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THE SECURITIES AND Exchange Commission recently proposed that registered financial advisors be compelled to act as fiduciaries when recommending rolling over 401(k) money to an IRA. Whether this rule gets adopted or not, plenty of advisors are eager to help investors with the issue.
Indeed, as I approached retirement, a number of advisors contacted me about rolling over my 401(k). Of course, these advisors also offered to manage my funds for a fee, usually around 1% a year of assets. I joined colleagues at a few lunchtime seminars that were put on by advisors who worked mainly with retirees from our employer. A couple of my friends ended up hiring one of these folks.
These advisors were, I believe, offering sound advice. Some colleagues had no interest in building a portfolio on their own, let alone understanding the complexities of when to claim Social Security or how to manage their income to reduce the Medicare premium surcharge known as IRMAA.
My quibble was with the amount the advisors were charging for their services. Let’s assume an engineer had been contributing to a 401(k) for 40 years, and the company had been matching part of those contributions. It wasn’t unheard of for the engineer to have a $1 million 401(k).
Although there were expenses associated with the 401(k), our company had chosen the plan provider carefully and the costs were minimal. By contrast, an advisor charging 1% of assets per year would be pocketing $10,000 annually from a $1 million IRA.
Let’s assume advisors were charging $500 an hour for their time. That would imply that they should be spending about 20 hours a year to develop a financial plan for you. In your first year as a client, as they get to know you and your goals, 20 hours seems like a reasonable estimate of the time they might spend on your account.
My concern was the second year: Was it really going to take another 20 hours that year, and every year thereafter? Although the advisors we spoke with were suggesting rolling the 401(k) into a series of low-cost exchange-traded funds, there’s a risk some advisors might recommend ETFs with higher fees than we were paying in our 401(k).
What did I do? Did I keep my money in the company 401(k)? Did I hire an advisor? My decision was based on a desire to simplify our finances as much as possible for my wife, should I die before her. I rolled the 401(k) over to an IRA at the brokerage firm we use for our taxable account investments, and then built my own portfolio.
The table below shows the cost of a hypothetical $1 million account at both Vanguard Group and Fidelity Investments, compared with my old employer’s 401(k). While Vanguard and Fidelity don’t offer funds tracking the exact same indexes as the 401(k) provider, you can get pretty close by choosing similar categories. As you can see, by carefully selecting low-cost funds, it was possible to keep costs comparable when moving to an IRA—and there was an opportunity to cut expenses.
Once I completed the rollover, I spent a few hours planning conversions of my IRA money to Roth IRAs, so I’d minimize future Medicare premium surcharges. All in all, I believe I’ve captured 90% or more of the benefit that an advisor might provide, and for a far lower cost than 1% of assets.
You do not need an advisor to manage your assets at 1%. Buy some index funds. The person who knows absolutely nothing about investing may want to hire a fiduciary at an hourly rate to develop an asset allocation and the funds/ETFS within it. Maybe hiring a manager for other reasons may make sense if you feel you know nothing about other financial issues, but not for a % of assets. However, in my opinion worrying about IRMAA is not a reason to hire a manager. For an individual Medicare costs increase if income is over $103,000, $206,000 for head of household. Most will be well below those levels. Aside from converting your IRA to a Roth well before age 70, there is not much else to do to reduce income. I have a substantial 7 figure IRA as well as SS for spouse and me, as well as dividends from investments, and still do not have to worry about IRMAA.
AUM is a carryover from when most FAs were investment managers/advisors. Even then it was highway robbery (similar to the 6% that Realtors charge). Compensation should be related to the work input. The size of one’s portfolio has no relation to the complexity of the account. We do not compensate other professionals in this manner (Lawyers, CPAs, etc.). The faster we move away from this compensation structure the better. AUM also provides a strong disincentive for moving money out of their control, and there are many situations where this is the best course of action.
For FAs it is fantastic! After a bit of work up from, the money rolls in for minimal work thereafter, typically accounts require only minor adjustments after the initial plan is developed. FAs do provide a valuable service and a fixed fee will not be cheap, but it should vary year to year based on the work input to the account.
I also manage my own assets post retirement, but I also worked in the investment business and have some idea of what I am doing. My experience when helping friends and family is that they are overwhelmed by the information available to them and either get frozen in place or sign up for an expensive asset management service that is not likely to pay for itself via superior returns. I’ve looked at too many portfolios where the owner had no idea what they were paying in direct and indirect fees and had no real sense as to how their assets were performing. But the portfolio manager/planner/broker sure is nice! It’s not all that hard to manage our assets if we stick to a few ETF’s and index funds, and most people could benefit from a little asset management education that can often be obtained through their local community college.
My non-Vanguard fund expenses are $250 for a Morningstar premium membership, and in January I will add a membership to New Retirement so I can utilize their Monte Carlo, and their Roth conversion calculator. A lot less than the $10K and advisor would charge.
We use a flat fee FA who also manages our assets. I see most of the value coming from the advice, rather than management of the assets. As far the fees, they have been decreasing as a percentage of portfolio over time. For the investment management piece, the bits where he is likely better than me including the process and timing of building the portfolio back after 401k transfer, rebalancing decisions and strategy of including a TIPs bond ladder and executing it, amongst others. On the holistic planning side there have been many examples over the last few years where he has added value in various aspects of our financial life-I could list them all but I’m confident I would not come close to capturing 90% he provides. He also provides value in getting my wife on the same page, providing continuity after loss of spouse, providing insurance for cognitive decline, providing financial education and providing peace of mind through ongoing professional service. The fees have decreased as a percentage of assets over time and are now around 0.2%, which to me is reasonable, if not a bargain.
I too find the 1% AUM Fee + ER’s to be excessive. Im surprised to hear that an Advisor is currently not required to act as a fiduciary with a roll over. Im thinking that means he/she should act in the owners best interest to analyze and advise if owner should indeed rollover the funds. I kept my 401K with my employer for many years because of the low cost index funds in the plan. Eventually, I moved it all to Vanguard.
In the analysis above (table of costs) it appears you are comparing Fidelity’s Zero funds with Vanguards Index funds. These are not exactly the same. The indexes they follow are close cousins, but the rules with Fidelity will not allow you to transfer those funds to another firm-you would have to sell them. But, if you like Fidelity it is a good low cost option.
Seems like you did a good job. Thanks for the article.
THIS IS NOT FROM ME Joseph Twardoski posted it on my blog
This is off subject but I could not figure out how to ask my question on HumbleDollar.
Rick Dunn stated “In the analysis above (table of costs) it appears you are comparing Fidelity’s Zero funds with Vanguards Index funds. These are not exactly the same. The indexes they follow are close cousins, but the rules with Fidelity will not allow you to transfer those funds to another firm-you would have to sell them.
But, if you like Fidelity it is a good low cost option.”
I am considering rolling my Fidelity 401(k) into a Fidelity IRA. Can you clarify the above? Thanks so much for your help.
I agree that 1% is excessive – though some advisors charge even more. An equitable option could be that a financial advisor charge 1% for the first year during which the heavy lifting of 401k conversions, social security timing, and financial plan generation is accomplished. After that a reduced annual maintenance fee could be charged. Hey, It’s just a thought!
Almost everyone on HumbleDollar – original posters and commenters – can probably do a financial plan and manage it themselves.
But there are lots of other people who don’t want the bother. Or they don’t feel they have enough savvy to do so. Some people, perhaps, just don’t care.
My financial advisor is a former coworker I that was both exceptionally bright and quite honest. If he made a mistake he would own up to it. He never tried blaming others.
So I feel good about chatting or emailing him about our finances.
My wife makes all the final financial decisions after listening to his opinion.
He spent a lot of time helping out with financial things when our parents passed. And never charged us a penny for that work. What a relief.
So while we realize we could probably save money doing more things ourselves … it would seem kind of churlish not to let him get his commissions.
Obviously YMMV :-;
If you are HumbleDollar reader and comprehend 75% to 90% of the posted articles, you are capable of managing your IRA. Yes, once I reach 70’s, I might have to reach out to an advisor. 1% fee at that point is worth the hassle.
I rolled my 401k over three years ago and 11 years after I retired – I had a strange attachment to the plan as I had managed the 401k since 1982.
All expenses were taken from the trust, thus participants paid to operate the plan. What got me to make a rollover was the company also added an annual fee on inactive (retiree) accounts thus we were paying twice to use the plan.
However, the rollover to Fidelity did not involve an advisor. One helped with paperwork, but no pressure to engage as advisor and none to this day. At the time I also consolidated brokerage accounts and moved a couple of stocks too. I should have done it when I retired.
I think 1% AUMs are daylight robbery. Just add that up over 20 or 30 years. Since I had an IRA at Vanguard in addition to my 401K, I rolled the latter over to Vanguard when it came time for RMDs, for the sake of simplicity. I have occasionally used an advisor, but only a fee-for-service one operating as a fiduciary.
I’ve worked with a fiduciary advisor for my investment account for many years. During that time, he charged 1% and provided what I believe to be excellent service. When I retired 3+ years ago, he suggested a 401k rollover to an IRA he would direct on my behalf. My advisor had provided gratis input for my 401k holdings through the years, too. As Kenyon said, working for 40 years as an engineer it’s possible to have a substantial sum in one’s 401k account. I indicated I wasn’t thrilled with the idea of paying 1% for both accounts. He offered to halve his fee, and offered that fee to my wife (second marriage for both of us and we keep finances separate) and sons. The upshot of this is I have reduced fees on my total holdings, and perpetually lowered fees for my immediate family.
I might be able to handle my holdings myself, but neither my wife nor my sons would be able to. I think this is the best for all of us.
Ken, thanks for the interesting article. You highlight one of my issues with financial planning. I know FPs that are full service – the 1% includes investment management, tax planning and prep, estate planning, insurance planning, and retirement planning. For many people, especially those who are not confident or interested in doing their own FP, this is probably a good deal. I also know folks who pay 1% and get nothing but – in my opinion – an unnecessarily complex portfolio. I recently had a conversation with someone who told the that his “wealth management” team couldn’t help him with Roth conversions – he would have to hire an additional expert. His team did not do taxes, or help him with estate planning.
I’ve also spoken with many folks who are very smart about their investments, but don’t have wills, POAs, HSAs, or check their beneficiaries. Holistic FP is about much more than asset allocation. As we get closer to retirement, and in retirement, the non-investment parts become very important.
I absolutely agree that there is much more to FP than asset management. And for people who need a push to remind them to take care of those other aspects, a FP is useful. I just never felt like I needed to retain one at the cost of 1% AUM.
My will, living will, POA and HPOA cost me $1,500, or there about, a few year’s back. Virtually all my assets are at Vanguard, with beneficiaries and TOD easily updated online. No reason to pay 1% of assets, which can reach a startling figure over a lifetime, or even a retirement.
Several years ago, shortly after I took control of my IRA accounts from the 1% per year advisors I had used for more than 20 years, I also did an in-service rollover from my 401(k) which at the time did not offer any low-cost index funds, Vanguard or others. After restructuring the investments my total expenses went from 1.9% to 0.12% per year.
When I did the in-service rollover I was disappointed that the 401(k) custodian required the investments be liquidated to cash instead of being transferred in-kind. Then I was floored when they used the U.S. post office to deliver a check to the IRA custodian instead of doing an electronic funds transfer.
I have been retired for two years and see no reason to move my 401k to a self directed IRA or rollover to an another financial institution and advisor. Many of these advisors don’t even build their own portfolios. They use company models that have been pre-selected. They keep expense ratios down, but still charge at least 1% for AUM. Basically for a million dollar portfolio they “click a button” and earn 10k
Smart. Also, I doubt many of these advisors mention that rolling over a 401K into an IRA means giving up the federal 401K ERISA protections for the (possibly much less) state protections.
Too often the rollover is facilitated by a high expense AUM brokerage firm that sends out the glossy information packet with the beach scenes. I did
the same thing you outlined in this article and have been happy with the
results over my first 8 years of retirement. In the second year, the cost is
more like 5000.00 per hour for the 1% AUM on a 1Mil portfolio.
Interestingly enough, someone making $500/hour (working 40 hrs/week, 50 weeks/year) would be making $1 million/year.
(Side note: if anyone can point me to a $500/hour job for myself, I would be grateful…joking of course.)
I purposely picked what I thought was a high number as an hourly rate. Assuming half the cost goes to overhead (rent, assistant, software, etc) – that leaves half ($250/hr) as earnings. Assuming the planner can bill 2,000 hours a year (50 weeks x 20 hours/week), that is an income of $500,000 per year.
Based on the amount of hair I have, that job would be my barber.