Fees Matter: Vanguard, PERA, TIAA and MetLife Comparison

Inspired by some of the work Ben Johnson has been doing, I decided to revisit two posts I’ve previously done on the retirement plans (401k/403b/457) available through Littleton Public Schools and Douglas County Public Schools. (Note that the expense ratios are slightly lower now than when I wrote those posts.)

It’s probably worth reading at least one of those posts for context, but I basically compared the fees you would pay for investing in PERA’s 401k/457 plan with those you would pay in the other vendor offered (TIAA for LPS, MetLife for DCSD). In this post I thought I’d take that a step further by showing the compounded effects of those fees over time, as well as throw in a comparison to an IRA at Vanguard.

Important note: IRA’s have much lower contribution limits than 401k/403b/457 ($6,000 vs. $19,500 if you are under the age of 50), so you can invest much more each year into your workplace plans. And there are also income limitations on whether you can contribute to an IRA, whereas there are no income limitations on 401k/403b/457 plans. And don’t forget the behavioral aspect – some folks need to have the money taken directly from their paycheck otherwise they won’t ever end up investing it.

So I created this spreadsheet to illustrate the impact of fees over time. Like all spreadsheets of this nature, it is based on many assumptions and those assumptions may be incorrect. Feel free to make a copy of the spreadsheet and change any of the assumptions you wish. For example, for the return on different asset classes, I put in the long-term compounded average return, but many folks think those will be lower in the future, so feel free to adjust. You also can adjust your asset mix between the different asset classes (I kept it fairly simple by limiting to US Large Cap Stocks, US Small/Mid Cap Stocks, International Stocks, US Bonds, and a Target Date fund choice.) Make sure the asset allocation mix adds up to 100%!

You can also change the initial amount you have invested (currently $0 in my examples) and the amount you are adding to your investment each year (currently $6,000 in my examples). You should not change the fees charged by Vanguard, PERA, TIAA or MetLife (unless you are reading this enough in the future that those have changed as well), nor the columns that keep track of your running totals with each vendor. Note that the fees for each are based on the lowest-cost fund offered within each asset class with each vendor.

You can change any of the numbers that are in cells with a purple outline, leave the rest alone.

So, let’s look at some selected results. First, what if you had an aggressive, all-equity allocation of 40% Large Cap, 30% Small/Mid Cap and 30% International? This is what it look like after 10 years:

As you can see, investing at Vanguard is going to get you the best overall return, and investing with PERA is going to be a better choice than either TIAA (LPS) or MetLife (DCSD).

How about after 30 years?

Wow. You’d have over $110,000 more in Vanguard than with MetLife, and over $90,000 more if you choose PERA over MetLife. And if you take it out to 50 years (think starting when you are 22 and not withdrawing until age 72 when you have to start taking Required Minimum Distributions):

Almost $1.5 million more in Vanguard than in MetLife, $1.2 million more with PERA than MetLife. (Note that these numbers get even further apart with contributions that are greater than $6,000 per year, although the percentage differences will be the same.)

Okay, well what if you just chose a Target Date fund (which is the default option in your 401k/403b/457 plans, and a good, simple choice for lots of folks) and put 100% of your money into that? Here’s after 10 years:

Note that here PERA is actually ahead of Vanguard due to the lower expense ratios on their Target Date funds, but both Vanguard and PERA are still doing much better than TIAA or MetLife.

30 years?

50 years?

Play around with the assumptions in the spreadsheet, including the asset mix that most closely reflects your desired asset allocation. But no matter what mix you choose, Vanguard and PERA will come out the best (usually Vanguard as the best, with PERA only if you go with just a Target Date fund). TIAA will come in a distant third, and MetLife a very distant last place. (And keep in mind that the negotiated fees with TIAA and MetLife are actually pretty good compared to many folks’ 403b choices around the country.)

And yet many employees in LPS and DCSD choose TIAA and MetLife. Why? Perhaps because a sales rep contacted them and was kind, concerned, and “helpful”. Perhaps because they think they can choose investments and “beat the market”. Or perhaps they just chose without much knowledge.

So, now that you know a bit more, what changes might you make with your investments? In general, if your adjusted gross income is not too high (varies depending on Traditional vs. Roth, and increases slightly each year), opening up an IRA at Vanguard is going to be your best choice to fund first (this is assuming you are disciplined enough to invest the money when it doesn’t come directly out of your paycheck).

If you max that out (remember, IRA’s have much lower contribution limits each year), then fund your PERA 401k or 457 next. In LPS, I would choose the 457 over the 401k, as it’s a bit easier to access the money before age 59.5 (unfortunately, DCSD has not chosen to offer the PERA 457), but otherwise the 401k and 457 are essentially the same.

If you are able to max out your personal IRA and your 401k or 457, then you can invest in the one you haven’t yet, as the 401k and 457 are different “buckets” and they each have their own, separate contribution limit (note that the 401k and 403b draw from the same contribution “bucket”). This means that in 2021 if you are under the age of 50 (if your income isn’t so high that you can’t contribute to an IRA), you can contribute up to $6,000 to an IRA, $19,500 to a 457, and another $19,500 to a 401k, for a total of $45,000. If you are 50 or older, you get “catch up” contributions, which gives you an extra $1,000 for your IRA and $6,500 for both the 401k and 457, for a total of $59,000. (And, depending your plan, there may be special catch up contribution provisions in your last 3 years of work that can let you contribute even more.) Keep in mind that for all of these you have the option of doing a Traditional (pre-tax) contribution or a Roth (post-tax) contribution, which is a complicated and entirely different conversation.

As always, feel free to reach out with questions (or comment below).

PERA Votes to Switch from Voya to Empower

The PERA Board voted, pending final contract negotiations, to switch record keepers for the Defined Contribution plans (which includes the 401k/457b plans) from Voya to Empower. Voya came in second place in the RFP process, and it would’ve been “fine” to continue with them, but staff, the consultant, and the Board all thought Empower would provide a better experience to members.

The fee each proposed is essentially identical (Empower was slight higher in their bid). I would suspect that it won’t change the fee structure for the plan/funds at all, but I don’t know that for sure as I don’t know how the proposed fee compares to the current fee. (Since PERA has consistently focused on lowering the fees, I would be surprised to see them go up, but we’ll see.)

I’ve shared screenshots of the two slides below as reference for the pros and cons of each. But, essentially, Empower appears to offer better service, more customized offerings, and better technology. Interestingly, Empower purchased Personal Capital last year and will be integrating that into the platform by year’s end. I think that has huge potential if it’s done correctly.

I also think it’s significant that the PERA staff ranked Empower higher, considering that makes more work for them as part of the conversion. Note that there was going to be a fair amount of work no matter what, because as part of this RFP PERA is going to transition away from single sign on (meaning you will no longer have to sign on to PERA’s website in order to get to Voya – soon Empower), and they will be aggregating the contribution data before it goes to the vendor (right now each employer sends their data to Voya, after this transition it will all get sent to PERA and PERA will send one file to Empower). But, even with that, there will be a ton of work in order to convert the data over and, of course, in communication.

I do not know the timeline of when this transition would actually happen, but my sense would be by the end of this calendar year. I’ll have to see the final details, of course, but at the moment I’m cautiously optimistic about this change.

Focus On: DCSD Retirement Plans (401k/403b/457 Plans)

Summary: Choose the PERA 401k plan and invest as much as you can.

 

dcsdretirement

The first part of this post repeats the information in the LPS Retirement Plans post, then the rest of it is specific to the choices you have in DCSD.

The idea of retirement is a fairly new one. It wasn’t until early in the 20th century that the concept of retiring from work and “living a life of leisure” was even a concept. Many employers started offering pension plans and then Social Security came along in 1937. Then in 1978, the idea of a tax-deferred savings plan (401k) was created, although it’s original intent was not the way we’ve ended up using it.

Social Security was really designed to be part of a “3-legged stool” concept of retirement, that retirees would draw from their company pension, from social security and from their personal savings. As pension plans have gone out of favor and 401ks have taken their place (particularly in the private sector), it has really become a two-legged stool (which is somewhat problematic). For public school employees in Colorado, PERA is a social security replacement plan, so basically covers those two legs, leaving the personal savings leg for you to figure out on your own. That’s where employer-offered tax-deferred savings plans come in.

All PERA employers offer the PERA 401k plan to their employees, and some employers also offer access to the PERA 457 and the newly created PERA Roth 401k/457 plans. Many school districts also offer additional, non-PERA options for tax-deferred accounts. This post will focus on what’s offered in Douglas County School District, but you should check with your employer to see what options they offer.

DCSD allows you to choose between PERA and MetLife for retirement savings vehicles, offering the PERA 401k and the MetLife 403b, 457, and Roth 403b plans. There are subtle differences between 401k, 403b and 457 plans that can be important but, for the purposes of this discussion, we’ll treat them as roughly the same, with the important exception that you have separate contribution limits for 401k/403b and 457 plans which gives you the ability to save more if you have the cash flow to do that.

This post is not intended to be an in-depth explanation of 401k/403b/457 plans (or their Roth versions), but let me try to briefly describe them (if you decide to work with me we can dive deeper if need be). The idea behind 401k/403b/457 plans is to save money in a tax-deferred account, which means that you are not taxed on your income that you place into those accounts now, nor are you taxed on the earnings in those accounts as they accumulate, but you are only taxed when you make withdrawals which will hopefully be when you are retired. The traditional thinking is that most folks will be in a lower tax bracket when they are retired, so not only do you reap the benefits of saving “extra” all those years by not paying taxes up front, but when you do pay taxes upon withdrawal you will pay a smaller amount.

More recently Roth 401k/403b/457 plans have been created (along with Roth IRAs, which don’t flow through your employer) that take a different approach. For these plans you do pay taxes on any income you invest, but the earnings grow tax free and all withdrawals in retirement are tax free as well. In other words, pay the tax up front, never have to worry about taxes on this money again. For folks who think their tax bracket might actually be higher in retirement, this is a better option.

The obvious conundrum is how do you know for sure whether your tax bracket will be higher or lower in retirement? You don’t, which is why many folks choose to put money into both types of accounts to hedge their bets and give themselves more flexibility in retirement by giving them the option to withdraw from whichever account makes the most sense based on their current tax situation. (There are also some really nice benefits of a Roth if you are trying to leave an inheritance.)

Many employees, especially younger ones, kind of throw up their hands at all this. Retirement seems like a long way off, the choices can be complicated, and of course choosing not to spend money right now can be difficult for some folks. But the beauty and power of investing is compound interest, and it’s most effective the more time you give your money to grow, so the sooner you start, the better (and easier) it is to generate the retirement savings you want.

Many folks thinking about 401k/403b/457 plans also don’t take into account the effect on the tax-deferral on their current income. They think about putting say $100 a month into a 401k, but then worry they can’t do without that $100 a month. But they’re missing that their actual paycheck won’t go down by $100, but more like $70 (if you are in the 25% federal bracket, plus 4.65% for Colorado taxes). The government is basically saying, “invest $70 and we’ll give you $30” (always remembering that eventually they are going to tax you on that when you withdraw it). If you choose the Roth options, you don’t get that tax break up front, so your paycheck will decrease by $100 (but the potential for tax-free growth over time is tremendous).

So, with that overview, if you are a DCSD employee, should you choose PERA or MetLife? Well, again, that depends on your individual circumstances and I’d be happy to discuss those with you, but for most people PERA is the better choice because of lower fees.

PERA offers a choice of several funds or a self-directed brokerage account if you want more control. For most folks, the funds are the better choice. In 2011 PERA chose to go with a “white-label” approach to investments. Research has shown that many folks make poor investment choices when given too many choices so, instead, a “white-label” approach has you choose among asset allocation choices instead of picking individual funds.

whitelabel

I’ll write more in future posts, but there are basically three things you can control when saving for retirement:

  1. How much you save.
  2. What asset allocation you choose.
  3. How much in fees you pay.

By going with a white-label approach and trying to keep fees low, PERA has tried to simplify the second and third choices for you. For each of their asset classes, PERA has typically gone with a combination of a passive (index) approach and an active (managed) approach. This combination gives you lower fees than a fully active approach, but higher fees than a strictly indexed approach. PERA thinks that they can achieve higher returns than the index this way. I’m a big fan of index funds, so I’m not totally convinced of this approach but, so far in their short lifespan (since 2011), they have mostly achieved this to a small extent.

perafees

PERA does also give you a self-directed brokerage option (for an additional fee), which allows you almost unlimited choices in investments. For most folks, the additional complication of choices and fees make this sub-optimal, but it’s there if you want it.

selfdirected

For some reason, DCSD and/or MetLife have made it extremely difficult to get information about the plan. It took me three weeks of emails and calls to finally get the information we needed. (The way they currently have it set up, you can only find out information about investment choices and fees after signing up and giving them money, which is less than ideal. They are working on fixing that.)

MetLife gives you access to a small set of individual mutual funds, which is one of the reasons the fees tend to be a bit higher (0.34% administrative fee plus the underlying fund fees, some of which are pretty high). Here’s a comparison of fees for a large-cap investment in the PERA white-label fund, the PERA self-directed brokerage option invested in a large-cap index fund (they require you to keep $500 in PERAdvantage funds), and the MetLife option invested in the same index fund. (You can view comparisons for other asset classes here.)

metlife

 

If you look carefully, you’ll notice that the cheapest option is the PERA self-directed brokerage option (as soon as you pass about $20,000 in your account), with the PERAdvantage funds coming in second, and MetLife coming in last. Since the middle and third columns are essentially the same choice in terms of what you’re investing in, there’s no reason to choose the higher fee MetLife option over the PERA option. If you are investing a lot, you can save in fees by going the self-directed brokerage option, but this is where PERA would argue that they think they will outperform the index and make up those fee differences. The differences are small enough between the first two columns that, for most folks, it’s probably best to stick with the PERAdvantage options.

Importantly, this fee difference gets much more extreme if you choose anything other than the three Vanguard choices in MetLife. The MetLife Target funds have a total fee of 1% (compared to 0.18% for PERA), and the International Fund is 1.48% (compared to 0.52% for PERA). This is really, really bad, and you should avoid these at all cost (pun intended). The only reason to choose MetLife is if you’ve maxed out your 401k and want to contribute additional money to a 457 (since their contribution limits are separate, and DCSD has chosen not to allow contributions to the PERA 457 plan). I hope that DCSD considers adding the PERA 457 option in the future as an alternative to the high-priced MetLife.

In future posts I’ll write more regarding possible asset allocations (which fund(s) should you choose), contribution limits (and the fact that you get separate limits for 401k/403b vs. 457, allowing you to save much more if you can), and the power of compounding. But, for now, this gives you an idea of where to start. The key thing is to start now and put as much as you can into one or more of these vehicles so that your “stool” will be sturdy enough to support you in retirement.

Focus On: LPS Retirement Plans (401k/403b/457 Plans)

Summary: Choose the PERA 401k plan and invest as much as you can.

lpsretirement

The idea of retirement is a fairly new one. It wasn’t until early in the 20th century that the concept of retiring from work and “living a life of leisure” was even a concept. Many employers started offering pension plans and then Social Security came along in 1937. Then in 1978, the idea of a tax-deferred savings plan (401k) was created, although it’s original intent was not the way we’ve ended up using it.

Social Security was really designed to be part of a “3-legged stool” concept of retirement, that retirees would draw from their company pension, from social security and from their personal savings. As pension plans have gone out of favor and 401ks have taken their place (particularly in the private sector), it has really become a two-legged stool (which is somewhat problematic). For public school employees in Colorado, PERA is a social security replacement plan, so basically covers those two legs, leaving the personal savings leg for you to figure out on your own. That’s where employer-offered tax-deferred savings plans come in.

All PERA employers offer the PERA 401k plan to their employees, and some employers also offer access to the PERA 457 and the newly created PERA Roth 401k/457 plans. Many school districts also offer additional, non-PERA options for tax-deferred accounts. This post will focus on what’s offered in Littleton Public Schools, but you should check with your employer to see what options they offer.

LPS allows you to choose between PERA and TIAA for retirement savings vehicles, offering the PERA 401k, 457, Roth 401k and Roth 457 plans, and the TIAA 403b, 457, Roth 403b and Roth 457 plans. There are subtle differences between 401k, 403b and 457 plans that can be important but, for the purposes of this discussion, we’ll treat them as roughly the same, with the important exception that you have separate contribution limits for 401k/403b and 457 plans which gives you the ability to save more if you have the cash flow to do that.

This post is not intended to be an in-depth explanation of 401k/403b/457 plans (or their Roth versions), but let me try to briefly describe them (if you decide to work with me we can dive deeper if need be). The idea behind 401k/403b/457 plans is to save money in a tax-deferred account, which means that you are not taxed on your income that you place into those accounts now, nor are you taxed on the earnings in those accounts as they accumulate, but you are only taxed when you make withdrawals which will hopefully be when you are retired. The traditional thinking is that most folks will be in a lower tax bracket when they are retired, so not only do you reap the benefits of saving “extra” all those years by not paying taxes up front, but when you do pay taxes upon withdrawal you will pay a smaller amount.

More recently Roth 401k/403b/457 plans have been created (along with Roth IRAs, which don’t flow through your employer) that take a different approach. For these plans you do pay taxes on any income you invest, but the earnings grow tax free and all withdrawals in retirement are tax free as well. In other words, pay the tax up front, never have to worry about taxes on this money again. For folks who think their tax bracket might actually be higher in retirement, this is a better option.

The obvious conundrum is how do you know for sure whether your tax bracket will be higher or lower in retirement? You don’t, which is why many folks choose to put money into both types of accounts to hedge their bets and give themselves more flexibility in retirement by giving them the option to withdraw from whichever account makes the most sense based on their current tax situation. (There are also some really nice benefits of a Roth if you are trying to leave an inheritance.)

Many employees, especially younger ones, kind of throw up their hands at all this. Retirement seems like a long way off, the choices can be complicated, and of course choosing not to spend money right now can be difficult for some folks. But the beauty and power of investing is compound interest, and it’s most effective the more time you give your money to grow, so the sooner you start, the better (and easier) it is to generate the retirement savings you want.

Many folks thinking about 401k/403b/457 plans also don’t take into account the effect on the tax-deferral on their current income. They think about putting say $100 a month into a 401k, but then worry they can’t do without that $100 a month. But they’re missing that their actual paycheck won’t go down by $100, but more like $70 (if you are in the 25% federal bracket, plus 4.65% for Colorado taxes). The government is basically saying, “invest $70 and we’ll give you $30” (always remembering that eventually they are going to tax you on that when you withdraw it). If you choose the Roth options, you don’t get that tax break up front, so your paycheck will decrease by $100 (but the potential for tax-free growth over time is tremendous).

So, with that overview, if you are an LPS employee, should you choose PERA or TIAA? Well, again, that depends on your individual circumstances and I’d be happy to discuss those with you, but for most people PERA is the better choice because of lower fees.

PERA offers a choice of several funds or a self-directed brokerage account if you want more control. For most folks, the funds are the better choice. In 2011 PERA chose to go with a “white-label” approach to investments. Research has shown that many folks make poor investment choices when given too many choices so, instead, a “white-label” approach has you choose among asset allocation choices instead of picking individual funds.

whitelabel

I’ll write more in future posts, but there are basically three things you can control when saving for retirement:

  1. How much you save.
  2. What asset allocation you choose.
  3. How much in fees you pay.

By going with a white-label approach and trying to keep fees low, PERA has tried to simplify the second and third choices for you. For each of their asset classes, PERA has typically gone with a combination of a passive (index) approach and an active (managed) approach. This combination gives you lower fees than a fully active approach, but higher fees than a strictly indexed approach. PERA thinks that they can achieve higher returns than the index this way. I’m a big fan of index funds, so I’m not totally convinced of this approach but, so far in their short lifespan (since 2011), they have mostly achieved this to  a small extent.

perafees

PERA does also give you a self-directed brokerage option (for an additional fee), which allows you almost unlimited choices in investments. For most folks, the additional complication of choices and fees make this sub-optimal, but it’s there if you want it.

selfdirected

TIAA is more like the self-directed brokerage option, which is one of the reasons the fees tend to be a bit higher (although still not bad compared to many other companies, 0.42% plus the underlying fund fees). Here’s a comparison of fees for a large-cap investment in the PERA white-label fund, the PERA self-directed brokerage option invested in a large-cap index fund (they require you to keep $500 in PERAdvantage funds), and the TIAA option invested in the same index fund. (You can view comparisons for other asset classes here.)

401kfees

If you look carefully, you’ll notice that the cheapest option is the PERA self-directed brokerage option (as soon as you pass about $20,000 in your account), with the PERAdvantage funds coming in second, and TIAA coming in last. Since the middle and third columns are essentially the same choice in terms of what you’re investing in, there’s no reason to choose the higher fee TIAA option over the PERA option. If you are investing a lot, you can save in fees by going the self-directed brokerage option, but this is where PERA would argue that they think they will outperform the index and make up those fee differences. The differences are small enough between the first two columns that, for most folks, it’s probably best to stick with the PERAdvantage options.

In future posts I’ll write more regarding possible asset allocations (which fund(s) should you choose), contribution limits (and the fact that you get separate limits for 401k/403b vs. 457, allowing you to save much more if you can), and the power of compounding. But, for now, this gives you an idea of where to start. The key thing is to start now and put as much as you can into one or more of these vehicles so that your “stool” will be sturdy enough to support you in retirement.