Straight Story: Retirement, the right way

Marketplace Staff Feb 16, 2007

TESS VIGELAND:
It’s time once again for our economics editor, Chris Farrell, to help you sort out what’s smart, what’s stupid, and what is the Straight Story. Hey, Chris.

CHRIS FARRELL:
How you doing, Tess?

VIGELAND:
I’m doing all right. You know, we talk all the time about 401K plans. Congress may be looking to make some changes to the system. So is this good news or bad news for the average worker?

FARRELL:
This is good news.

VIGELAND:
Yay.

FARRELL:
Now, a lot of times I criticize congress, criticize regulators. I want to say something good. Now, let me explain what’s happening. Congress is getting hawkish about 401K fees. Sometimes these fees are disclosed, but often they are buried in the fine print. Lawmakers want them unearthed; full up-front disclosure. The idea is that transparency will bring fees down, and that means more bang for an investor’s retirement buck. Who can’t like that, right?

VIGELAND:
Absolutely.

FARRELL:
And this is on top of another good bill: last year’s Pension Protection Act. It makes it easier for employers to automatically sign up new participants, automatically increase their contributions, and yes, I’m going to say it one more time, automatically put them in a well-diversified portfolio. So here’s the Straight Story: The 401K market is getting better. Let’s keep up the momentum.

VIGELAND:
Well, certainly nobody likes to pay fees that they don’t have to. But how do these actually work? Is this money that comes straight out of your investment?

FARRELL:
Typically, the way the plans are designed, the employer picks up part of the fee, employee picks up part of the fee. The reality is the employee picks up the whole fee. I mean that’s how economists look at it.

VIGELAND:
Well, how does that work?

FARRELL:
Well, if you think about it, here’s how economists look at Social Security tax: Now, you pay half of the Social Security tax. The employer pays half. But the way economists look at it is you actually pay the whole tax because you’re going to get less of a wage increase, or less of a benefit increase in order to compensate the employer for what they have to put into your Social Security tax, essentially the same dynamic is at work when it comes to fees. But here’s the real critical issue, Tess: There are fees that come from plan administration, their investment fees. Because of all these different fees, and a lack of clear disclosure, employees really don’t know whether they are paying a lot or a little. And by the way, it can make a big difference. Can I give you a calculation?

VIGELAND:
Absolutely. I’d like to get some kind of real world idea of how this works.

FARRELL:
All right. So let’s say you had $25,000 in your 401K plan.

VIGELAND:
Sounds good.

FARRELL:
And you have 35 years to retirement, and you don’t put any more money into that plan, which by the way, I would criticize you for doing that. But just for the moment, we’re going to make this assumption. And you earn seven percent average annual return on your money, and you’re paying half a percentage point in fees every year. You retire with $227,000. Now let’s say your fee was 1.5 percent. You would retire with $163,000; a 28 percent difference. That’s why fees matter, and that’s why employees need full disclosure. Employees aren’t stupid. They’re going to go, “We want the lower fee option.”

VIGELAND:
Well, so how is congress planning to fix this problem? Is it going to be as simple as you can actually see the percentage of fees that you’re paying, or the $3.00 that they are charging you to switch from one mutual fund to another?

FARRELL:
Yeah. This is part of where the hearings that are going to be going on to congress, and in the next several months, and you’ll get some rule regulations out of the Department of Labor. But the bottom line goal is to make it a little bit just like you described. Some sort of expense in fee ratio so that you can see I’m paying 5/10 of a percent, or I’m paying 1.5 percent. And the consultant fees that are being paid; rolling that into a total fee and expenses disclosure system. It’s always a little more complicated, and you don’t want too much regulation because then that does increase costs. But by and large, I think there is general agreement: fuller disclosure and then employees will be better able to compare. And by the way, so will employers. It’s going to make it better and easier for employers to decide who they want to do business with.

VIGELAND:
All right. And that is the Straight Story from our man, Chris Farrell. And Chris, let’s put in a plug for another Straight Scoop the folks can get from you on our website.

FARRELL:
That’s right. You can go to our Web site, and we have this segment called Money Clips web video.

VIGELAND:
You get to see what Chris looks like.

FARRELL:
You get to see what I look like, and the topic that I’m addressing is one we get all the time. How do you find a good financial planner?

VIGELAND:
All right, that’s at Marketplace.org. You are working it, Chris.

FARRELL:
Thanks.

As a nonprofit news organization, our future depends on listeners like you who believe in the power of public service journalism.

Your investment in Marketplace helps us remain paywall-free and ensures everyone has access to trustworthy, unbiased news and information, regardless of their ability to pay.

Donate today — in any amount — to become a Marketplace Investor. Now more than ever, your commitment makes a difference.