In the May issue of CFO Magazine, Russ Banham takes up the issue of whether people should roll their 401(k) balance to an IRA when they change jobs or retire. It's an important question, but we think Banham misses a few key points in recommending that participants may be better served by leaving their assets in their former employers' retirement plans.
First, Banham seems to underestimate the costs of the typical 401(k) plan (a topic we've written about here) relative to the IRA alternative. Naturally, some methods of managing rollover accounts are more expensive than others. In general, however, an appropriately priced rollover program should be significantly less expensive than the vast majority of 401(k) plans.
Another cost-related advantage of the rollover option, at least in our world: Larger accounts enjoy meaningful economy-of-scale savings, as graduated fee structures bill marginal dollars at lower rates (e.g., 1% on the first $250k, 0.75% on the next $250k, and 0.5% on each additional dollar). Due to appropriate non-discrimination rules in ERISA plans, your 401(k) can't offer those marginal savings for larger account balances. In fact, in plans that pay administrative expenses on a percentage basis (often through elevated mutual fund expense ratios, which facilitate kickbacks known as "Sub-TA revenue-sharing"), larger accounts actually pay significantly more for basic fund administration.
Second, Banham cites the fiduciary duty of the plan sponsor as an advantage of the 401(k) over an IRA rollover. Unfortunately, given current practices, sponsors' fiduciary duties only go so far, and in light of the recent wave of class action litigation against major corporate retirement plans, it seems they don't go quite far enough. Fiduciary duty to investors is hugely important, but every registered investment advisor (RIA) in the country operates under that legal obligation, so investors can enjoy fiduciary guidance by working with a responsible, cost-conscious RIA.
Third, Banham seems to applaud the introduction of a truly superfluous feature in one particular retirement plan. Says the CFO in question (emphasis added): "We publish newsletters and regularly communicate [with employees] about their retirement investments. We've also introduced an online system [that enables] people to check their balances hourly." This is truly backward.
As Banham points out, academic research indicates that an excess of investment choices in retirement plans can impair participant decision-making. A similar logic applies to an excess of information. Research also suggests that infrequent monitoring of account balances correlates with better performance. The premise is: "Don't just do something, stand there!" When it comes to shuffling assets around in retirement plans (and elsewhere), less is truly more.
Hourly updates? Neither necessary nor helpful. We don't know the details, of course, but we suspect that somewhere, somehow that particular feature may cost a little something. And stories like this one suggest service providers are peddling bells and whistles that don't help improve participant outcomes. And ultimately, those outcomes are what all of this is all about.
Bottom line: We think Banham overstates the drawbacks of a high-quality rollover arrangement and understates the costs of a typical 401(k) plan.
As always, there's more on this topic to come...
Russ Banham, "To Rollover, or Not? Why retirees should think twice before shifting 401(k) assets into an IRA," CFO Magazine, May 1, 2007
Gregory L. Ash, "401(k) Plans in the Cross-Hairs," Spencer Fane Britt & Browne, March, 2007