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If you have a pension plan through your employer, you’re probably making some costly mistakes with it. The three most common mistakes I see are clients not taking 100% of their employer’s pension match, taking too much/too little risk, and selecting poor investments. But that’s an article for another time.
This article is about the missteps your employer is making. The good news is that they aren’t your fault. The bad news is that they are costing you money. You can’t fix these problems yourself, but if you want to take action, forward this article to your firm’s Pension Committee or CFO for them to consider. If you don’t know who is on your Pension Committee, ask your HR representative, they should know.
These missteps can reduce your rate of return and can add up to big money. To demonstrate, take a highly simplified scenario of an employee who earns $75,000 in salary and contributes 12% to their pension each year. Over a 30-year career, a cost savings of 0.5% on investment fees adds up to $70,000. Put another way, this employee is working an extra year of her life to make up the loss.
1) Overpaying
If you have a defined contribution (DC) pension – the most common kind – it’s probably administered by one of the big three providers (Sun Life, Manulife, and Great-West Life). While your employer hires the administrator, you’re the one who foots the bill. You don’t ever have to write a cheque but make no mistake, you are paying. These fees (known as expense ratios) are charged on the investments you make within your pension.
Most pension plans offer you a selection of pooled funds (similar to mutual funds) that charge anywhere from a little under 1% to over 2% annually. Compared to typical mutual fund fees, pooled fund fees are competitive. But in many cases, they could be lower.
One common cause is that too many companies fail to renegotiate prices regularly. And in this world, the squeaky wheel gets the grease. It’s similar to your cable/mobile bill. Everyone knows that if you call Rogers/Bell/Telus, and threaten to leave, they will find discounts to offer you. Few of us bother though because it’s a tiresome rigamarole. Your pension committee feels the same way.
Unfortunately, some companies pay much higher fees than they would if they negotiated more regularly. I’ve seen firms with pooled funds charging employees close to 2% annually when they should be closer to 1% given the size of their firm’s pension. Growing companies, in particular, should aim to renegotiate pension prices every few years as the size of the plan assets grow and their bargaining power increases.
Robo-advisors like Wealthsimple have started to disrupt this space by offering employers low-cost and highly convenient alternatives to the established providers. By way of comparison, their fees come in around 0.6 to 0.7% all-in. Companies with proactive pension committees are starting to wake up to the fact that they have options. But too many still have their heads in the sand.
2) Offering limited/poor investment options
Another problem is that many employers choose poor investments. Pension administrators have a huge list of available pooled funds to choose from. In past years, employers would make hundreds of investments available to their employees and let them decide for themselves. Bu this had a nasty unintended consequence. Employees couldn't decide what to invest in or made poor choices.
The paradox of choice has been well documented. Many of us have heard of the classic supermarket study which demonstrated how offering too many jam flavours led to fewer jam sales. If you want to get a human to stop thinking so much and just buy your jam, don't offer too many choices. This led many employers to severely limit their investment menus. It's now not uncommon to find plans where employees have 8 - 12 investment choices.
The trouble is when it comes to your pension you're trying to secure your financial future, not decide what to put on your toast tomorrow at breakfast. Restricting your choice may increase the odds that you make a decision but won't necessarily improve the quality of your decisions.
Still, in theory, pruning an unwieldy list of investments is probably a good thing but the trouble comes in the execution. There are several ways employers tend to get it wrong.
First, these more limited menus are still dominated by expensive actively managed funds despite the fact that most actively managed funds underperform after you subtract out their high fees.
Second, employers aren't very good at deciding which actively managed funds to include. It's not their fault really. Picking winning funds is tough. It was my job for 13 years while I was Director of Manager Research at Morningstar. With nearly 100 analysts across the globe dedicated to picking winning funds, we were only successful 55% - 65% of the time. So I don't expect non-professionals to bat above 50%.
The last problem is that plans do not include any passive investment options on their menu. And when they do, many of the passive investments are relatively high fee mutual fund versions (as opposed to lower fee ETFs); these high fees negate much of their benefit. This is a shame since even the great Warren Buffett argues that low-cost index funds make the best retirement investment.
If employers are going to restrict the investment choices an employee can make, they better be absolutely sure what they do have on the menu is very high quality and constructed sensibly.
It is worth noting that many larger companies contract outside consultants to help them curate their lists. But this comes at a cost. And the lists they produce are often not any more inspiring. Their advice is more about playing it safe (they want their contracts renewed) than picking winning investments. So they stick to recommending the big brand names. During my time at Morningstar, I ran in the same circles as these pension consultants and it was often said, "No one is ever fired for recommending Fidelity (one of the largest money managers in the world)."
3) Not offering financial advice.
Instead of trying to game employee behaviours by severely restricting their choice (even if that includes low-cost investment alternatives) companies should provide employees with more guidance. Having a smaller menu to choose from may make reduce paralysis by analysis, but it doesn't ensure employees will enjoy better financial outcomes.
Instead, companies should make it their responsibility to provide guidance. I would propose they go about this in two ways. First, employer plans should default employees into Target Date Funds where each employee's pension is managed automatically according to their expected retirement date. While Target Date funds have their limitations, their simplicity and the minimum level of quality they ensure make them a great default option.
Nearly 1/3 of Canadians feel very stressed about money either often or all the time. 2018 Study on Poverty, The Angus Reid Institute
Next, employers should allow employees to opt-out of the Target Date defaults and select their own investments if they wish. This allows the more financially savvy, or those working with a financial advisor, to customize their pension investments more fully to their personal appetite and tolerance for risk.
This approach would ensure a basic floor is in place (Target Date Funds) to ensure most employees do not squander their pensions but not prevent others from taking greater control of their retirement.
Still I imagine employers and plan sponsors will worry about the potential for the DIY employees to make poor investment choices. To that I would say, if employers are really worried, they should ensure staff get access to unbiased personalized financial advice. This will help ensure employees are not only making good choices with their pension assets but have the added benefit of helping them make better financial choices elsewhere too. This will improve the financial health of employees and can dramatically reduce the financial stress and anxiety of their staff.
Given how many people suffer money-related stress and anxiety, it should be a big concern for employers. Research has shown that employees who are worried about money tend to be less productive and raise their employer's health care costs.
"46% of employees allow personal financial stress to impact their workplace performance." 2018 Canadian Payroll Association Survey
Recognizing this, progressive companies are increasingly offering financial wellness services to their employees. This can take a variety of forms but all have to do with providing employees access to a human being who can provide education or advice that is unbiased.
According to a recent Consumer Financial Protection Bureau (CFPB) report, companies that offer this sort of benefit could save $3 for each dollar they spend; not to mention a great way to attract and retain quality employees.
Keep in mind, big pension administrators do offer pension participants access to a "financial advisor". However, this advisor is employed by the pension administrator to sell their financial products. This person should more accurately be titled a product salesperson. Just last month I had a new client approach Kind Wealth because she wanted some unbiased advice. She had recently purchased a large insurance policy after her pension administrator sent one of their "financial advisors" to speak with her.
Offering true financial wellness means offering employees access to advice and education that is objective and free from conflicts of interest. Companies have a variety of ways to help employees access financial wellness services. Employers can contract with an unbiased firm and absorb the entire cost as an employee benefit, partially subsidize them, or simply use their scale to negotiate favourable rates for employees. However, it is orchestrated, offering employees financial wellness services can be a big win for both employees and employers.
About the Author
David O’Leary is Founder & Principal of Kind Wealth and host of The Impact Investing Podcast. He is the former Managing Director of Origin Capital; a provider of high-impact investments that provide an opportunity for the world’s most vulnerable people in the hardest to reach places. Read Dave’s bio or connect with him on LinkedIn.