Employer sponsored retirement plans, like your 401(k), have an administrator who is usually a company employee overseeing the plan for participants. The financial company that actually holds the assets and makes investments is the manager.
The sponsor, your employer, pays a fee for each participant and management fees, either a fixed annual amount or a percentage of the total assets of the plan. This is important to understand; either the employer is paying a one time annual fee, or the manager is reducing the return to everyone in the plan to pay the fee, or both. Over your 40-year career you can lose tens of thousands of dollars in fees or even upwards of double that depending on the structure of your plan.
While serving as tacit administrator of an employer-sponsored plan at a past employer I began to question rates of return that just didn’t seem right. The plan manager representatives were of no help, either they really didn’t know or they didn’t want me to know how returns and fees were calculated. Either, in my mind, is a dereliction of duty.
Hence I ran my own test. On the first day of a calendar quarter I made an investment in my personal mutual fund account in the exact fund I held in my retirement account. At the end of the quarter I had a significantly better return in the personal account than I did in the retirement account.
The largest fee charged, and the real reason that big banks and insurance companies are in the retirement fund management business, is a portion of the yield of each participant’s investment. This is the number I ferreted out in my test and it was a big number, about one half of one percent. Doesn’t seen big? If you save $10,000 each year for 40 years you will have about $125,000 less. That’s a big number.
This charge to participant’s savings through reduction of returns is systemic and no plan manager is going to readily alert anyone, though the amounts are all disclosed in the plan documents. According to the ICI 2013 Fact Book employer sponsored retirement plans hold about $5 trillion, which yields about $25 billion in returns stripped as fees by plan managers from participants each year.
Finding the discrepancy in our plan sent me to the plan managers’ representatives for an explanation. All of sudden they turned from my best buds into marble mouthed idiots. They spoke over and around the point and could not, or would not, say how it all worked. Though it took months of research I found out that the plan used mirror funds. This is the same kind of mirror you use to model your new gay threads, a reflection.
A mirror fund is a vehicle that is essentially a copy of an existing name brand mutual fund. Rather than investing directly into the actual fund, your retirement money is invested in another account that is then used by the plan manager to buy into the actual mutual fund. The benefit of this concept is that there are no entry or exit fees and plans with many participants making many trades can be sold the idea that overall costs will be lower. A mirror fund is generally not as profitable as it originally seems because the management fee can be substantially higher than the mutual fund it reflects. Mirror funds can easily be a false economy.
Employer sponsored retirement plans can be as difficult to grasp as the guy you pursue around the gay bar. Weighing the benefits of tax deferral and employer matches against excessive fees and limited access to your money can be a tough call. Like any investment decision, approach your employer sponsored retirement plan with knowledge and understanding.