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Annuities load 401(k)s with fees
A whopping 35% of your profits may be going to cover plan fees, which often include annuities you didnt know you had. Heres how to find out what youre really being charged.
By Timothy Middleton
Eager to make a financial killing? Sell annuities.
Go for the gold -- earn more! 12% commission reads an e-mail I recently received from LifeStar Financial Network, which evidently thinks Im an insurance agent. Get your fall sales off to a fast start with an index annuity that clients love.
Unfortunately, the hottest market for annuity salesmen is 401(k) plans. By slapping hidden fees on employees, even the tiniest firm can offer a plan that doesnt cost it a penny to set up and run. Workers might never know theyre being gouged, because fee disclosures are so easy to shirk.
Sharon Nappi of Port Orange, Fla., says she has been unable to get any fee disclosure on her husbands small-company plan, which is run by MetLife. But she knows costs must be significant. The plans money-market fund showed a negative return on the quarterly statement; these cash-like accounts are supposed to be safe as houses.
Can I request that they must give me (documents) to fully disclose all fees charged to the employee? she asks. My answer: Yes, but it can take some doing.
Who's looking out for you?
Regulation of what are called defined-contribution plans, better known as 401(k)s, 403(b)s and 457s, is spread broadly among agencies at nearly every level of government. Complaining to city hall becomes a nightmare when so many potential city halls exist, from the Labor Department to the local school board (for a teacher's plan).
This is true in spades of plans administered by insurance companies, because they're overseen by state insurance commissioners already up to their necks in crises, from hurricanes in Alabama to flooding in New Jersey and wildfires in California.
Group products are regulated to a much lower extent . . . than individual products, says Tomasz Serbinowski, a spokesman for the Utah Insurance Department. Our thinking is the (plan) sponsor is looking out for the interests of those individuals.
Plenty of sponsors obviously arent. Matthew Hutcheson, an independent plan fiduciary in Portland, Ore., says insurance-company charges sometimes range as high as two to four percentage points annually. Added to management fees of the underlying investments, typically mutual funds, "You can be looking at annual charges of 3% to 5.5%, and thats just sucking away the life of these participant accounts, he says. If people wonder why they cant seem to get ahead, thats why.
My column of two weeks ago, Is it time to dump your 401(k)?," sparked more than 600 e-mails from readers, and the most common complaint was inadequate fee disclosure in plans whose investment options are variable annuities.
Heres why the fees are so high, and what you can do about it.
Youre lining insurers pockets
Group variable annuities are an insurance contract wrapped around an array of investment options, usually mutual funds. The funds are the investment; the annuity is the insurance, and you pay extra for it. As investments, therefore, annuities are inherently inferior to straight investment portfolios such as funds, because theyre more expensive.
The annuity industry, of course, thinks theyre superior. These are a beautiful thing, says Beth Hirschhorn, MetLifes chief marketing officer. They have guarantees, having to do with account values and death benefits. They are only expensive if people are buying something they dont know theyve received.
These guarantees are called riders, and they vary depending on the contract your employer has. The most common guarantees are that youll get back every dime you contributed, even if markets are down, or your beneficiaries will, if you die.
These attributes have value. The insurance company is certainly charging you plenty for them. But in my opinion, theyre trivial. There has never been a significant time span in modern financial history when markets have failed to go up; the average for a blend of stocks and bonds is around 8% annually.
As to life insurance, well, you can always buy life insurance if you want it. In annuities, however, you're paying for it whether you want it or not.
And part of the price you're paying for this insurance is that variable annuities have back-end sales commissions called surrender charges, which typically run as long as seven years. They have a current value of 5%; that is, thats what the insurance company pays the agent who sells them. (Or a load-fund company pays the broker who sells Class B shares.)
This is why these plans are so attractive to small (or just cheap) employers. The insurance company has the money locked up for years, so it can afford to pay the salesman, subsidize the costs of establishing the plan and providing such infrastructure as payroll deduction, Web sites, toll-free numbers and so on.
The insurance company also pays the agent a trailing commission that runs in the neighborhood of 0.5% to 1% of the plans assets every year. It may also levy other charges, as well. Several of my e-mails cited quarterly fees in the range of $25.
Fees pile up
Mike Robinson, who works for a small technology company in Bedford, Mass., says his plan, operated by Manulife Financial, charges him $200 a year.
MetLife insists Hutchesons estimate of average expenses is too high. Several of my e-mail correspondents (those who know what theyre paying) pegged their annual mortality and expense charge, as it's called, at about 1.3%.
When added to the typical 1.5% annual expense ratio of an equity mutual fund, that produces a total charge of 2.8%. So if you have $50,000 in your plan, you're paying $1,400 a year in expenses.
Viewed from the perspective of portfolio profits, that means an investment whose gross return is 8% is netting you just 5.2%. An astonishing 35% of your profits are being eaten up by expenses. When I recommend shunning a bad 401(k) plan, thats why.
Finding the truth
With numbers as dismal as these, no wonder your boss isnt eager to share them with you. Heres how he gets around that.
Full disclosure of all plan expenses is required, but the disclosure doesnt automatically have to be made to the participant. Annuities inside retirement plans arent like mutual funds, which publish their expenses prominently. They're contracts between the insurance company and the plan. Fees must be fully disclosed within that contract. If theyre not, the plan has failed in its fiduciary duty and you can sue over that.
But in routine communications with participants, insurance-run plans seldom mention fees, since the details -- like riders and the charges for annuities and other expenses -- can be very different from plan to plan.
So if youre eager to read the fine print, you begin by asking your employer for a copy of the contract. It is your money; you have this right. The sticky part is exercising it.
Private plans are subject to the Employee Retirement Income Security Act of 1974, or ERISA. It requires full fee disclosure. The Labor Department is responsible for oversight. It publishes several brochures on the topic at its Web site.
If your plan is run by, God forbid, a church or a school district, youve got other problems, because those plans arent subject to ERISA. No public plan is. Hence the Labor Department, the most powerful pension oversight agency, is out of the picture.
And if the plan is run by an insurance company, your problems are even worse because that industry is overseen by state insurance commissioners, whose knowledge of and interest in investing is nil.
So if you have trouble getting the information from your employer, your best shot is to pester the insurance company for it. The information exists on records that company maintains. If it balks, ask for the name, address and phone number of your states insurance commissioner and direct your pestering in that direction.
Looking into the issue
Fortunately, the Labor Department is awakening to the abuse of fee disclosure. Recent developments have raised questions about whether the current rules (on fees) are adequate, says Ann Combs, assistant secretary of labor. We have asked our ERISA Advisory Council to study the issue and make recommendations about fee disclosure by the end of the year.
Other agencies, including insurance commissioners, closely follow the Labor Department's agenda on pension issues, and many state laws are based on its regulations. If the hundreds of you who complained to me about this begin complaining to regulators, numbers alone will help press your case, which is really everybodys case.
Meanwhile, annuity salesmen are knocking on the company door. That LifeStar index annuity happens to be an individual, not a group, annuity, and the agent gets such a big commission because the surrender period is 12 years. But it demonstrates that there's big money in peddling annuities.
Scott Levy, marketing analyst for the Salt Lake City-based company, says he can offer a variety of plans, some with much lower commissions, depending on whether theyre client-friendly or agent-friendly. You know, whether youre selling them to your mother or somebody you dont like.
Of course, even if your boss is the agents mother, whose money do you think she worries about more: Yours or Juniors?
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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