For Joanmcg

[Golden Rocket]

Joan, I'm going to start a new thread to answer your question so we can focus on it. The other thread has sprouted tentacles and tangents.

I overwhelmingly suspect that J Hancock or almost any insurance company is raking fees off the top. Here's how it works:

Salesman comes to your company and "sells" you a qualified plan consisting of payroll deductions and employer matching funds. The employees are given a choice of perhaps several dozen mutual funds, ranging from low-risk to high-yield, high-return. A document serving as a prospectus trumpets the average return for these funds over the last year, last five years, last ten years, etc. etc. Some of the returns are more impressive than others, and the funds that have ten-year history probably appear weaker because they include the years 2001 through 2004.

You select Aim Small Cap for your payroll deduction and your employer matches 50%. The prospectus says AIM Small Cap has an inception-to-date history of 14%, so you look forward to a good tax-deferred return over the next several years. During the calendar year, you put in $3000, and your employer puts in $1500. At the end of the year, AIM says that its fund earns 10% for the year, and the insurance company sends you information to that effect.

Watch the numbers, Joan. You will be outraged. You have an average investment of $2250, so you would expect to earn $225. Added to the $4500, your year-end statement should show some $4725, or you would think so. However, your statement shows only $4536. Here's what has happened: The money is going into an AIM "shrink wrapped" house account at the insurance company. 4% of all money in this "house" account is unavailable to invest in AIM. It goes to pay the salesman, adminstrative expenses, and profit.

This means that only $4320 has actually gone to AIM through the house account, an average investment of $2160, which earns $216. The $216 is added to the $4320 giving you an available balance of $4536. The insurance company tells you that AIM has earned 10% and they are legally allowed to do so.

Another popular variation of the above is to show $4700 on your statement, but in reality you have only $4536. If you try to get a distribution of the money, they keep the difference as a "sales charge."

Is the 401k a good deal for you? Sure. You've put in $3000 and now you have $4536. Could it be better? You bet'cha. Have you been lied to? I think so.

[RJM]

Agree with Goldenrocket

For small companies that use Paychex and ADP for payroll, there are direct and indirect fees which similarly make the 401(k) administration less attractive. Using local benefits administration companies and 3rd party brokerages is the cheapest way I have found, although some of these benefits admin firms are real expensive, so it is smart to shop around.

My secret hope is that the IRS would prepare some kind of safe harbor 401(k) plan document, with check-the-box features, so that small business clients would be more willing to sponsor plans like these without the added costs, then using any desired brokerage or mutual fund company to custody the accounts. Or, possibly some of the mutual fund companies will do this soon, as they have for regular profit-share plans, SEPs, and SIMPLEs.

While they are at it, the IRS could also provide some safe harbor cafeteria plan documents, so more small businesses would be encouraged to offer these great plans.

[joanmcq]

Yes, we are a pretty small company, probably about 200 year-round employees. And no employer match, so its all my money going in. For the last quarter, fees of 9.35 have been deducted from my paltry $3100 balance, as says the statement. Ohhh, you are right, the statement says my personal rate of return for the period is 1.54% which on my contributions for the period, plus the beginning balance should have yielded me $48.06, but the statement shows earnings of $39.58. And then they deduct the $9.35 from the $39.58.

Before I even joined, the two earliest hires in my department, who have contributed to the plan since inception, complained about the rate of return, and how, with a $100,000 balance they should have gotten much more in the way of earnings on it. This explains it. And gives us ammunition for them trying to get us a better deal. And yeah, the company uses ADP for payroll.

Jeez, we're all tax pros (except for the clerical people) but there are only two CPAs (I'm one of 'em, and the other is way part time). So lots of tax knowledge, but not enough accounting maybe to know when we're being ripped off?

[Golden Rocket]

Discussion-Worth

Jeez, we're all tax pros (except for the clerical people) but there are only two CPAs (I'm one of 'em, and the other is way part time). So lots of tax knowledge, but not enough accounting maybe to know when we're being ripped off?

Joan, we've just finished a discussion on another thread as to whether, as tax pros, we should be spending time talking about investments. I think our conversation is clear proof that it is worthwhile. Some of these shell games played by banks and insurance companies are not widely known, even among CPAs and EAs.

Thanks for your interest. GR

[joanmcq]

I get asked for investment advice all the time; even last night with a friend/client who asked about the fund her IRA was in. I've been investing for years and read a lot about strategies and the marketplace etc. etc. (in fact just finished a newsletter from my dad's broker), but this one was new to me. Thank you for your comments and insight.

[veritas]

Yes, we are a pretty small company, probably about 200 year-round employees. And no employer match, so its all my money going in. For the last quarter, fees of 9.35 have been deducted from my paltry $3100 balance, as says the statement. Ohhh, you are right, the statement says my personal rate of return for the period is 1.54% which on my contributions for the period, plus the beginning balance should have yielded me $48.06, but the statement shows earnings of $39.58. And then they deduct the $9.35 from the $39.58.

Before I even joined, the two earliest hires in my department, who have contributed to the plan since inception, complained about the rate of return, and how, with a $100,000 balance they should have gotten much more in the way of earnings on it. This explains it. And gives us ammunition for them trying to get us a better deal. And yeah, the company uses ADP for payroll.

Jeez, we're all tax pros (except for the clerical people) but there are only two CPAs (I'm one of 'em, and the other is way part time). So lots of tax knowledge, but not enough accounting maybe to know when we're being ripped off?

Since your company is not matching why not put the money in your own IRA? That way you can have better control of where it is invested and minimize the fees.

[joanmcq]

That's what I had been doing, but I'm trying to sock away more than $4000 per year, now that I have to take RMDs from my dad's IRA. So the plan is to replace the IRA withdrawals with 401k contributions. And still sock away $4000 in a Roth! I admit, I could be in a worse situation.....like having no $$ socked away like so many people out there...

[JohnH]

Investment Advice - Response

I'd suggest that when anyone asks for investment advice, one excellent response would be to tell them to read everything they can find by John Bogle. There are numerous articles written by him at the Vanguard website or by googling his name, and they are well worth absorbing for anyone who actually cares about what happens to their investments, even if they don't have the option of choosing Vanguard funds through an employer's plan.

John Bogle is the father of the index mutual fund and he constantly confounds those in the investment community who waste everyone's time trying to refute his wisdom. His "Common Sense on Mutual Funds" is still the seminal work explaining the superiority of index funds over actively-managed mutual funds. If nothing else, anyone who reads his advice will come away understanding asset allocation, which in my opinion is the basic building block of rational investing.

[sea-tax]

I'd suggest that when anyone asks for investment advice, one excellent response would be to tell them to read everything they can find by John Bogle. There are numerous articles written by him at the Vanguard website or by googling his name, and they are well worth absorbing for anyone who actually cares about what happens to their investments, even if they don't have the option of choosing Vanguard funds through an employer's plan.

John Bogle is the father of the index mutual fund and he constantly confounds those in the investment community who waste everyone's time trying to refute his wisdom. His "Common Sense on Mutual Funds" is still the seminal work explaining the superiority of index funds over actively-managed mutual funds. If nothing else, anyone who reads his advice will come away understanding asset allocation, which in my opinion is the basic building block of rational investing.

I have not read any of Mr Bogle's books but does he also let people know that index funds only provide the return of the index less expenses. Therefore you actually are making less than the index . While there are actively managed funds which consistently beat the index even after the fees taken into consideration.
I agree that fees are and should be an important factor but they are not the only important factor to consider when choosing a mutual fund. I would rather pay a load fee and say expense ratio of 1% if I had some assurances through past performance that this fund beat the index year in and year out. That to me is far better than a low cost index fund that charges a .5 expense ratio which means that I loose compared to my index .5%.

Also to Joan and other tax folks who provide any kind of investment advice to clients in excess of the tax situations, you may want to check with the SEC and NASD you may be in violation of securities laws. As I understand it only licensed individuals may offer financial advice for compensation. I am not saying this to start an argument but once the client leaves your office and tries some of the ideas you told them they may look to sue you once that advice goes south , which happens from time to time. Just a word to the wise.

[joanmcq]

I only provide very general advice, such as 'you may want to consider a SEP' instead of just a regular IRA, explain concepts like dollar cost averaging and diversifying investment, the benefits of compounding, etc. I will also say, I am not a licensed financial planner so I cannot recommend specific funds or investments, but will tell them about general types of funds and what they are good for.

[JohnH]

Yes, fees are a factor

--> Therefore you actually are making less than the index . While there are actively managed funds which consistently beat the index even after the fees taken into consideration. <--

I agree, fees are certainly a factor, but for a different reason. Good index funds with reliable companies charge fees of 18-25 basis points, whereas your average managed fund will hit you up for 100 - 300 basis points. Actively managed funds are always sailing with the wind in their face with respect to fees alone, which are a serious drag on their performance and a secret they do their best to obscure. Add to that the fact that 70-96% of actively managed funds fail to beat the best index funds and you see a pattern emerging. (The broad range is partly due to the fact that a slick company will oftern terminate a poor-performing fund in an effort to get it out of the mix)

So all one has to do is consistently choose the actively managed funds that have a 3-5-10 year record of regularly beating the index by enough of a margin to absorb the fees and still turn in better results, and have a reasonably good expectation that the management will be able to replicate that record going forward. Given that one has at best a 1 in 3 chance of achieving that goal, and at worst a 1 in 57 chance, the wisdom of indexing becomes more apparent. I'll stick with John Bogle on that math.