Changing Investment Structure: Reducing Retirement Plan Costs

In managing a retirement plan, one of the most effective strategies for enhancing participants' outcomes is reducing investment costs. A key approach to achieving this is by changing the investment structure of the plan. This involves reevaluating and potentially altering the types of investment vehicles offered, such as shifting from actively managed funds to passive index funds or opting for collective investment trusts (CITs) instead of traditional mutual funds. Understanding these changes and their impact on investment costs is vital for fiduciaries who aim to maximize the retirement savings of plan participants.

Understanding Investment Structure

The term "investment structure" refers to the framework within which a retirement plan's investments are managed and organized. This includes the types of investment vehicles offered, such as mutual funds, collective investment trusts (CITs), separately managed accounts (SMAs), or index funds. Each of these vehicles comes with its own fee structure, investment strategy, and management approach. For example, actively managed mutual funds are typically designed to outperform the market by employing professional fund managers to select investments. These funds often charge higher fees to compensate for the active management involved [1]. In contrast, passive index funds aim to replicate the performance of a market index, resulting in lower management fees due to their simpler investment approach [2].

How Changing Investment Structure Reduces Costs

Switching to a more cost-effective investment structure can significantly reduce the fees associated with managing a retirement plan's assets. One common change is moving from actively managed funds to passive index funds. Active management generally incurs higher costs because it requires a team of analysts and portfolio managers to research and select investments. These fees are passed on to investors through higher expense ratios. On the other hand, passive index funds track a market index, which involves less frequent trading and lower management costs, leading to lower expense ratios [3].

Another effective strategy is shifting from mutual funds to collective investment trusts (CITs). CITs are pooled investment vehicles similar to mutual funds, but they are only available to qualified retirement plans and typically have lower administrative costs. Unlike mutual funds, CITs are not regulated by the Securities and Exchange Commission (SEC), which reduces their compliance costs and, in turn, lowers the overall expense ratio [4]. By incorporating CITs into a retirement plan, fiduciaries can offer similar investment strategies as mutual funds but at a lower cost.

The Impact on Retirement Outcomes

Reducing investment costs through structural changes can have a significant impact on the long-term growth of participants' retirement savings. Even a small reduction in fees can lead to substantial increases in retirement account balances over time. For instance, a 0.50% decrease in annual fees could result in tens of thousands of dollars more in retirement savings over a participant's career, depending on the amount invested and the length of time the funds are held [5]. These savings occur because lower fees mean a higher proportion of investment returns are retained in participants' accounts rather than being paid out in expenses.

Fiduciary Considerations

Fiduciaries have a legal obligation to act in the best interests of plan participants, which includes minimizing investment costs where possible. Regularly reviewing the plan's investment structure and considering changes that could reduce costs is an essential part of this responsibility. This process should involve benchmarking current investment options against lower-cost alternatives, evaluating the potential impact on performance, and documenting the rationale for any changes made [6]. By proactively managing the investment structure, fiduciaries can ensure they are fulfilling their duty to maximize participants' retirement savings.

Conclusion

Changing the investment structure of a retirement plan is a powerful tool for reducing costs and enhancing participant outcomes. By transitioning to lower-cost investment vehicles like passive index funds or collective investment trusts, fiduciaries can help ensure that more of the investment returns are retained in participants' accounts, leading to greater retirement security.

References:

[1] U.S. Securities and Exchange Commission. (n.d.). Investor Bulletin: Mutual Funds. Retrieved from https://www.sec.gov/investor/pubs/investor-bulletin-mutual-funds.html 

[2] Bogle, J. C. (2019). The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. John Wiley & Sons.

[3] Vanguard Group. (2020). The Case for Low-Cost Index Fund Investing. Retrieved from https://www.vanguard.com/low-cost-index-fund-investing 

[4] Callan Institute. (2021). Collective Investment Trusts: An Overview. Retrieved from https://www.callan.com/research/collective-investment-trusts-overview/ 

[5] Morningstar, Inc. (2021). The Impact of Fees on Retirement Savings. Retrieved from https://www.morningstar.com/articles/the-impact-of-fees-on-retirement-savings 

[6] U.S. Department of Labor. (n.d.). Meeting Your Fiduciary Responsibilities. Retrieved from https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/meeting-your-fiduciary-responsibilities.pdf 

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