Investment fees can badly dent retirement funds

CANADIANS who participate in their company's pension, group RRSP and deferred profit-sharing plans pay hundreds of millions of dollars in investment fees and embedded adviser compensation each year. These costs are coming under increasing scrutiny given muted investment returns, proposed low-cost investment options for pooled registered pension plans and growing concerns over ethics in the financial services industry.

Significant regulatory changes in other countries have also highlighted how Canada continues to fall behind in the areas of investment fee and compensation transparency and disclosure.

Earlier this month, the U.S. Employee Retirement Income Security Act (ERISA) started requiring significant disclosures relating to company-sponsored retirement and pension programs. All direct and indirect compensation (including money, gifts, finder's fees, placement fees, commissions or other fees) must be disclosed. U.S. employers must also ensure investment fee information is provided on retirement plan statements, including total operating expenses as a percentage and as a dollar amount for an assumed investment of $1,000.

Excessive fees have been the subject of a number of high-profile U.S. court cases.

Walmart Stores Inc. and Merrill Lynch & Co. recently agreed to a US$13.5-million settlement related to a class-action lawsuit alleging fiduciary duties to past and current employees were breached due to high-fee mutual funds.

A more thorough disclosure of investment fees could raise a few eyebrows if required by law in Canada, as few retirement plan members know they're paying any fees in the first place. Quite to the contrary, many plans are structured so all participants pay investment fees, which include embedded adviser or consultant compensation. Compensation disclosure on account statements is not a requirement in Canada.

According to pension consultant Shawn Patton of Ampersand Advisory Group, "fee disclosure and transparency can be a powerful catalyst. In the months leading up to the deadline on the new ERISA disclosure requirements, media reports suggested a significant number of companies got ahead of the curve by reviewing their plans and investments with a marked interest in ensuring their fees were reasonable and competitive.

In many cases, investment fees which had not been reviewed for years were able to be renegotiated significantly lower, benefiting plan members and reducing the liability of plan administrators and sponsors." Patton's firm offers a fee-based approach to compensation when supporting a company's retirement program and can provide services on a project basis, such as conducting a governance review or auditing a plan's existing investment fees or adviser compensation.

Investment fees are important for two reasons. For one, they diminish a plan participant's retirement nest egg. A mere 0.5 per cent difference in fees, assuming identical rates of return, will mean about a 10 per cent difference in account balances after 20 years -- equivalent to about two years of contributions. Studies also suggest little evidence funds with higher fees outperform low-cost funds, which makes fee disclosure and comprehension essential.

Secondly, the industry is fraught with a lack of compensation transparency and conflicts of interests, including conference travel and hospitality, sales contest prizes, retention bonuses and annual sales bonuses.

These compensation practices could result in an adviser focusing his clients' business with a single company, which may or may not be the best option for plan participants.

The U.K. Financial Services Authority will be putting an end to embedded commissions in investment products by Jan. 1, 2013. "From the end of 2012, firms will have to be upfront about how much they charge for their services, and no longer hide the cost of their advice behind the cost of a product," it said.

Furthermore, firms are prevented from accepting commissions to recommend specific products. The FSA sees the changes as ensuring advisers act in plan participants' best interests. In addition, the new rules will be instrumental in "exploding the myth that investment (and financial) advice is free."

According to Ampersand's Patton, "Oversight of a company's retirement program is often lower down the priority list for many HR and finance executives juggling many responsibilities. Understandably, they are busy running the business and leading their people. Larger companies are more often on top of their plans, but small to mid-sized companies typically don't have the personnel, expertise or market insight to effectively scrutinize and negotiate fees." Perhaps that's why so many governments abroad are working to force change.

At least the Canadian government has gone so far as to validate the importance of low fees by making them a central requirement as part of the new PRPP framework. But if you're a group plan participant, or a corporate decision maker responsible for such a plan, you should know fees are negotiable, competition to earn your business is fierce and compensation practices in the industry can create conflicts of interest.

At a time when many suggest we're entering a Canadian pension crisis, make sure you do everything you can to tilt the scales in your favour.

Jason Heath is a fee-only certified financial planner (CFP) and income tax professional at Objective Financial Partners Inc. in Toronto.

-- Postmedia News

Republished from the Winnipeg Free Press print edition July 26, 2012 B8