The 401(k) is a great retirement savings option if the company you work for offers one… and even better if the company matches a percentage of your contribution. Through payroll deduction, you can conveniently invest to build a tax-deferred nest egg.
The typical 401(k) plan is managed by a provider and offers employees a preselected menu of mutual funds. That means you can create a diversified portfolio of investments by splitting your regular contributions into a mix of funds. And that’s great, if you know which funds and asset allocation make sense for your personal retirement goals.
According to a 2015 Schwab study, 67% of respondents said they would like personalized investment advice for their 401(k) plan.
Research from Morningstar Associates suggests that participants who receive investment advice could end up with nearly 40% more income in retirement.
The Problems With Many 401(k) Plans
Yet most third-party provided 401(k) plans — which are readily available to employers who wish to offer a retirement savings plan as a benefit — offer no investment advice or guidance to employees.
And most 401(k) plans are laden with high fees, in large part due to the provider who acts as a middleman. When shopping for a company 401(k), an employer typically has two choices:
- A plan with high employer costs but low-fee funds, or
- A plan with low employer costs but high-fee funds.
Research shows that many well-meaning business owners see their 401(k) plans as an optional employee benefit and, as such, seek to minimize the cost to the company. And many 401(k) plans embed fees (e.g., 12b-1 fees), so the employee, not the company, pays them, often without knowing.
So, for companies that want to tick the box of “We offer a 401(k) plan” but don’t want to pay for it, the high costs are easily — and invisibly — passed to the employee.
The Solution: Betterment for Business
Enter Betterment for Business. Launched in early 2016, Betterment for Business is a 401(k) service that can, according to Founder and CEO Jon Stein, “allow any employer to offer the Tesla of 401(k) plans at a Honda price.”
Betterment, one of the leading robo-advisors, founded in 2010, manages more than $5 billion for more than 175,000 clients. When searching for a 401(k) plan to offer their own employees in 2014, Stein explains, the 401(k) landscape was a myriad of confusing options that were difficult for employers to navigate, labor intensive to administer and expensive for both employers and employees who opted to participate.
Being unable to find a suitable plan, Stein and the Betterment team set about designing an employer-sponsored plan that’s “better for both employers and employees” by resolving several inadequacies of 401(k)s, including:
- They’re too complicated and expensive for most small businesses.
- Employees pay too much for them.
- Even the least-expensive plans with low-cost funds don’t ensure retirement readiness. Employees need personalized guidance.
- Most 401(k) plans are loaded with levels of complexity, and streamlining every aspect would increase efficiency and decrease cost.
How It Works
Initially, each participant is set up with a portfolio of stocks and bonds based on their age. Participants can modify their portfolio allocations anytime through a dashboard or via a mobile app.
Participants can provide information on their current savings and income, desired retirement age, spending, and other criteria to get personalized advice based on their personal investment needs through RetireGuide, a proprietary Betterment program that provides tailored advice.
The Retirement Savings Calculator takes into account the individual’s cost of living, net worth, spousal assets, income and other personal details.
Participants can invest in a portfolio of passive, exchange-traded funds (ETFs) and can also open taxable investment accounts, IRAs, Roth IRAs, and trust accounts.
The lineup of choices for participants includes well-known low-cost funds. The average expense ratio of the underlying ETFs is 0.147%, and the maximum expense ratio is 0.151%.
“The plan can be customized to your situation, to your goals, to your family, to your savings, to your outside accounts, your social security expectations, all of those kinds of things,” said Stein.
Betterment seeks to deliver the best take-home returns possible, defined as returns net of fees and risk-borne and behavioral or financial mistakes. Participants are invested in a globally diversified portfolio of index-tracking ETFs and can access personalized advice geared toward their personal investing goals.
Although Betterment for Business just launched, their ETF choices have a long history of decent returns. The Betterment team back-tested an asset allocation model using their fund choices and calculates the average return for a participant invested 70% in stocks would have done better with the offerings of their 401(k) plan than the average 401(k) plan investor.
- Low costs — Participants pay 0.10%–0.60% in fees depending on the plan size, and there are no upfront fees for company plans over $1 million in assets.
The fee is calculated as a percentage of the assets under management, with the largest companies paying 10 basis points, or 0.1%, up to 60 basis points, or 0.6% for the smallest plans. According to Brightscope, the average fee for small 401(k) plans is between 1.5% and 2.0%.
And a company has the option of paying some or all of the fees on behalf of their employees.
- Employer-friendly — Offering a 401(k) plan often entangles employers in mountains of paperwork, faxing and dealing with multiple vendors. Betterment for Business has removed this mess by streamlining the process with technology and handling the plan design, investment management, recordkeeping and compliance.
- No hidden fees
- Holistic retirement planning approach — Asset allocation is arguably the biggest determinant of long-term investing success. Creating and maintaining proper asset allocation is an often-ignored challenge for couples when each spouse has various accounts.
Betterment for Business allows participants to enter all their retirement accounts — their own and those of their spouse — to make investment decisions that consider diversification and proper asset allocation of all family retirement accounts.
- No high-fee proprietary fund conflicts of interest — Betterment doesn't use proprietary funds like some mutual fund companies, so there’s no commission incentive.
- Robo-advisor management — Betterment for Business uses robo-advisor technology to manage each participant’s portfolio systematically and automatically, making optimal decisions such as rebalancing and goal tracking, with no effort on the participants’ part.
- Investment guidance — Investment advice to plan participants is provided by Betterment LLC, an SEC-registered investment advisor. Brokerage services are provided by Betterment Securities, an SEC-registered broker-dealer and member ofFINRA and SIPC. Employees can access Betterment advisors to set retirement goals, get personalized advice and customize their plan.
- Flexible options — Participants can also open taxable investment accounts, IRAs, Roth IRAs, and trust accounts, which Betterment for Business’s robo-advisor tools will then manage for them.
The 401(k) plan industry is getting some desperately needed shaking up. America's Best 401(k) is another innovative “disruptor” that’s also challenging the long-standing inefficiencies and high costs of the industry. Competition benefits consumers by improving service and lowering costs. I’m stretching to find the downside to Betterment for Business, but I’ll offer two possibilities:
- Robo-advisors are new and untested over the long term — If employees decide to not avail themselves of the personal investment guidance options, Betterment’s robo-advisor will select the funds and asset allocation on their behalf. Of course, this may be a “pro” more than a “con”; time will tell how robo-advisors perform over the long term.
- ETFs only — In designing a plan from scratch, Betterment for Business chose ETFs for good reasons: They are low-cost funds by design, they perform well compared to other funds, and fee-hiding is not possible with ETFs. Does a menu of ETFs only fit the investment needs of every employee? An argument can be made either way.
By combining (1) access to a team of registered investment advisors, (2) Betterment’s existing artificial intelligence/robo-advisor capabilities, (3) technology that coordinates and streamlines every aspect of the 401(k) plan, and (4) a selection of low-fee index-tracking funds (ETFs), Betterment for Business promises a 401(k) plan that simplifies and improves the deferred benefit retirement planning experience for both employers and participants.