Since Betterment launched in 2010, our mission has been to improve the way people save and invest through smarter technology.
For individual investors, Betterment offers automated investing and personalized advice based on specific goals, such as retirement, college savings, or building wealth. For financial advisors, Betterment for Advisors provides an automated service so that advisors can increase efficiency and spend more time building relationships with their clients.
Now, we’re changing how people save and invest in employer-sponsored plans with Betterment for Business, a 401(k) service that’s better for both employers and employees.
While the number of U.S. adults enrolled in 401(k) plans has grown quickly, roughly half of Americans don’t work for an employer that sponsors a retirement savings plan. The main reason: The plans are too expensive and too time-consuming for their employers to implement.
People who do have employer-sponsored plans—including Betterment employees—don’t have it much better. We offer the lowest-cost 401(k) to our employees, yet they’re still concerned about ensuring they’re saving the right amount, and how to maximize the growth of their savings, because the plan doesn’t offer that kind of advice.
No matter how low-cost the funds, typical plans do not ensure solid retirement readiness; they offer little guidance, are hard to navigate, and aren’t personalized to the employee’s circumstances and goals. Meanwhile, employers want to lower the costs, risks, and headaches of providing a plan.
We wanted something better. So we built it.
With Betterment for Business, we are bringing both efficient technology and personalized, unconflicted advice to 401(k)s so that employers can provide a benefit that’s truly a benefit, and employees can know that they’re invested correctly for retirement. The era of expensive, impersonal, unguided retirement saving is over.
The Current 401(k) Landscape: Confusing and Expensive
Even before we started building Betterment for Business, we knew that the system was broken. But we didn’t realize how bad it was until we were searching for our own.
High-Cost and Tedious for Employers
In 2014, we set out to find the best 401(k) plan for Betterment employees. We not only wanted to offer this benefit for our team to help them save for retirement, but it was also necessary to attract and retain good talent; in a recent Charles Schwab survey, 90% of respondents said they’d think twice about taking a job if it didn’t offer a 401(k) plan.1
As we explored the 401(k) landscape, we were faced with a myriad of confusing, expensive options that included mountains of paperwork and ongoing administrative and compliance duties. While we were lucky to be in the business of investing and have experts to rely on, for the average employer setting up a 401(k) for the first time is like navigating the Wild West.
And then there were the fees. As we talked to our fellow employers who were in a similar position, not one person could answer what I had at one point thought was a simple question: “How much does your 401(k) cost you and your employees?”
As it turns out, it’s not simple. The below table is a vendor fee comparison of a Request for Proposal (RFP) for a $35 million 401(k) plan. Just by looking at price, it feels impossible to choose the best option. Can you imagine trying to optimize this?
In the end, we went with what we believe to be the best currently available choice, a Vanguard plan and a separate record keeper, and Betterment decided to cover all 401(k) costs for our participants. This came out to $9,600 per year for the company, plus the funds’ underlying expense ratios.
If we view those costs in terms of our total cost to have a 401(k) service, this comes out to 0.82%:
- 0.64% in plan costs (employer costs)
- 0.18% in fund costs (employee costs)
And that was a bare-bones plan with no broker or advisor, no separate third-party administrator, and very limited personalized employee guidance. This is as cheap as plans come, until now.
Hidden Fees and No Guidance for Employees
The 401(k) options we looked at were no better in terms of the service and product for our employees. Many vendor options tended to have poor website interfaces and a tremendous deficit of advice. They felt archaic and hard to navigate.
For example, when we launched our 401(k) plan, our employee recordkeeping site—which is different from our plan site—required employees to enter a percentage of their annual gross salary for their deferral. Someone on our operations team had to then manually convert those percentages into dollar amounts. Nothing about this process is efficient. A computer can, and absolutely should, do this for you.
How Did These Plans Become So Expensive?
Let’s look at how the 401(k) system became the expensive and dysfunctional beast that it is today.
Most people might guess that the way 401(k) fee structure works is:
- Your employer pays the fee to a plan provider to administer a 401(k).
- The employee pays fund fees, which are just the costs of the fund manager.
But it turns out that most of the time, 401(k) fees are much more complicated than that. The graphic below from a 2011 Deloitte study2 breaks down the service providers involved in generating plan costs.
There are actually quite a few moving parts, most of which are done by hidden third parties, who all have to figure out how to integrate and coordinate with each other. All that coordination and friction drives up costs, not to mention the potential for errors in your plan administration.
Why do all these middlemen exist? And what exactly do they do? Most of them serve regulatory and compliance purposes, and they exist as a result of the ever-changing employer-sponsored account landscape over the last 35 years. Similar to the healthcare industry, many providers have legacy processes and technology that would never exist if you were designing it from scratch today.
Prior to 1981, there was little compliance and no such thing as an independent record keeper. Pension plans were all the rage, and pencil and paper were sufficient to calculate participant allocations.
That year, the IRS introduced legislation that opened the door for 401(k) plans, forcing compliance to become a key focus and major reason that plan sponsors started outsourcing their recordkeeping. By the mid-1980s, there were likely more than 500 different recordkeeping systems available, and with them came the addition to the sales process of the investment advisor and the broker.
As the 401(k) market grew in the 1990s, the competition for services increased, and plan sponsors could now bid for the best recordkeeper, the best investment manager, the best at participant communications, and any other third-party service they wanted, enabling almost every single financial service company to compete in this marketplace.
Meanwhile, new regulations kept coming: 404(c), the Economic Growth and Tax Relief Reconciliation Act of 2001, Sarbanes-Oxley Act of 2002, and The Pension Protection Act of 2006, among others. This continued to impact the 401(k) regulatory requirements to varying degrees; with each new regulation came an additional set of compliance requirements, and providers. Each of the providers needed to integrate with each other, causing a web of redundant, specialized layers, each costing a fee but collectively resulting in lower retirement returns for the consumer.
How does this impact you as the employee?
When setting up a 401(k), an employer is often given some version of this choice:
- A plan with high employer costs (but low-fee funds)
- A plan with low employer costs (but high-fee funds)
This puts the employer into the awkward position of having to decide between lower costs for the company or higher (hidden) fees for participants. Even most well-meaning business owners see their 401(k) plans as an optional employee benefit, and they try to minimize the cost to the company.
But retirement saving isn’t optional for most Americans. And the best way to save is in a tax-deferred account. Through so much compliance regulation, we’ve made 401(k)s more expensive than they have to be.
These costs are often passed to the employee through the high-fee funds, embedded in the expenses of mutual funds. Mutual funds are designed such that you can hide fees.
Note that this fee-hiding is not possible with exchange-traded funds (ETFs), which are what we use at Betterment. The legal structure of mutual funds in the 401(k) marketplace is designed to drive revenue for service providers by embedding hidden fees for employees (e.g., 12b-1 fees). This is also how they price-discriminate between companies who actually want the plan to be good for their employees, and those who want to tick the box of “we offer a 401(k)” but not pay for it.
How Do These Fees Affect Employees?
For Betterment employees, we went with excellent, low-cost Vanguard target-date funds. But not all 401(k) plans are as inexpensive. And a high-fee plan can have a substantial negative impact on participants’ retirement savings over the long term. The average fee for a plan at our asset level is 1.48%.3
“A person saving for retirement who chooses low-cost investments could have a standard of living throughout retirement more than 20% higher than that of a comparable investor in high-cost investments,” wrote Dr. William Sharpe, Nobel Prize winner, Stanford professor, and the creator of the Sharpe Ratio.
That means the small differences in percentage point fees are vital to coming out ahead. To cut to the chase, for many people starting a new job, a 401(k) plan is less of an “employee benefit” if it means joining a plan with high fees.
Take the chart below, taken from a 2012 Demos study. It shows how much in fees this complex, opaque 401(k) system actually costs employees over their investing lifetime. The study assumes a two-earner household at the median income level (approximately $35,000 to $45,000) from 1965 to 2005, contributing 5% to 8% of their income.
Based on these assumptions, and typical 401(k) fees, this household loses 30% of their savings, or $154,794, to fees.4
A higher-income household, one that earns more income than three-quarters of American households, and that saves and invests identically to the “ideal” household above, can expect to pay an even steeper price: up to $277,969.
Fee Cost to an “Ideal” Household
Over 40 years of retirement saving, the difference between mere basis points in fees is a huge differentiator in achieving retirement goals.
Employees Want Guidance
Fees are not the only downside of many existing 401(k) plans; even with the low-fee funds we’ve chosen for Betterment employees, the experience is still poor and difficult to navigate. And this is even for our own employees, who are in the investing business. When they enroll, they often ask questions like, “Which funds should I pick?” “Should I roll over previous 401(k) assets to this new plan, or an IRA?” “Should I save in a Roth or traditional account?” And perhaps most importantly, “Am I saving the right amount?”
Betterment employees aren’t alone. According to the Schwab study, 67% of respondents said they would like personalized investment advice for their 401(k) plan. However, only 12% indicated they actually get it. Survey participants indicated that such advice would dramatically increase their confidence in making the correct investment decisions.
Solid retirement readiness comes from saving in the right types of accounts, at the right rate, across your household, and maximizing employer matches. It can be amplified by embedding tax rate diversification, making the most of how Roth and traditional accounts are taxed now, versus in retirement. We realized that funds alone, no matter how low cost they were, would not solve the problem that employees were not receiving the guidance and the advice they deserved.
B4B: The Better 401(k) for Employers and Employees
We created Betterment for Business to ensure that we could coordinate and streamline every aspect of a 401(k) in one place.
That means we’re using smarter technology to manage administration, recordkeeping, compliance, and customer service, making plans easier and more efficient for employers to implement, and more transparent and lower cost for employees.
To create Betterment for Business, we worked backward from what the ideal 401(k) would be to come up with the most efficient way to make this work for everyone.
When we compared that vision to what was available today, we knew we were on to something good—maybe even great. Using vertical integration, we can give holistic, unconflicted advice to employees about savings rates, account types, and investment selection, while also reducing costs and inefficiencies.
Unconflicted, Holistic, and Personalized Advice for Every Employee
With Betterment for Business, employees can use RetireGuide to get personalized advice on their retirement plan from a completely holistic view. RetireGuide tells employees how much they need to save to have a comfortable retirement based on whether they’re married, where they live, where they plan to retire, their income, their current savings with other providers, and even their spouse’s holdings. RetireGuide will look at what employees are saving in their 401(k) to offer guidance on the other types of accounts they should open.
This personalized investment advice, offered by Betterment LLC, a registered investment advisor, is built into every employee’s experience using the Betterment 401(k) service. Uniquely, we are selecting all of the best-in-class ETFs for participants, and optimizing the allocation of portfolios that we recommend based on that individual participant’s investing needs.
Less Expensive for All
If inefficiency and conflicts of interest have been driving the cost and problems in most 401(k) plans, our pricing reflects our ability to reduce these problems across the board.
|$10 – 49MM||50bps|
|$50 – 249MM||40bps|
|$250 – 499MM||30bps|
|$500 – 999MM||20bps|
Let’s compare the total cost of a B4B 401(k) plan with the total cost of our Vanguard retirement plan.
Vanguard vs. B4B Pricing
|Vanguard and Record Keeper||B4B|
|Total Administrative Costs ($)||$9,600|
|Advisory Costs (%)||0.60%|
|Underlying Fund Costs (%)||0.18%||0.10%*|
|Total Annual Plan Cost ($)||$12,300||$10,500|
|Total Annual Plan Cost (%)||0.82%||0.70%|
*For investors with an accumulation period of 20 years or longer, Betterment LLC, the registered investment adviser, recommends a portfolio with an average expense ratio of 0.10%, shown here. For investors closer to retirement, the recommended portfolio’s average expense ratio gradually increases, up to 0.12%
Total Plan Cost by Plan Size
Betterment is delivering a more complete 401(k) service, at a lower price, compared to other more established providers.
To be clear, in a Betterment portfolio, a number of your investment funds are still Vanguard funds, but Betterment’s registered investment advisor also uses iShares, Schwab, and other funds to ensure that you, the employee, are getting the most efficient market exposure in the most liquid, cost-efficient manner. Unlike the legacy firms, we have no incentive to offer any particular fund, and therefore we can offer any fund, which means we can be a true fiduciary to our customers.
But once you’re competing on recordkeeping efficiency and personalized advice, Betterment for Business is less expensive, and a more complete service. This is a whole new kind of 401(k) service. One that uses vertical integration to eradicate inefficiencies, streamline decision making, and allow any employer to offer the Tesla of 401(k) plans at a Honda price.
Betterment for Business
Betterment for Business will be open for business in Q1 2016. It’s time to change the way employer-sponsored plans work, and make them work harder and smarter for both employers and employees.
If you’re interested in learning more, get in touch here.
It’s that simple.
More from Betterment:
- How to Select Investments for Your 401(k)
- Can You Have a 401(k) and an IRA?
- IRA Calculator: Which Is Right for Your Savings Goals?
401(k) plan administration services provided by Betterment for Business LLC. Investment advice to plans and plan participants provided by Betterment LLC, an SEC registered investment adviser. Brokerage services provided to clients of Betterment LLC by Betterment Securities, an SEC registered broker-dealer and member FINRA/SIPC. Betterment LLC and Betterment Securities are affiliates of Betterment for Business LLC.