For the past year, buzz in the 401(k) arena has been all about the new disclosures regarding plans’ administration fees that plan participants will start receiving this year. Experts expect that more than a few participants will panic, given new awareness of how much their plans cost to run.
Amid that environment, one plan provider, Charles Schwab, is taking an unusual step: offering a plan composed entirely of index-based funds. Also called passively managed funds, the less-labor-intensive index funds carry much lower fees than the far-more-prevalent actively managed funds. That motivates most plan providers to train most of their marketing focus on the latter. A typical plan allows participants to pick from many actively managed funds and a smaller roster of index funds.
Among major providers, only Vanguard heavily promotes index funds as key components of its product lineup. Still, Vanguard’s off-the-shelf retirement plans, like those of other providers, generally contain a mix of the two fund types. Vanguard and most other providers would likely build an all-index-fund plan if a plan sponsor wanted one, but Schwab stands alone in its promotion of such a plan.
Schwab claims that for an average 401(k) participant, the amount trimmed off the expense drag will translate to an incremental $115,000 upon retirement. That seems good, though active fund managers who consistently outperform the market could have a much bigger impact. “This is a targeted approach — an answer to the sensitivity toward fees that’s out there in the market right now,” says Gregory Marsh, vice president and corporate retirement plan consultant at Bridgehaven Financial Advisors. Schwab, for its part, says it has been developing the plan for two years.
Another aspect of Schwab’s new offering is that participants are automatically enrolled in a low-cost (0.45% of account assets per year) program under which an independent plan adviser, GuidedChoice, will allocate their account balances among the plan’s various index funds. Participants also can schedule personal consultations about their investments.
Schwab claims that only about 10% of 401(k) participants nationwide get expert investment advice. Yet, says Jim McCool, Schwab’s executive vice president of institutional services, “There are two things about 401(k)’s that matter that can’t be argued with: the impact of expense and the impact of advice on returns.” McCool says the savings on administration fees are significantly greater than GuidedChoice’s fees for its services.
Many other providers also offer advice, through either wholly owned subsidiaries or third parties. But such programs generally carry higher costs for participants than Schwab’s 0.45%, which holds utilization rates down, says Marsh.
Schwab’s new plan also includes Federal Deposit Insurance Corp.–insured deposits in Schwab Bank. If 60% of a participant’s account was allocated to equity funds, 20% to bond funds, and 20% to capital-preservation instruments with the bank, the bank-instrument portion would be insured up to $250,000. “That is unusual and innovative. Most providers have not focused on that,” says Alan Vorchheimer, a principal at Buck Consultants.
But a much bigger issue for retirement planning than lower fees, investment advice, or FDIC coverage is simply getting participants to sock more cash into their plans, Vorchheimer observes. And Schwab claims the advice feature of its all-index plan would have that effect. “People who are deferring, say, 5% of their income typically start saving twice as much after they start getting advice,” says Steve Anderson, Schwab’s head of retirement-plan services.
Still, it’s too early to even guess how popular Schwab’s new offering will be, says Vorchheimer. “If Schwab is going to offer an overall lower-cost option, run the basic investments for you, help you with asset allocation, and enroll you in a service that most others charge more for, that sounds like a good thing. Cheaper, with better service? It actually sounds too good to be true.”