The Trouble with Variable Annuities

Annuities can very confusing, especially when there is a broker involved who earns compensation through commissions that are built into the cost.  But the broker has to get paid, right?  Actually, no the broker doesn’t have to get paid because many annuity companies offer the exact same annuities with the same riders (except that they don’t have any surrender charges or commissions) that are sold through registered investments advisors (RIAs).  Consequently, all of the costs are the same except for the mortality and expense (M & E) charge because the annuity company has to charge a higher ongoing M & E expense in order to recoup the cost of the commissions paid out to the broker.

Now the broker could come back and say, “The RIA is just going to charge a 1% assets under management fee, which over time, will cost the client just as much if not more than buying a commission-based annuity.”  This statement may be true depending on the annuity and the face amount, but it misses the larger point:  How much work is the advisor or broker doing, and are services provided commensurate with the fee the client is paying?

In both cases, the answer is of course no since there are little if any ongoing “management” services to perform, especially for a tax-deferred investment which has no tax consequences from buying and selling securities.  As Warren Buffet said in one of his annual letters to Berkshire shareholders, dated February 28, 2014:

“If “investors” frenetically bought and sold farmland to each other, neither the yields or prices of their crops would be increased.  The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties.

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions.  The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit.  So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

My advice to the trustee couldn’t be more simple:  Put 10% of the cash in short-term government bonds and 90% in a very low-cost S & P 500 index fund (I suggest Vanguard’s).  I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions, or individuals – who employ high-fee managers.

Brokers, for example, who work for firms that are dually registered as RIAs and brokers should at the very least explain the different compensation arrangements to clients.  Otherwise they aren’t acting in the clients’ best interests.

So in the event that a variable annuity is a fit for a client, it would be best to use Vanguard’s variable annuity that has an annual M & E charge of only 0.20% and offers low cost Vanguard index funds.  If an RIA receives an hourly fee or a flat annual fee that also includes comprehensive financial planning services – meaning the services to place a client into an annuity are simply included in the flat fee to provide a financial plan – then that would make more sense.  But since there are little if any ongoing services required, the annual financial planning fee should be adjusted accordingly.

How to Design the Worst 401(k) Plan and Make Sure it Stays that Way

If I were to advise a plan sponsor to design the worst possible 401(k) plan, this is what I would suggest:

1.  Hire a commission-based broker who does not act in a fiduciary capacity and can only earn percentage-based kickbacks (known as 12b-1 fees) from certain mutual funds and not others.

2.  Include as many investment options as possible that nobody understands in order to give the impression that there is a lot of “work” for the broker to do.

3.  Hire a third party administrator (TPA) who receives percentage-based kickbacks (known as sub-transfer agent revenue) from certain funds and not others in addition to the flat dollar quarterly fee he bills you.  You also might want to make sure that the TPA dually acts as a commission-based broker so he can monitor his own services rather than bother to have a third party do it and puts you in a variable annuity contract to ensure he can continue to earn commissions deducted from participants’ accounts which he is allowed to do without having an investment license.

4.  Hire a record keeper who not only also receives sub-transfer agent revenue from certain funds and not others, but also is a mutual fund company who offers its own proprietary funds.

5.  Create an investment policy statement (a written description of a plan’s investment related decision-making process) and then forget about it and don’t follow it.

6.  Make sure you have no idea how much money your providers are taking out of participants’ accounts in hard dollars and that if you ask, that the disclosure is impossible to understand.  It would also be best to always think about your plan in terms of percentages rather than hard dollars because 1% always seems like a small number and therefore a good deal.  And of course, whatever you do, don’t ask for a breakdown of each service fee (advisory/broker, record keeping, administration, and custodial).  That way you will continue to never be able to make any meaningful comparison of fees and services.

7.  Also make sure you continue to keep paying your providers more money each year without them doing any more work.

8.  Always believe your trusted advisors (especially if they are your close friends or family members) when they say “Everything is fine and “in-line” with other plans in the industry.”  Don’t ever compare their fees and services (IN HARD DOLLARS NOT PERCENTAGES) to other providers because it might offend your service providers.  And if a third party ever raises questions and concerns about the unnecessarily increasing fees of your current plan and conflicts of interest that your trusted advisors have, make sure not to think about these concerns too much and forward these concerns to your trusted advisors so they can tell you everything is ok.

Retirement Plan Fascism

“Political language – and with variations this is true of all political parties, from Conservatives to Anarchists – is designed to make lies sound truthful and murder respectable, and to give an appearance of solidity to pure wind.” George Orwell

The Department of Labor’s recent fee disclosure rules have brought out another government buzzword. This time it’s “transparency.” While the word may sound new to people not familiar with government schemes, its purpose is the same: to obfuscate the truth. Unfortunately, the very people with the fiduciary responsibility of overseeing trillions of dollars of retirement plan participants’ money – namely human resource managers, chief financial officers, and business owners – have no better understanding of this subterfuge than anyone else. For this reason, when speaking with people in these positions, the typical response I receive when suggesting that they may not fully understand the corruption, conflicts of interest, and excessive and hidden fees that continue to plague the retirement plan industry is: “Everything now must be disclosed” despite the fact that they still have no idea how much money service providers are taking from participants’ accounts nor how these providers make their money. Ironically, this false sense of security creates a moral hazard by making plan sponsors less likely to actually fulfill their fiduciary responsibilities of monitoring their service providers, asking about conflicts of interest, benchmarking their fees, and fully understanding and complying with the fee disclosure rules. It’s almost as if the government aims to turn people into criminals in order to solidify the power of the largest retirement plan service providers who control the industry.

Those who act in a fiduciary capacity should clearly bear some of the blame, but if we want to understand the real cause of the retirement plan racket, we must turn to central economic planning – especially public education which has turned so many of us into mindless automatons. How else can it be explained why so many people in charge of protecting people’s money lack the critical thinking skills to ask the most basic questions of retirement plan service providers – questions like “How do you actually make your money?” or “How much money in hard dollars did you make from our plan last year?” Given the unrestricted access we now have to technology, retirement plan fiduciaries have no excuse to plead ignorance. A simple Google search for retirement plan fees can level the playing field very quickly.

Those who serve and represent the industry should know better as well, but they tend to view problems through the lens of central economic planning and focus on how central planners should solve our problems rather than if they should do so. The fiduciary standard debate serves as a good example. This debate centers on whether these planners should require that brokers adhere to the fiduciary standard instead of the suitability standard which does not require that a broker act in a client’s best interests. As a registered investment advisor who acts in a fiduciary capacity and has harshly criticized brokers, there is nobody who would like for advisors to act in their clients’ best interest more than me. However, rather than spend my time trying to add more energy to the system that created the same problems we are now trying to solve, I choose to direct my energy into my own business and educating people through voluntary and peaceful means which are far more effective as illustrated by how much easier it is to understand retirement plan fees by visiting my website as opposed to the confusing maze of information put out by the Department of Labor. Albert Einstein reflected this belief when he said, “We cannot solve our problems with the same thinking we used when we created them.”

This centralized retirement planning system is characterized by a partnership between large politically connected businesses and government and an industry-wide revolving door between public and private sector employees, two defining characteristics of economic fascism. Former SEC attorney Edward Siedle and economics professor Thomas DiLorenzo have separately provided parallel accounts of this revolving door in both our current investment industry and Benito Mussolini’s fascist regime. The similarities are eerie and should not be dismissed as hyperbole as we must examine economic regulations in light of the coercion that distinguishes all forms of central planning.

Another characteristic of fascism is the restricted ownership of resources in which private businesses retain ownership, but the state exercises control over how resources are used. For example, while people are free to invest in a 401(k) plan or IRA, the government places restrictions on the level of contributions and types of investments people can choose as well as the kinds of services and advice they are able to receive in connection with their retirement plans. Furthermore, the government even restricts the tax deductibility of IRAs for participants who earn above a certain income if they already participate in a 401(k) plan. There is even a possibility that traditional IRA contributions will be eliminated which will steer even more contributions to 401(k) plans and thus create an even greater windfall for the politically connected 401(k) service providers who lobby through industry groups to ensure the government enacts legislation that favors their interests at the expense of their customers and competitors. In fact, one small retirement plan provider actually had to raise its fees in order to comply with the new fee disclosure rules when its website already clearly disclosed all of its fees! Consequently, while capitalism gets blamed for the failure of our retirement plan system, it is the government’s restrictions on the use of resources and crony capitalism that are causing the erosion of people’s retirement savings. As Sheldon Richman, writer and Vice President of the Future of Freedom Foundation noted, “As an economic system, fascism is socialism with a capitalist veneer.”

These restrictions result from a vertically integrated and institutionalized power structure. Southwestern Law School professor Butler Shaffer has cited the observations of various historians regarding the idea that “institutionalization – with its insistence on regulatory conformity, standardization, and the protection of existing organizational interests – has been a principal cause of the collapse of previous civilizations.” For this reason, understanding the retirement industry in this context might help us understand its true nature and the effect that dependency on politically driven systems has on our lives.

Some people, however, believe that “hope and change” depend on the party in office, but the only real difference is what each party does with our money after they steal it. It’s time we expose central planners for who they really are: people who seek power over others for their own benefit at the expense of those they rule.

Why I often Give Away my Advice for Free

Here’s a great post from the Self-Pay Patient blog:

I’ve written about medical bill negotiators in the past, but I don’t know that I’ve specifically described CoPatient and how they work. The process as described on their web site is pretty straightforward and has one helpful service that I’ve not seen before from a medical bill negotiator. Here’s how they describe their services after people create an account and submit their bills:

  1. Organize all your paperwork. We match your provider bills to your EOBs. You get access to a consolidated view of all your bills.
  2. Review your bills and insurance coverage. We use technology. industry know-how and knowledge generated from other consumers like you to uncover the many errors that happen in medical billing.
  3. Provide you with a report. You can then go in and see a nice snapshot of what you owe and what we think you can save.
  4. Get the errors fixed and recoup or lower your expenses. We fight insurance denials and negotiate your doctor and hospital bills. We have the experience and relationships to do this and you don’t have to spend all day on the phone. We charge a small percentage of what you save as a fee.

One of the interesting things about CoPatient is that they provide you with a report before you pay anything, meaning if someone wants to they can use the information to try to negotiate a discount on the bill themselves. They address this in their ‘Frequently Asked Questions’ section:

Are you concerned the individuals will take the free audits and contact providers or payers directly? Our goal is to create an environment where consumers take a larger role in their healthcare management, and that starts by understanding medical billing. Our philosophy is that if a consumers shares their medical bills with CoPatient — which in turn helps our system grow smarter and faster — then we want to give them something of value in return. Some consumers may want to take action on that data, and we encourage them to fight for what is fair and accurate. However, others opt-in to our appeal service to let our Billing Advocates make the phone calls, send the letters and follow-up with their providers and health plans to fix errors and overcharges.

Needless to say, ‘free’ is a pretty good price for such a valuable report! But the thing that really caught my eye was the fact that CoPatient will also review patients insurance coverage and appeal adverse decisions by insurers to deny payment.

In the modern world of bureaucratic medicine, there are few more frustrating experiences than having medically necessary treatment denied by an insurer. Having someone like CoPatient to help navigate the insurance appeals process seems like a terrific option for self-pay patients who do have some form of insurance!

Similarly, the more a 401(k) plan sponsor shares with me, the more I learn about the industry – which helps me grow smarter and faster – so I want to give them something of value in return.  Some plan sponsors may want to take action on the advice I provide and use it to negotiate a better arrangement with their existing providers, and I encourage them to fight for what is best for themselves and their participants.  However, others decide to engage my services and either have me deal with their existing providers or recommend new providers.

In the modern world of bureaucratic 401(k) plans, there are few more frustrating experiences than having to ask your service providers what you are paying them and then having to hire a consultant just to understand their response!  It’s like someone picking your pocket and then selling you back your own watch – after breaking it – and then providing a manual that only a watch expert can understand .  Having someone who actually acts as your advocate seems like a terrific option for plan sponsors who would otherwise be in the dark.

Book review: Simple Wealth, Inevitable Wealth: How You and Your Financial Advisor Can Grow Your Fortune in Stock Mutual Funds

1.  The main premise that returns are primarily driven by investor behavior is a good one.  Investor behavior is definitely not often driven by a rational and disciplined approach, so I share Murray’s view that the best way in which an advisor can provide value is by protecting investors from themselves.  In fact, I recently sent each of my clients this article that reflects this view:

Conflicts of Interest and Mutual Fund Advice –

The last part is insightful:

“A client called up his advisor, wanting to know what he should do in reaction to the plummeting market. “Nothing,” said the advisor. The next year, he called again, wanting to know what he should do in response to the soaring price of gold. “Nothing,” was the advisor’s response. In year three the client called again, wanting to know what he should do to take advantage of the soaring bull market. “Nothing,” said the advisor again. “Excuse me,” said the client, “but every time I ask your advice, you tell me to do nothing. Remind me again what I’m paying you for.” “You’re paying me,” said the advisor, “to keep you from doing something.”

And therein lies the true value of advice.”

He went on to rightfully criticize all of the unnecessary hype and unfair criticism of financial advisors from journalists who promote a do-it yourself approach that can be reckless at worst and irresponsible at best that promotes active trading which has an inverse relationship with growing your portfolio.

I also liked the behavioral psychology insight about how people have such an aversion to and fear of losing money that it will outweigh their desire to make money.  This type of behavior is evident when people sell at the bottom – the worst possible time to sell.

2.  I enjoyed the empirical evidence Murray provides to support the idea that investing in equities is actually a safer way to protect your wealth in the long-term than investing in cash and bonds.  I have made this claim as well, but it’s nice to have more evidence to back it up.

3.  His discussion as well as empirical evidence of the value of dollar cost averaging was useful.  When you look at investing this way, bear markets are great because now you can purchase investments on sale!

4.  It was nice to see that Murray took a balanced and unbiased approach to the active vs. passive debate.  Murray correctly pointed out that index funds (depending on the fund) can be more volatile and expensive than some actively managed funds that focus on long term returns and minimizing trading and volatility.  He also points out time periods when most actively managed funds outperformed the S & P 500 as well as thinly traded asset classes like small cap that are more likely to outperform the index benchmark.  On the other hand he warns against accidentally creating your own overly expensive index fund by investing in several large actively managed funds that collectively replicate the market.

5.  While Murray pointed out the pejorative way in which the media refers to financial advisors as “brokers”, he completely ignored the distinction between a broker and a registered investment advisor who acts as a fiduciary and is legally required to act in a client’s best interest as opposed to a broker who is subject to the suitability standard and does not have to act in a client’s best interest.  The main difference is that a registered investment advisor cannot take any kickbacks from a third party whereas a broker can only earn percentage-based kickbacks from financial products known as 12b-1 fees.

For more information on the subject, I would suggest watching the two videos along with reading the article below:

Butchers v Dietitians Brokers v Advisors Suitability v Fiduciary:

Retirement Gamble:

Suitability vs. Fiduciary Standard:  It’s a Big Deal:

6.  Murray does give a brief mention to various organizations one can contact if he needs to find a financial advisor, one of which was an association of fee only planners.  However, the focus of his book was on the idea that it is generally a good idea to pay an approximate 1% ongoing fee to a financial advisor while ignoring the fact that you could get the same level of service for a flat annual fee or hourly fee that would not necessarily be every year, as a portfolio doesn’t necessarily have to be reviewed literally every year.  The two attached articles go into more detail about this issue.

Furthermore, there are still conflicts of interest with an asset-based fee, even if it is charged by a registered investment advisor.

This article elaborates:

There are Conflicts of Interest Inherent in Assets-Under-Management Pricing –

Here are some highlights:

Charging clients on an AUM (assets under management) basis, however, presents more-serious conflicts of interest than those faced by brokers, because the conflicts may involve much more money than the value of a trade.
Here are some typical situations where asset-based fee compensation poses conflicts for advisers:

• When advising a client to roll over a 401(k) for the adviser to manage, even when the client has equivalent and less costly options if they leave their funds with the employer’s fund manager.

• When advising not to pay off a mortgage (thus diminishing assets), even when the mortgage carries a high interest rate.

• When advising against making a large charitable contribution to get a tax deduction (but decrease assets under management).

• When advising not to give large gifts to children to avoid estate taxes.

• When advising not to buy a larger home.

• When advising not to buy an annuity or set up a charitable annuity.

• When advising not to invest in real estate.

He also should have mentioned how significant a 1% can be, as the Department of Labor explained:

Assume that you are an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in your account over the next 35 years average 7 percent and fees and expenses reduce your average returns by 0.5 percent, your account balance will grow to $227,000 at retirement, even if there are no further contributions to your account. If fees and expenses are 1.5 percent, however, your account balance will grow to only $163,000. The 1 percent difference in fees and expenses would reduce your account balance at retirement by 28 percent.
7.  Murray also ignores the vast body of research that suggests not that passive is better than active, but that broker sold funds on average significantly underperform direct sold funds because the funds in the broker channel invest far more heavily in sales and marketing activities vs. the direct channel which invests more in the expertise of the fund managers.  This article elaborates:

Does New Study Seal the Deal for Fiduciary Standard – or Just Warn Plan Sponsors? (about broker sold funds):

8.  When discussing the benefits of a financial advisor, Murray should have also mentioned perhaps the most significant reason to use a financial advisor – tax loss harvesting.

For your non 401(k)/IRA investments, I would consider using Betterment –  They do charge based on a percentage, but it is low – only 0.35% and only 0.15% for assets over $100,000.  They focus on using low cost ETFs which are similar to index funds.

I do not earn any compensation if you use this firm.  I just like their approach.

For your IRA investments, however, there is not as much value to using a firm like Betterment because the tax loss harvesting does not apply.  I would consider an index fund such as the Vanguard Total Stock Market Index Fund (VTSAX) or replicating one of Betterment’s portfolios.

This article shows how firms like Betterment are changing the industry:
The Rise of Robo Advisors:

Are Health Sharing Ministries a Better Alternative to Traditional Health Insurance?

I normally write about issues pertaining to qualified retirement plans, but health care also plays a major role in our retirement, so I believe I need to address this issue.  I recently learned about health sharing ministries at an event put on by the Heartland Institute, a Chicago based think tank promoting public policy based on individual liberty, limited government, and free markets.

I was immediately interested upon reading the description of the event which mentioned how self-pay patients can find more cost effective healthcare alternatives.  Since I try to avoid solving medical problems through unnecessary and potentially harmful prescription drugs and prefer to take a more holistic approach to health and wellness, I was eager to hear what Sean Parnell, the event speaker and author of The Self-Pay Patient had to say, and I wasn’t disappointed.

For one thing, I was surprised to learn about the extent of the potential difficulty in getting reimbursed by an insurance company.  Parnell relayed a story about his wife’s terrible experience with her health insurance company because of migraine headaches she had been having, which resulted in years worth of wasted time, energy, and exasperation along with mounds of paperwork several feet high!  While a story like this may not necessarily be the rule, I wondered how many other people had this type of experience.

When he finished speaking, I had the opportunity to ask about what someone like me, a healthy 36 year old who does not wish to participate in the corrupt and conflict ridden medical system, could do to protect myself in a cost efficient manner.  At the time, I was paying $163 per month for an individual policy with a $5,000 deductible that covered very little with the exception of emergency care.  And because of the Affordable Care Act, I knew my premiums were going to continue to increase significantly.  In fact, I learned that my policy was soon going to be phased out because it did not meet the requirements of this new legislation, and that I would soon be forced to purchase a more expensive policy and therefore more fully participate in a health care system that I didn’t believe in.  So I was pleasantly surprised when Parnell responded that I could consider a health sharing ministry as an alternative which would be exempt from the fines levied by the Affordable Care Act.

I did some research on health sharing ministries and came across the following information:

Here are some highlights:

U.S. News article:

“A health care sharing ministry (HCSM) provides a health care cost sharing arrangement among persons of similar and sincerely held beliefs,” the Alliance of Health Care Sharing Ministries states on its website. “HCSMs are not-for-profit religious organizations acting as a clearinghouse for those who have medical expenses and those who desire to share the burden of those medical expenses.”

According to the HCSM, health care sharing ministries currently cover 300,000 people in all 50 states.

Instead of deductibles, participants are subject to annual unshared amounts. For example, some plans pledge to cover medical expenses after a family spends $1,500 out of pocket for their own medical care, while others don’t begin offering benefits until you spend $5,000. However, unlike health insurance plans offered through the ACA, health care sharing plans are not required to cover some medical procedures – including certain procedures the group finds morally objectionable. 

Of course, there are other differences between traditional health insurance and sharing plans. For example, health care sharing ministries reserve the right to deny applicants due to pre-existing conditions, which is in stark contrast to new guarantees offered by the ACA. Sharing plans also often come with lifetime caps on coverage that range from $250,000 to as much as $1 million depending on the plan you choose, and participants are required to pay for their own well visits and preventive care.

Washington Times article:

Typically, a hospital patient paying out of pocket for major surgery needs a long-term payment plan, so when Gary L. Edwards‘ friend paid off his $30,000 emergency hernia operation tab in about a month, it left hospital officials flabbergasted.

Mr. Edwards and his pal are members of Samaritan Ministries International, a “health care sharing ministry” in which Christian members pay for each other’s health care needs through monthly shares.

While most Americans next year will have to grapple with the intricacies of President Obama’s health law and the “individual mandate” requiring residents to have health insurance, Mr. Edwards and more than 160,000 others who use health-sharing ministries will be exempt.

They’re one of nine exemptions built into the health care law, covering everyone from illegal immigrants to prisoners; those who have religious conscience objections, such as the Amish; and health care sharing ministries members like Mr. Edwards.

USA Today article:

Ellery Hunsley doesn’t have health insurance. But eight years ago, when his daughter went through treatment for a brain tumor, the assistant pastor at a local church didn’t worry about the medical bills.

Hunsley paid every bill out of pocket, largely thanks to the help of strangers — people who, like himself, participate in an alternative to insurance, a health care sharing ministry.

Reading this was great news to someone like me, and finding out about Liberty HealthShare –, a non-denominational organization, was even better news as I am not Christian.

Here is a sample of what Sean Parnell wrote about Liberty HealthShare:

One of the interesting things about Liberty HealthShare is that they are organized around ethical beliefs and not religious beliefs. Most people don’t know that the Obamacare exemption for sharing organizations must be composed of members who “share a common set of ethical or religious beliefs…”

By establishing a set of ethical criteria that members must subscribe to, Liberty HealthShare has found a way to expand the number of Americans who can opt for this low-cost alternative to conventional health insurance.

Liberty HealthShare isn’t just unique in its expanded membership eligibility. Unlike the other three ministries, they handle payment of medical bills directly. The other three ministries distribute the shared funds directly to the patient (or their family), who then pay medical bills directly.

Because health sharing ministries like Liberty HealthShare have lifetime caps and membership restrictions, they are able to control their costs so members won’t see significant annual cost increases.  As someone who is young and healthy, I am willing to accept a lifetime cap in exchange for a lower monthly sharing amount.  Furthermore, my network spinal analysis chiropractic treatments are very important to my health and personal development, because Liberty HealthShare does not have networks,  it fully shares the cost of 12 annual chiropractic treatments, regardless of which chiropractor a member uses – and unlike having a $5,000 deductible, each Liberty HealthShare plan has a $500 annual unshared amount (like a deductible).  This type of structure is valuable to me because I would not have received any cost sharing at all with a traditional health insurance provider because I would not have met my deductible and my chiropractor was not within the network of my old plan.  And Liberty HealthShare even pays a $50 referral fee for each new member you refer!

Health sharing ministries may not be a fit for everyone, but our health care is too important not to include them as part of our evaluation when making health care decisions.  Here are two excellent resources for those who are looking for information that will allow them to make more informed health care decisions:

How Law Firms (and organizations whose primary business is serving the legal community) Can Control their Investment Advisory Fees and Avoid Paying any Non-investment Related Fees for Defined Contribution Plans

All law firms are eligible to participate in the American Bar Association Retirement Funds Program.  This program (for defined contribution plans) allows participants to avoid paying any record keeping, administration (with the exception of minimal cross-testing fees), custodial, or investment advisory fees to the extent they use the brokerage account option offered through TD Ameritrade – and there is no limit to how much money participants can invest in the brokerage account.  The reason participants can take advantage of this opportunity is that the program also offers core investment options that include percentage-based fees that are paid to Voya and Northern Trust for record keeping, custodial, administration, and investment advisory services (if plan sponsors require more advanced plan design services such as cross-testing, they still have the option of retaining their administrator and paying this provider separately).  Since the vast majority of the money is invested in these core funds, the program is able to survive as both ING and Northern Trust are able to generate a sufficient amount of revenue to make up for the revenue they don’t receive from the funds that are invested in the brokerage account. TD Ameritrade also makes a payment of 8 basis points (0.08%) to the plan’s collective trust in order to lower Voya’s fee.  TD Ameritrade is willing to make this payment because it typically receives more than 8 basis points worth of revenue in trading fees.

Furthermore, most (and perhaps all) of the funds that most plans have available are also available through TD Ameritrade.  All mutual funds have the same expense ratio regardless of where you buy them, so participants can purchase most (or all of the same funds) at a lower price.   Granted, the core fund options are part of a collective trust, so they are not available through TD Ameritrade.  However, given that they are loaded with record keeping, administration, custodial, and investment advisory fees, it seems far more reasonable to purchase comparable funds in the brokerage account without these additional fees.

In addition, if you were to use the ABA Retirement Funds Program, the only way the advisor could get paid would be for the firm or company to write a check or for the advisor to come to an agreement with each individual participant.  Under most plans, the advisor (along with the record keeper and custodial and possibly the administrator) gets a percentage of the of account value and gets paid regardless of the utilization of the services.

If you view the program’s website (, you will not see any of the above information advertised.  However, if you contact a representative from the program, you can confirm that this information is accurate.

So if all of what I have written is true, it would seem that all law firms and those that serve law firms that continue to pass on record keeping, custodial, administration, and advisory fees to their participants are missing out on a great opportunity, especially since in addition to the enormous cost savings, the ABA Retirement Funds Program acts as a discretionary trustee and therefore assumes a higher level of fiduciary responsibility than almost any other retirement program in the marketplace.

The case of the plan sponsor who thought a $41,540 broker’s commission was a good deal for the participants who paid for it

I recently had a conversation with a plan sponsor where I pointed out that his broker took $41,540 in commissions which were deducted directly from participants’ retirement accounts in 2012 along with an additional $5,543 in commissions in 2013.  Given that there were only 61 participants with balances in his plan through 2013 which would indicate to any reasonable person that there couldn’t possibly be $41,540 worth of work to do (even if this was the year when the plan sponsor changed providers), one would think he would have thanked me for pointing out this fact.  However, he instead accused me of trying to make his broker look bad, and insisted that the arrangement was a good deal because the broker only took $5,543 in commissions in 2013.  This conversation may sound like a parody, but it is sadly true – and even more sadly this type of thinking (or more accurately lack of thinking) represents the mindset of most plan sponsors.  As I have pointed out in an earlier post, there is no value to paying any commissions at all, let alone allowing a broker to take $41,540 from participants’ accounts – for doing next to nothing – or at most maybe spending no more than 10 hours of his time in a 12 month time period.  So what can be done about this?  How can people who oversee millions of dollars of people’s retirement plan savings begin to change their thinking?  There are no easy answers, and nothing is going to change any time soon, but we can at least start by calling these people out and exposing their actions.

Procedural prudence vs. substantive prudence

Here is a significant passage from The Fiduciary Handbook for Understanding and Selecting Target Date Funds:
Fiduciaries are obligated to monitor and evaluate the performance of their TDFs, but relative to what? Much debate and controversy surround the benchmarking of target date funds (TDFs). The challenge revolves around the fact that the asset allocation and, therefore, risk of TDFs changes through time. But, if fiduciaries will take a step back to look at the big picture, they will recognize only two choices: Procedural Prudence or Substantive Prudence. The fiduciary can use a benchmark that captures common practice, which is a Procedural Prudence benchmark. Procedural Prudence is satisfied when a fiduciary acts as others in a similar capacity act, following commonly accepted processes: follow the herd. The S&P and Morningstar Target Date Indexes are good benchmarks for Procedural Prudence because they are composites of all TDF mutual funds –they are consensus indexes. By contrast, a benchmark of Substantive Prudence reflects best practices, doing what is right for the beneficiaries, regardless of common practices. This may sound like a high and mighty benchmark, but it’s not. Its derivation ties directly to something quite simple: what are the appropriate objectives for a TDF.

Procedural prudence benchmarks fail in the courts. Herd mentality is inadequate (TheLemming analogy). The better choice is substantive prudence because it is in line with the core principles of ERISA which direct that all activity must be conducted in the best interests of participant sand beneficiaries. Mechanically, the only“safe” prudent process would be to attach individual benchmarks to each participant, taking into account all the relevant facts and circumstances of each individual’s financial and personal circumstances.  Of course, this is not practical in big plans.

In making these choices, the following three questions might be helpful:

1) Am I choosing this fund in the sole interest of my participants?
2) Have I prudently sought the best available choice for my participants?
3) Have I exercised due care by ensuring this choice will provide my participants with the greatest opportunity to achieve retirement income security?”

Click to access Fiduciary-Handbook.pdf

Even if plan sponsors don’t have target date funds, the concept of substantive vs. procedural prudence and not simply following the herd also very much applies to assessing the reasonableness of participant fees.

It is difficult to comprehend how a plan sponsor can insist that participant fees are reasonable in light of the services required when they are allowing asset-based fees to be deducted from participants’ accounts.  If plan sponsors claim that participant fees are competitive compared to other percentage-based providers who also overcharge their participants, then they are likely correct.  However, that does not mean that their participants’ fees are reasonable.