There are two types of people in the world: those who believe people can fend for themselves and those who think they can’t. If you fall into the latter category, read this article are your own risk.

I recently published an article where I interviewed several financial professionals. In it, they discussed the increased fiduciary liability imposed on 401(k) plan sponsors when former employees opt to leave their assets in their old 401(k) plan rather than roll over those assets into an IRA. The article (“Ex-Employees Who Don’t Rollover – Will 401k Fees Increase Plan Sponsor Liability?” Fiduciary News, June 28, 2011) noted most financial planning textbooks suggest employees should take their retirement savings out of their old company’s plan. It also acknowledged this adage remains controversial.

The controversy ends here.

First, let’s agree there’s no such thing as an absolute. Therefore, anything I'm about to say has an exception. But, be forewarned, those exceptions only prove the rule.

Here’s the blunt premise: It's in the best interest of all parties for ex-employees to roll over their retirement funds into an IRA. And by all parties, I mean the 401(k) plan sponsors, the plan’s current employees and the ex-employees themselves. Here’s why – costs and control.

A 401(k) plan requires service providers (and their associated costs) that IRA plans do not. This means even when a 401(k) plan negotiates lower expense ratios for the mutual funds it offers, there are still administrative and compliance related fees on top of that. In some cases, the company pays these direct fees. If the company pays administrative and compliance fees for individuals no longer under the employ of that company, this hurts the company, its shareholders and its current employees. In many cases, the company doesn’t pay these fees (and a DOL report concludes this is increasingly the trend), saddling the costs on the former employees.

With this in mind, the 401k Averages Book suggests the average total bundle of fees in a typical 401(k) plan ranges from a minimum of 30 basis points to a maximum of 3.94% with a median range from 0.92% to 2.72% (this covers plan sizes ranging from $0.25 million to $250 million). You can see this range is quite large, but it still shows that even in some quite large plans, the total costs far exceed the costs associated with an IRA.

For example half of the $100 million 401(k)plans exceed 1% in annual costs – meaning anyone with retirement assets exceeding a few hundred thousand can easily hire a personal fiduciary (a.k.a., a registered investment adviser). RIA fees generally start at about 1% and go down depending on the size of the account. This is the equivalent of jumping from a city bus (i.e., the 401(k) plan) with its pre-scheduled drop-off points to a chauffeur-driven limousine (i.e., an IRA) that offers door-to-door service. Who wouldn’t want that?

This isn’t to say some employees make unfortunate decisions and jump from the frying pan into the fire by choosing a high cost alternate for their IRA rollover. The point is, there are low cost alternatives available. Admittedly, in the extreme case the existing 401(k) plan will be cheaper (admin and compliance costs included) than an IRA. Certainly, if you’re in a $250 million 401(k) plan with a total cost of 30 basis points, you’d be hard pressed to beat that on price alone (unless you limit your options to index funds).

But we can’t view the issue on price alone. The lack of control often compels many former employees to take their 401(k) assets when they leave (and also provides the primary reason why most financial planning text books suggest they not leave their funds with the old company). Going back to our hypothetical 30bp 401(k) plan, what if that low cost was achieve solely by limiting the investment options to index funds. Some former employees, after seeing how much better actively managed funds performed vs. index funds in the “lost decade,” might prefer to pay more just to broaden their options.

In general, it is precisely this greater control, on top of the already mentioned higher fees, which might be responsible for increasing the 401(k) plan sponsors fiduciary liability should ex-employees leave their retirement assets in the company plan. Very rarely does a 401(k) plan provide an investment option not available to IRAs. Even the much loved stable value fund is now available to IRAs.

So if rolling over is better for the former employee and retaining assets is worse for the 401(k) plan sponsor, why don’t those 401(k) plan sponsors just say “buh-bye” to former employees by requiring them to clean out their retirement assets when their done cleaning out their desks?

Instant Insights /

Why 401(k) plan sponsors should say &#039;buh-bye&#039; to former employees

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