How to Retire $100,000+ Richer

• Your retirement has become a Wall Street piggybank
• Ted Benna: I created a 401(k) “monster”
• How to save hundreds of thousands of dollars today

If you’re in a typical retirement plan, this could save you hundreds of thousands of dollars.

That may sound outlandish.

But according to a recent study, the typical American household will pay roughly $155,000 in 401(k) fees over their lifetime…

This is the single greatest threat to your wealth right now.

And unlike when the next financial crisis will strike… or how much debt Washington piles up… it’s 100% within your control.

For many folks, we’re talking four… five… or even more years of retirement income down the drain. All because of unnecessary Wall Street fees.

And many are paying 10 times more in fees than they need to. Over 30 years, that can eat up half of your returns.

Now, the issue of fees is slightly off our regular beat. But our mission at Inner Circle is to help you build wealth by bringing you the best ideas from Agora founder Bill Bonner’s top advisors and contacts.

And this is one of the most important ideas to cross my desk lately. You might even say it’s the most important idea.

Because there isn’t a single more straightforward way to boost your wealth than cutting the fees you pay on your investments.

As you’ll learn today, it could mean retiring more than $100,000 richer.

401(k) “Monster”

It’s not just 401(k)s…

Just about every kind of retirement account is laden with wealth-sapping fees.

And it’s not just folks nearing or already in retirement who are losing out. The further out you are from retirement, the more corrosive the effect of fees on your wealth.

Thanks to the power of compounding, shaving off half a percentage point… even a quarter percentage point… in fees can make a big difference to your end wealth.

Don’t believe me?

Take a look at the chart below. It shows the effect of paying annual fees of 0.25%, 0.5%, and 1% over 20 years on a $100,000 portfolio with a 4% annual return.

If you’re paying 1% in annual fees (yellow line), after 20 years, you’ll end up with just under $180,000. By paying 0.5% in annual fees (red line), the same $100,000 will leave you with just under $200,000 after 20 years. And by paying just 0.25% (blue line), you will end up with just under $210,000 after 20 years.

In other words, over 20 years, 1% annual fees reduce the value of your portfolio fund by $30,000 compared to a portfolio with 0.25% fees. And keep in mind that the typical retirement plan costs between 1.5% and 2.5% and lasts a lot longer than 20 years.

For more on how to fight back on fees… and reclaim your wealth… I caught up with the “father” of the 401(k), Ted Benna.

In 1980, Ted created the first 401(k) – a tax-deferred retirement plan with a company match – after spotting a new change to the Internal Revenue Code.

Americans now take for granted that they can salt away money for retirement without first paying tax on it. And more than 70 million Americans now have an estimated $15 trillion saved in Ted’s invention. But back in 1980, this was a radical and highly controversial idea.

Shockingly, Ted now calls the 401(k) a “monster.” And he’s urging savers to take radical action now to save their retirement funds from financial disaster.

As he explains below, that starts with firing your financial advisor…

Q&A With Ted Benna

Chris Lowe (CL): Let’s start with the 36,000-foot view. Roughly 100,000 baby boomers are retiring every day. What’s retirement going to be like for them?

Ted Benna (TB): You’ve gotta keep in mind that the whole idea of retirement is a fairly modern thing. The first formal retirement system was set up in Germany under Otto von Bismarck in the 1880s.

And when Social Security was set up in the U.S. in the 1930s, the workforce was made up predominantly of men. Many of them were in heavy industry – jobs in the steel industry, coal mines, and so forth. So, for men retiring at 65, living for another 10-12 years was the norm.

These days, thanks to increased life expectancy, you’re talking about people living 30 years in retirement – or three times longer.

That presents unique challenges. For instance, let’s assume a 3% annual rate of inflation over the course of your retirement plan. It takes five times as much savings – and not three times as much, as you’d expect – to fund a 30-year retirement as it does to fund a 10-year retirement.

CL: Why so?

TB: You hear a lot about the benefit of compounding when it comes to building wealth. Well, inflation is the exact reverse of that during your retirement years. It more aggressively eats into your savings the longer you live.

So unfortunately, retirement is going to be a mixed bag for baby boomers, who are set to live a lot longer in retirement than anyone before them. Some are going to be well prepared and in good shape financially. Others are going to be completely unprepared. And that’s going to be very difficult for them because poverty and old age don’t mix well.

CL: We’ll get to some of your advice on what can be done now to avoid falling into the second category in a moment. But first, I want to get some background. You’ve had a big influence – perhaps more than anyone alive today – on how Americans save for retirement. You created the 401(k) plan that more than 70 million Americans now use to save for retirement. How did that come about?

TB: In 1978, the government added a new section to the Internal Revenue Code that gave a tax break for deferred income. I was working as a benefits consultant at the time, and I used it to redesign the retirement program of a bank client of mine.

I knew lower-paid employees were not going to defer money for retirement if the only incentive they had was a modest tax break. You know – give up $500… put it away for retirement… and maybe save $50 or $75 in taxes. So I linked the idea of tax-deferred payments to a matching employer contribution. I wanted to up the ante and give a bigger incentive to employees to save.

What I take credit for is applying those two things to this new provision in the tax code to create the first 401(k) Savings Plan – a plan where employees could put their money in pre-tax and get a matching contribution from their employer.

CL: You’ve recently become critical of your creation. You’ve called the 401(k) a “monster.” What is your biggest issue with what the 401(k) has become?

TB: The biggest problem is fees. They’ve gotten excessively high. Originally, these plans were structured so that the employer paid all the administrative fees. The only thing the participants – the folks saving for retirement – paid was the direct investment expenses.

That started to change in the late 1980s. That’s when we got into what became known as “bundling.” Large employers would turn their plans over to the big mutual fund companies such as Fidelity. And they passed the fees involved along to the participants.

Wall Street co-opted these plans. Since then, they’ve become a real piggybank for them. According to one recent study, the typical American household will pay roughly $155,000 in 401(k) fees over their lifetime. That’s crazy. You could buy a house where I live in central Pennsylvania for that kind of money.

The other big problem is that these plans have gotten too darn complex. Originally, the investment process was easy. As someone saving for retirement, you typically had just two investment options. And you had to split the money in 25% chunks. So you had only five choices. You had two funds you could split 100/0, 25/75, 50/50, 75/25, or 0/100. That was it.

Then the number of funds began to grow. It went to 3… to 5… to 10… to 12… and beyond. This then required the involvement of investment advisors.

These advisors started to take a fee for helping plan sponsors set up the menu of funds that was going to be offered and helping participants decide what to do. Then what happened was that the investment folks on Wall Street started to say, “We can make even more money with this sucker.” And they got into introducing advice in “managed accounts,” as they’re called – with an additional layer of fees on top of what they were already charging.

CL: I have personal experience of this. My parents are retired back in Ireland, where I’m from. They were paying close to 1.4% a year in fees on their retirement plan, including 0.5% for an advisor. I told them 1.4% was way too high. Their response was, “What’s the big deal? It’s small potatoes.” That’s perfectly understandable – 1.4% sounds like a small number. How important to your retirement wealth is that kind of annual charge over the lifetime of a typical plan?

TB: It probably soaks up about five years of retirement income.

CL: That much? Wow… that’s shocking. You mean the difference between paying 1.4% in annual fees and getting those fees down to, say, 0.4% means five years of extra retirement income?

TB: Absolutely. I’ll tell you a story. On the way back from a visit to your colleagues at Palm Beach Research Group in Delray Beach, Florida, I met with a lady in Charlotte County, Virginia. We got to talking. She started telling me what she and her hubby were doing with their retirement savings, and she mentioned they had an advisor whom they paid “just” 0.9% a year of their retirement account.

I asked her, “What does your advisor actually do?” And she said, “He put us through a process and came up with a recommended solution for us.” And I’m there thinking, “Oh, my gosh. All he did was run your profile through a computer program. Now he’s charging you 0.9% a year – forever.”

CL: You’re saying that’s too high?

TB: All this woman’s advisor had done was put her in a bunch of Vanguard funds! She could have gone directly to Vanguard and bought a prepackaged solution with exactly the same investment mix her advisor gave her… and paid 0.14%. That’s less than one-fifth what she’s paying her advisor.

CL: You mean she could have picked up an “off the rail” fund with a similar asset allocation mix?

TB: Exactly. For example, if you choose what’s known as a target-date fund [see box below], it’s the same kind of mix of investments – stocks, bonds, etc. – you’re going to get with one of these advisors. But you can own it for a total fee of 0.14% instead of an advisor-generated fund solution, which typically has fees in the 1.5% to 2.5% range.

That’s saving you hundreds of thousands of dollars right there, if you’re in a typical retirement plan. We’re talking years of retirement income not handed over in fees.

What Is a Target-Date Fund?

A target-date fund is a mutual fund that sets the mix of stocks, bonds, and cash in its portfolio according to when you intend to retire.

For example, a worker hoping to retire in 2050 would choose a target-date 2050 fund, and someone hoping to retire in 2025 would choose a target-date 2025 fund.

Typically, the closer you get to your retirement date, the more these funds allocate to bonds over stocks.

CL: Why are so many people willing to overpay for investment funds when they might spend hours comparing prices for relatively small purchases such as a new car or a vacation?

TB: Let’s focus on people who are a year out from retirement or already retired. If you’re in a 401(k), and you’re 59 ½ years old and up, you’re legally allowed to take your money out of your 401(k) and move it into an IRA. You don’t need to be trapped. You have an alternative available to you.

[An IRA is an Individual Retirement Account. Only people who are employed can contribute to a 401(k). By contrast, anyone can make tax-deferred payments to a traditional IRA, as long as they are under the age of 70 ½.]

What happens, generally, is these folks automatically think of an investment advisor. So they go to a Merrill Lynch or a Morgan Stanley or whatever. Particularly if they’ve got $100,000, $200,000, $300,000, or more. Because these companies have prestige.

These Wall Street types now call themselves “wealth managers.” They’re no longer “brokers” or “agents.” They’re the wealth managers. I mean, that’s the big thing. It sounds good.

But all that’s going to happen is you’ll go into some office and talk to someone who will put you into mutual funds with an overpriced structure. You could go to Vanguard directly and get a prepackaged solution that does exactly the same thing at one-tenth of the cost.

CL: That doesn’t make sense. At least not from a rational point of view. With all the information out there on the importance of keeping fees low, how do you explain why this continues to happen?

TB: There’s probably some ego involved. You go to a Merrill Lynch guy, you’re essentially saying, “Look how much money I have.” It makes you feel good to talk about that to an advisor. Some of that probably comes into play.

CL: It’s also easy to confuse high fees with high-quality funds or investments and low fees with low-quality funds or investments. I encountered this with my parents. When I was trying to get them to switch to low-cost funds, they kept saying, “But if we pay less, aren’t we going to get a worse fund?” Naturally enough, they associate high fees with high levels of service or high levels of quality.

TB: It’s certainly a factor. But it isn’t true. They’re not getting a better result. They’re just paying more.

Just think about it logically for a moment. Regardless of how you get there, if you’re saving for retirement, most of your money is going to be invested in large-cap S&P 500 stocks. It’s a given. They’re going to dominate your portfolio mix. What exact percentage of stocks? Who knows? But they’ll be a big part of the allocation.

There aren’t that many large-cap stocks. You’re investing in pretty much the same companies – whether it’s on your own selection of funds, an advisor’s selection, or a canned solution. And the bond mix isn’t going to be that different from Fund A to Fund B. It just isn’t.

That means the end result isn’t going to be a whole lot different – no matter which funds you’re in. Bottom line: If you’re aged between 65 and 100, the result is going to look pretty much the same.

Yet the same process – where an advisor sits down with a client to help them find the right fund mix – is repeated over and over. Advisors are being paid as though they are doing a unique, creative piece of work each time they go through that process of generating a canned solution. It just doesn’t add up.

CL: What about so-called robo-advisors? Instead of going to a human advisor, you can now choose to have a computer algorithm decide what fund mix you should be invested in for a lower fee than a human advisor would charge.

TB: Well, it’s an alternative. But again, they’re going to give you pretty much the same outcome you would get by going to Vanguard and putting your money in the applicable target-date fund.

All these human advisors and robo-advisors are doing is putting people through a somewhat laborious questionnaire process to drive them to anywhere from 8 to 12 prepackaged portfolios. They’re not coming up with millions of individualized portfolios.

CL: For folks in the earlier stages of saving for retirement, what steps can they take right away to make sure they’re on the path to a comfortable retirement?

TB: If they haven’t done so already, they should take advantage of the retirement calculators that are out there. You plug in your age, your salary, and what you hope to live off of in retirement, and they determine if you are on track with your savings plan.

Are you on track? If not, you need to get there. The worst thing is to wait until you’re close to retirement age before getting serious about saving. If you start this process 15… 10… even 5 years out from your retirement, you can begin to sharpen up your plan.

CL: How might you sharpen up?

TB: Depending on where you’re at with your savings plan, you might think of pushing your retirement back a bit. I can only speak for myself. But I’m 75, and I can’t quite wrap my head around what a full retirement might be. I’m not ready for that.

You might also think about where you’re going to live during retirement – both a geographic issue and a housing issue. For instance, when we were in our mid-50s, my wife and I made a decision to get off the high-priced coast and move inland. That knocked our expenses roughly in half.

So if you’re a couple of years from retirement, begin to get serious about where you want to live and the cost of that decision. If you are in a high-cost area, getting the heck out of there is certainly something to seriously think about. Or maybe you have a big McMansion, and there’s no reason to hold on to it as you go into retirement. If so, you might think about downsizing.

Finally, I recommend your younger readers, especially, find out from their retirement plan providers exactly what fees they’re paying as part of their retirement plan. Providers are required to give you a form when you join the plan that shows all the fees you’re paying.

If you’re paying a lot, what I’ve always advised folks to do is go to the key people in your company and talk it over. And rather than going in and saying, “Hey, our plan stinks,” give them some concrete information that backs it up. The key people in the plan, particularly in a small business, usually have the biggest account balances. So they’re the ones getting hammered the hardest if they’re paying high fees.

CL: What about folks who are nearing retirement or already retired?

TB: If you want the answer the investment community is going to give them, you want to hold a broad mix of funds with low fees.

If you’re retiring today, for instance, just go to Vanguard and put your money in its Target Retirement Income Fund. About 70% of this fund is in bonds. The other 30% or so is in stocks. It’s the kind of mix you’re going to get going through any other process. But you’re going to pay just 0.14% a year directly with Vanguard as opposed to anywhere upward of 1% if you go through an advisor.

But as I mentioned in the recent video I recorded for Palm Beach Research Group, I would temper this advice a bit and say, “Don’t think that those funds are necessarily safe, conservative investments.”

CL: What’s unsafe about them?

TB: No matter what names they give these funds, they’re made up of stocks and bonds. And given where the U.S. stock and bond markets are today in terms of valuations, there’s an awful lot of risk involved.

This is underlined by recent history. During the 2008-09 collapse, the typical target-date fund appropriate for a 65-year-old dropped close to 30%. Some of them dropped 40%.

I’m not an advisor. My expertise is in benefit consulting. But I’d say if you have a pretty good nest egg, preservation is now a bigger issue than anything else.

What to Do

If you want to hear more from Ted about how to add years of retirement income… and sock away as much money as possible for your golden years… make sure you check out the presentation he recorded recently with Palm Beach Research Group’s Bob Irish.

In it, Ted reveals details of a comprehensive three-step program for helping you bridge the gap between what you have today and what you need for a comfortable retirement.

It’s what Ted calls the “501(k) plan.” Find out all about it here.

Regards,

Chris Lowe
Editor, Inner Circle