Voices is an occasional column that allows wealth managers to address issues of interest to the advisory community. Sev Meneshian is the owner of Public Retirement Planners in Evanston, Ill.
A lot of public sector employees now contribute to 457 plans as part of their retirement savings strategy, and many don’t realize that they are being hit with exorbitant expenses in their accounts.
State and local governments that sponsor these plans will typically partner with an institution that administers the plan and charges a management fee for that service. While that’s a reasonable practice, the administrator may also seek to benefit by offering participants their own in-house funds that sometimes have ridiculously high fees. The expenses related to these funds can range from 1.5% to as high as 2% or 3%, compared with 0.5% to 0.75% for a low-cost index fund.
“What’s interesting is that if I tell my clients that these fees are costing them thousands of dollars a year, they don’t seem to pay much attention to me. But when I tell them they’re losing $300 a month, their ears suddenly perk up” according to Sev Meneshian, CFP® – owner of Public Retirement Planners, LLC.
There are a couple of different ways that clients can reduce these high expenses. If they’re nearing or at retirement age, clients can transfer the funds out of the 457 and into an IRA where they can select low-cost index funds. Most plan participants are passively managing their accounts anyway, and transferring allows them to avoid the high mutual fund and plan administration expenses that are commonplace with 457 plans.
Younger clients could theoretically make the same kind of transfer to an IRA, but they have to understand that they’ll be hit with penalties if they need to use the money before age 59 1/2. There’s no penalty for withdrawing money early from a 457, but once it is rolled over into an IRA, the 10% penalty will apply. So they should only transfer the money if they’re absolutely certain they won’t need it before age 59 1/2, otherwise they’re better off leaving it in the 457, where they’ll have unrestricted access to it.
A different approach is for younger clients to contribute the maximum amount to a Roth IRA before they contribute to the 457. Many of these younger clients receive tax breaks for mortgages and children, and so they don’t derive much immediate benefit from the tax deferral provided by the 457. In fact, they’ll likely have a higher tax rate later in life and get hammered when they try to take withdrawals out of the 457. They can reduce some of those taxes, and cut down on their 457 fees, by diverting contributions to low-cost index funds in the tax-free Roth account.
If they can recruit other employees to join them, clients may also have success petitioning the plan sponsor, usually via the human resources department, to use lesser-known, smaller 457 plan administrators. Employee costs can often times be cut dramatically, by 50% to 60% or more, by selecting a lower-cost administrator.
Clients need to carefully watch their costs with these 457 plans. Change is always difficult, and clients who are comfortable with their plan may be resistant to shaking things up. However, those who take action to reduce their costs seldom seem to regret it. It is almost like you can see that cost burden lifting off their shoulders immediately.
For more information, visit Public Retirement Planners, LLC.