The Retirement Plan Solution: The Reinvention of Defined Contribution

Chapter 9. Reduce Fees

As we search the defined contribution (DC) landscape for leakage and inefficiency, one topic stands out as especially contentious, and we will award it its own special chapter. That topic is fees. In DC, unlike in defined benefit (DB), fees have a direct impact on the benefit received by the plan participant. This creates a different set of dynamics. One danger is that those in a position to monitor and manage fees (the plan fiduciaries, most notably the plan sponsor) have less direct incentive to do so.^[72] The result can be that fees are inadequately managed. Another danger arises when awareness of this first danger grows: Controlling fees becomes a goal in itself. This produces the opposite—but potentially just as damaging—outcome: The cheapest route is chosen even where this acts against the interests of participants.

THE IMPACT OF FEES

In Chapter 4 we showed how very important investment returns are. Anything that reduces those returns unnecessarily is a waste, and potentially very damaging. Because fees are paid year after year, their impact can add to a lot over the course of a lifetime. In our base case example, for instance, an 8.4 percent savings rate produced a 40 percent income-replacement ratio. That was based on an annual investment return (after the impact of fees) of 7.5 percent. Suppose a further ½ percent a year were to be lost to fees, reducing the effective return to 7 percent. Now, the same 8.4 percent savings rate produces just 34 percent ...