right wing" of very smart, authoritative people who think that savers and retirees should be investing conservatively because stocks are so risky. And then there's a "left wing" of equally smart and authoritative people who believe the opposite.
I was trying to reconcile the two views. Plus, I wanted to deal with what happened in the 2008 financial crisis, which changed how people, myself included, think about risk.

How so?

A lot of people had won the game before the crisis happened: They had pretty much saved enough for retirement, and they were continuing to take risk by investing in equities.

Afterward, many of them sold either at or near the bottom and never bought back into it. And those people have irretrievably damaged themselves.

I began to understand this point 10 or 15 years ago, but now I'm convinced: When you've won the game, why keep playing it?

How risky stocks are to a given investor depends upon which part of the life cycle he or she is in. For a younger investor, stocks aren't as risky as they seem. For the middle-aged, they're pretty risky. And for a retired person, they can be nuclear-level toxic.

But at retirement you could be investing for several more decades. Don't you have time to make up for short-term losses?

At the end of your career, you have no more earnings capacity left beyond Social Security or a pension. You have less of what life-cycle theory calls "human capital."

So if you have a long series of bad returns, plus you're withdrawing 4% or 5% of your portfolio to live on it, then in 10 to 12 years, you may not have anything left. Withdrawals during the distribution phase combined with a bad bear market can completely destroy a retirement.

So how should I be investing near and after retirement?

You want to end up with a portfolio that matches your liabilities, meaning the amount you'll need to spend in retirement. The rule of thumb I came up with, based on annuity payouts and spending patterns late in life, is that you should save 20 to 25 times your residual living expenses -- that is, the yearly shortfall you have to make up after Social Security and any pension.

This portfolio should be in safe assets: Treasury Inflation-Protected Securities, annuities, or even short-term bonds.

Anything above that, you can invest in risky assets. That's your risk portfolio. If you dream about taking an around-the-world trip, and the risk portfolio does well, you can use it for that. If the risk portfolio doesn't do well, at least you're not pushing a shopping cart under an overpass.

What if you are nearing retirement age and you don't have that 20 to 25 years saved?

You should be working until you get that number. If you're 65 and you've only got half of your living expenses saved, you can retire and you may skate through.

You may die early, or you may have a good market. But there's a significant chance you're going to be eating Alpo when you're 85. That's the risk you're taking. The other choice you have is to work a few more years and reduce expenses.

One thing that we point out to our readers is that if you don't have stocks in your portfolio, you expose yourself to inflation risk.

That's true. By owning stocks you do mitigate inflation risk, but of course, you're exposing yourself to equity risk to do it. It's sort of like all these people who are now buying dividend-yielding stocks because Treasury bonds don't have any yield; they're exchanging a riskless asset for a risky asset.

But there's another asset class that people really don't think about when they think about inflation protection, which is short, high-quality bonds with a maturity of less than three years. If we ever do get an inflationary shock, investors will demand a high real short-term rate of return. It's what happened during the late '70s and early '80s.

Even though interest rates are terrible right now, if inflation recurs -- as I think it probably will -- short-term bonds are a fine place to be, as are individual Treasuries or certificates of deposit.

Since they mature soon, you can replace them quickly with newer, higher-interest bonds.
Interest rates usually more than keep up with inflation. It's true that real yields right now are historically low, but as a student of financial history I have to believe that's not going to last forever.

Okay, so stocks are risky at retirement. What about when I'm young?

For the average person, you'll want a very high stock allocation. Let's imagine you start working at age 25, and let's say for the sake of argument you have 35 years worth of human capital -- that is, 35 years of salary left in you. That's an asset that you own. What you've saved in one year for retirement is still minuscule compared to that 34 years of earning and saving that you have left.

So even if your investment capital when you're 26 years old falls by one-half, your total worth has fallen by only a couple of percent because you still have that 34 years of human capital left. Your ability to earn and save dwarfs the loss in your portfolio.

And what about when I'm in the middle of my career?

That's the key phase. You need to start bailing out of risky assets as you get closer to achieving that liability-matching portfolio? When you can "win the game" without taking so much risk.

Instead of cutting your stock allocation one percentage point a year -- the standard formula -- in a year with absolutely spectacular returns, you might want to take 4% or 5% off the table. In a series of years when stock returns have been poor, you don't take anything off the table. And over time you start laying down a floor of safe assets with the proceeds from the stocks you've sold.

When exactly am I doing this?

Getting close to hitting your number is usually going to happen during a bull market, so the psychology of doing this right is tricky. It's hard to cut back on risk and accept lower returns when your neighbors are getting rich.

If you're very lucky and very frugal, hitting your number might happen when you're 45. In the worst-case scenario, you do everything right and still come up short at 65, so you wind up working longer or greatly paring back your expectations.

It sounds like retirement success depends on when you were born.

Yeah, that is certainly true. Young people should get down on their knees and pray for a brutal bear market at the beginning of their savings career, because that's going to enable them to buy a large number of shares cheaply. Having a sequence of bad returns first, followed by strong returns, is the best-case scenario.

I did a little thought experiment in which I calculated how many years it took people starting work in different years to make their number. I realized that the cohort that started working during the worst of economic times is the one that did the best.
The last cohort that actually was able to make their number started their careers in 1980, and they made their number in 19 years. And the graph ends in 1980, because no cohort that started work after 1980 actually made the number.

Ouch. Can the average person overcome that using the investing strategy you lay out?

I've flown airplanes, and as a doctor, I've taken care of kids who can't walk. Investing for retirement is probably harder than either of those first two activities, yet we expect people to be able to do it on their own.

An alternative would be to have a pension system such as in Singapore, where the government forces people to put money into a dedicated investment pool that it manages at minimal expense. And when people get to be of retirement age, they are forced to annuitize some of those savings, which turns into safe income.

The political chances for a plan like that in the U.S. seem low.

Yeah, I'm definitely in tune with the times.

What about target-date mutual funds, which gradually take on less risk as you age?

They're better than what 95% of people are going to do, particularly if they're run with low
expenses. If you're not capable of doing what I suggest, then a target-date fund is not a bad solution.

What if you want an adviser to help you? How do you find a good one?

Interview one and say, "Look, this is my portfolio now," and you show him or her a simple, cheap index-fund portfolio.

And if he says, "You know, this is really good, you've got the right idea, I think we can diversify you a little more by using some more cheap index funds," that's the answer you want to hear.

You've probably found an honest adviser. And someone who adheres to an index-fund portfolio will probably be more likely to adhere to the policy because you've got someone who has some humility and realizes he doesn't know how to time the market.

Social Security Not the Deal It Once Was for Workers

By Stephen Ochlemacher, AP

Editor's note: Few issues touch as many people in the United States as does Social Security. In a four-part series continuing through August, The Associated Press examines the changing dynamics of the government retirement program and what it means for workers and present and future beneficiaries. This first story examines whether Social Security is still a good deal, and for whom.

WASHINGTON (AP) - People retiring today are part of the first generation of workers who have paid more in Social Security taxes during their careers than they will receive in benefits after they retire. It's a historic shift that will only get worse for future retirees, according to an analysis by The Associated Press.

Previous generations got a much better bargain, mainly because payroll taxes were very low when Social Security was enacted in the 1930s and remained so for decades.

"For the early generations, it was an incredibly good deal," said Andrew Biggs, a former deputy Social Security commissioner who is now a scholar at the American Enterprise Institute. "The government gave you free money and getting free money is popular."

If you retired in 1960, you could expect to get back seven times more in benefits than you paid in Social Security taxes, and more if you were a low-income worker, as long you made it to age 78 for men and 81 for women.

As recently as 1985, workers at every income level could retire and expect to get more in benefits than they paid in Social Security taxes, though they didn't do quite as well as their parents and grandparents.

Not anymore.

A married couple retiring last year after both spouses earned average lifetime wages paid about $598,000 in Social Security taxes during their careers. They can expect to collect about $556,000 in benefits, if the man lives to 82 and the woman lives to 85, according to a 2011 study by the Urban Institute, a Washington think tank.

Social Security benefits are progressive, so most low-income workers retiring today still will get slightly more in benefits than they paid in taxes. Most high-income workers started getting less in benefits than they paid in taxes in the 1990s, according to data from the Social Security Administration.

The shift among middle-income workers is happening just as millions of baby boomers are reaching retirement, leaving relatively fewer workers behind to pay into the system. It's coming at a critical time for Social Security, the federal government's largest program.

The trustees who oversee Social Security say its funds, which have been built up over the past 30 years with surplus payroll taxes, will run dry in 2033 unless Congress acts. At that point, payroll taxes would provide enough revenue each year to pay about 75 percent of benefits.

To cover the shortfall, future retirees probably will have to pay higher taxes while they are working, accept lower benefits after they retire, or some combination of both.

"Future generations are going to do worse because either they are going to get fewer benefits or they are going to pay higher taxes," said Eugene Steuerle, a former Treasury official who has studied the issue as a fellow at the Urban Institute.

How can you get a better return on your Social Security taxes?

Live longer. Benefit estimates are based on life expectancy. For those turning 65 this year, Social Security expects women to live 20 more years and men to live 17.8 more.

But returns alone don't fully explain the value of Social Security, which has features that aren't available in typical private-sector retirement plans, said David Certner, legislative policy director for AARP.

Spouses can get benefits even if they never earned wages. Children can get benefits if they have a working parent who dies. People who are too disabled to work can get benefits for life.

Because of spousal benefits, most married couples with only one wage earner will continue to get more in benefits than they pay in taxes for the foreseeable future.

"You are buying this lifetime inflation-protected benefit that you can never run out of and that will always be there for you," Certner said. "It protects your spouse, protects your family and protects you from disability."

Certner noted that private pensions, retirement savings and home values took a big hit when the economy collapsed, putting a dent in the retirement plans of many Americans.

"When you have that combination of factors, Social Security becomes more and more important," Certner said. Social Security is financed by a 12.4 percent tax on wages. Workers pay half and their employers pay the other half. Self-employed workers pay the full 12.4 percent.

The tax is applied to the first $110,100 of a worker's wages, a level that increases each year with inflation. For 2011 and 2012, the tax rate for employees was reduced to 4.2 percent, but is scheduled to return to 6.2 percent in January.

The payroll tax rate was only 2 percent in 1937, the first year Social Security taxes were levied. It did not surpass 6 percent until 1962.
Even with low tax rates, Social Security could afford to pay benefits in the early years because there were more workers paying the tax for each person receiving benefits than there are today. In 1960, there were 4.9 workers paying Social Security taxes for each person getting benefits. Today, there are about 2.8 workers for each beneficiary, a ratio that will drop to 1.9 workers by 2035, according to projections by the Congressional Budget Office.

About 56 million people now collect Social Security benefits, and that number is projected to grow to 91 million in 2035. Monthly benefits average $1,235 for retired workers and $1,111 for disabled workers. Social Security provides most older Americans a majority of their income. About one-quarter of married couples and just under half of single retirees rely on Social Security for 90 percent or more of their income, according to the Social Security Administration.

"Social Security is what's carrying me," said Neta Homier, a 79-year-old retired hospital worker from Toledo, Ohio. "There's no way I would have made it without it. The kids, they're on their own, now, and I'm not going to be a burden for them. That's what it would have been if I hadn't had Social Security."

Homier said she started receiving Social Security when she was 63 and now gets about $800 a month, after her Medicare premiums are deducted. She said her father died at 51, so he never received Social Security, and her mother died at 71 and collected benefits for only a few years.

"It's definitely worth it," she said.

At 52, Anthony Riley of Columbus, Ohio, has a different perspective. Riley said he has a private retirement account because he worries that Social Security won't provide adequate benefits throughout his retirement.

"I use to think that it was worth paying for your Social Security, but now I don't think so," Riley said. At 22, Mackenzie Millan of Los Angeles has even greater doubts about whether Social Security will be a good deal for her.

"The money that I put aside now, it's not like that money is going to be waiting for me. That money is going toward someone else," the recent college graduate said. "If I wanted Social Security 50 years from now, when I wanted to retire, I would have to hope that someone else is still working and putting money aside in their paychecks to pay for my Social Security at that point."

Die Broke -- on Purpose: An Unconventional Retirement Plan

By Selena Maranjian, The Motley Fool  
This will probably come as a shocker to most people: Three economists from leading universities have found that "a substantial fraction of persons die with virtually no financial assets -- 46.1% with less than $10,000 -- and many of these households also have no housing wealth and rely almost entirely on Social Security benefits for support."

Got that? The findings, in a paper published by the National Bureau of Economic Research show that a huge portion of America is relying almost completely on Social Security, and that they die with hardly any money to their name.

Awful ... or Awesome?

Dying broke probably sounds just awful. But it doesn't have to be.

In fact, it should almost be a goal to which we all aspire. For many of us, a perfect financial life would be one in which we amassed exactly the amount of money we'd need in life, and in which we ran out of money the day we died.

After all, what's the sense of dying with lots of money in the bank? You can't take it with you.

The reality of those who do die broke isn't as neat and clean, though. The professors' data reflects millions of Americans not living perfect financial lives, but instead struggling to get by in retirement. They don't end up running out of assets on their last day, but long before it.

For a clearer picture of the situation, know that the average monthly Social Security benefit (as of early this year) is $1,230. That's $14,760 per year. Can you imagine yourself living on that – or, let's even up it a little, on, say, $20,000 or $25,000 per year?

Even if you can imagine it, would you want to live that way? Probably not.
Problems with the perfect plan

As nice as it might be to run out of money on the day you die, there are a few problems with that plan.

•You don't know exactly how long you're going to live, so you don't know if you need to have ample funds for 10 years or 50 years.
•You also don't know exactly how much money you'll need for the rest of your life. Sure, you can estimate it based on your expenses and assumptions, but a single medical emergency can eat up a big chunk of your nest egg, as can various other surprises.
•You might actually want to leave a big pile of dollars behind, for your loved ones.

Given all that, the bottom line is that you probably need to accumulate a lot of money for your retirement -- just in case you have high expenses and just in case you live a long time.

Many experts suggest that when it comes time to live off your nest egg, you should plan to withdraw about 4% of it in the first year, and then adjust for inflation annually. Thus, if you're looking for income of $40,000 per year, you'll need a million dollars. (Remember that everyone's needs are different -- you might want more income than that, but you might also be expecting some Social Security income and perhaps even some pension money to make up some of that income.)

Make the 'Die Broke' Plan Work for You

If you're reading this wishing you'd started saving for retirement aggressively many years ago, don't freak out. All is not lost, no matter how imperfect your current financial situation may seem.

There are still a bunch of ways that you can make your retirement much more comfortable.

Here are some of the main ones:

• Save more aggressively. The old rule of thumb to sock away 10% of your income is too low for many people. Aim for 15%, or even 20% or more, if you can. And remember that due to the ability of money to grow over time, the dollars you sock away today will likely contribute much more to your retirement than dollars you sock away next year or in five years. So don't put it off.

• Invest more effectively. Keeping everything in a bank account isn't investing -- with interest rates below the average rate of inflation, you're actually losing buying power every year. Bonds are appropriate for those in or near retirement, but ideally in combination with stocks, which usually build wealth much faster. Within the stock world, you needn't take chances on obscure potential high-fliers, either. Over long periods, healthy, growing dividends can build great wealth. And if all goes well, the dividend payouts will rise over time, as will the stock prices, too.

• Retire a year or three later than you've been planning to, if possible. The benefits are many: For each extra year you work, you'll keep workplace benefits such as health-care coverage, and won't have to pay for them. You'll also delay tapping your nest egg for money to live off. And ideally, you'll be able to contribute to the nest egg for a few more years, as well. Meanwhile, for every year that you delay starting to receive Social Security benefits, they'll go up about 8%. Delay three years, and you'll collect roughly 24% more. That's a big difference!

• Cut costs. Another way to make your retirement fund last longer is to use less of it each year. You might move into a smaller house, for example, or to a region with a lower cost of living. You and your partner might make do with one car in retirement, instead of two, saving money on insurance and upkeep. And if you've been supporting some grown and able children or grandchildren, you might rein in that spending, too.

Some or all of these moves can have a powerful effect on your financial condition now and in retirement. You don't have to be among the 46% who die with more worries than dollars.