Did you know the match on the 401(k) was simply a bribe to get rank and file employees to sign onto a system that was designed to move them out of defined benefits plans and into defined contribution plans? Even the nomenclature is misleading. “Defined contributions plan” sounds good, right? Almost identical to “defined benefits.” I mean, both start with the word “defined.” But when we look at the difference, we discover there is no relationship at all.

What is a defined benefit (pension, Social Security, etc.)? It’s a promise to pay. It’s a promise of a certain amount of income for a specific period. It’s a pact between you and the plan. You give it a certain amount of money, and it will promise you a specific amount of income for a specified period. It’s a promise to take on the various types of risk, from investment risk to longevity risk. The plan is stating that it doesn’t really matter what happens or how long you live, we are still going to absorb any losses and pay you what we promised. It’s a covenant of a time.

What’s a defined contribution plan (401(k), Roth, IRA, etc.)? It’s a bucket for you to put your money into. Period. There are no guarantees. There is no absorption of risk. There is only this: you put your money in our bucket, which WE have defined, and over which WE have control, and when you leave our employment, you can take the bucket and good luck with that. What comes out at the other end is purely a matter of luck.

Think about what they (your employer and the plan broker) have designed. They have picked the assets in which you can invest. What criteria did they use? I can think of two. First, they would have picked a mix that provided protection from legal challenges. There are certain provisions in the code which prevent your ability to sue the plan, provided it has a certain number of certain types of assets. That’s the first thing they look at.

The second criteria I can think of is, which assets pay the most? Now you may think that’s a good thing, but I am not talking about you. I am referring to which assets pay the most revenue share to the company and the broker? Because which options end up in your account isn’t driven by what’s good for you, it’s driven by which offerings make the plan sponsors the most. Don’t for a minute think benefits are defined with you in mind. They are always designed to help the employer recruit and retain

employees.

To pay those revenue share fees, the plan must charge enough to cover those costs plus the plan costs, plus the investment company costs, plus the fund management and trading costs. That’s why a) most plan fees are hidden away, and b) why they are so high.

Think about it. The broker gets an ongoing fee for as long as you own your investments (whether in an employer-sponsored plan or an individual plan).

Every year, your broker takes between .5%-1% of your assets as a “management” fee. What, pray tell, are they managing? When do they ever give you any advice? They don’t, and they can’t, because then they become a fiduciary and they take on the liability.

Next comes the plan administrator. The company that set up the plan and does the record keeping, manages the billing, the enrollments, the requests for loans, all those essential things. They get about 1%.

Next comes the management fees charged by the mutual funds and other assets involved. Those aren’t free. There are the management fees, the trading fees, the revenue share fees (kickbacks to your employer), etc.

Total fees are estimated to be as high as 2.22%, or even greater. Different studies have shown they can range between .2% and 5%! The Center for American Progress found that the average American worker who earns a median salary beginning at age 25 will pay about $140,000 in 401(k) fees over their lifetime. Most 401(k) plans don’t even have that much money in them!

How much exactly does that hurt you going forward? Referring to a 2% annual fee over a 50-year investing lifetime which incorporates 30 years of accumulation and 20 of retirement, Jack Bogle, the late founder of

Vanguard, is quoted as saying: “It doesn’t take a genius to know, the bigger the profits to the investment company, the smaller the profit the investors will get…. What happens in the funds business is that the magic of compound returns is overwhelmed by the tyranny of compounding costs…. It’s a mathematical fact; the fact that we don’t look at it, too bad for us…. Do you really want to invest in a system where you put up 100% of the capital, you take 100% of the risk, and you get 30% of the returns?”

In addition to the fees, there is the risk associated with these accounts, both investing and actuarial. Investment, or market risk, hurts you whether you lose money in the market or not. Just the threat of losing money is damaging. In fact, it’s the reason for the 4% Rule, which states that if you want a 90% chance of not outliving your money over a 30-year retirement, you should begin withdrawing just 4% of your assets and adding a 3% (of the 4%) annual inflation bump. You may have heard about this rule. Why is it so small, when the market is said to have a 7%-10% average rate of return?

It’s because you might lose money in the market, not the result of losing money. It’s just the threat of losing money that causes people to reduce their income to such small amounts. So, now we aren’t just worried about the damage market losses actually cause, we are reacting to damage the market could cause.

In fact, the only guarantees provided by the average defined contribution plan is high fees, high potential risk causing low payouts, and high taxes in retirement. Some benefit.

Stephen Kelley is a recognized leader in retirement income planning. Located in Nashua, NH, he services Greater Boston and the New England areas. He is author of five books, including “Tell Me When You’re Going to Die,” which deals with the problem unknown lifespans create for retirement planning. It and his other books are available on Amazon.com. He can be heard every weekend on “The Free Money Guys Radio Hour” on WCAP and WFEA, and he conducts planning workshops at his New England Adult Learning Center, located in Nashua. Initial consultations are always free. You can reach Steve at 603-881-8811 or at www.FreeToRetireRadio.com.

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