Many companies offer their employees a group RRSP rather than a defined-benefit pension plan. The main attraction of a group RRSP is that the employer often matches employee contributions with an additional 50 cents to a dollar on each employee dollar. Such plans have embedded costs as well. Here I look at my own plan’s costs to examine which are providing value and which are not.
There are actually more parties involved in our group RRSP than I initially guessed:
Employees: Those who save money and invest it in their personal accounts within the group RRSP.
Employer: Main functions are to hire a benefit services expert and match employee contributions (with an extra 50 cents on the dollar in my case).
Benefit Services Expert: Hired by the employer to help choose a group RRSP provider and set up the plan to suit the employer’s needs. Also performs ongoing negotiations with the group RRSP provider to make changes such as lowering fees or changing the available investments within the plan.
Group RRSP Provider: Typically an insurance company that does most of the administrative work of handling employee accounts, collecting contributions, issuing tax receipts, etc. Also works with institutional money managers to create a set of available investments for employees to choose from.
Institutional Money Managers: Similar to mutual funds, these money managers take grouped assets within the plan and invest it in stocks, bonds, real estate, etc. The funds may be actively managed or passively managed (index funds). In the case of my group RRSP, only one fund is a passively-managed index fund.
Nobody works for free
The benefit services expert, group RRSP provider, and money managers get paid. In my case, I’ve been told that my employer pays the benefit services expert and also pays certain administrative costs from the group RRSP provider. The remaining group RRSP provider costs and institutional money manager costs come out of employee savings. That’s the way you need to think about these costs. The helpers who make the plan work earn a living by dipping into the savings in your account.
The all-in cost borne by employees varies by fund. In the case of my group RRSP, after adding in HST and not counting trading expenses within each fund, the fund costs range from 1.45% to 2.11% per year. Even the recently reduced cost of the one Canadian stock index fund is still 1.50% per year.
Who gets these fees?
I tried to find out how these costs were split between the group RRSP provider and the institutional money managers. Our benefit services expert was very reluctant to put a number on this, but finally estimated that only about 30% of costs went to the group RRSP provider. If true, this means that we pay over 1% of our savings every year to institutional money managers.
But institutional money managers are the least valuable part of the entire group RRSP. Active picking of stocks and bonds is a zero-sum game. This means that, on average, institutional money managers add no value. In fact, once you factor in the higher trading costs, they subtract value.
You might think that you’ll only pick the good money managers. But which are these? Poorly-performing funds are routinely closed. Funds with good past performance routinely give mediocre results in the future. Odds are the funds you pick will be just average and their returns will lag index returns by the amount of fees charged.
How to lower fees
The employees would be better served by replacing all actively managed funds with index funds and passing the savings on to employees. It’s bewildering that the one index fund offered in my plan has its fees set so high. This fund’s managers get paid the same as active stock pickers, but they just let a computer make all the decisions.
If the fund choices were all index funds, the costs to employees would be just the rock-bottom index fund costs plus the group RRSP provider’s administrative costs. As assets in the plan grow, these administrative costs would become a progressively lower percentage of employee savings.
Barriers to lower fees
There is a big barrier to moving to index funds. The benefit services expert touts the access to institutional money managers as second biggest advantage of my group RRSP after employer matching of employee contributions. Some of these money managers only accept clients with large investments such as $250,000.
Even this could be overcome if it weren’t for the fact that this pitch was so effective. Most employees seem sold on the idea that these star money managers offer real value. Maybe some employees even feel the supposed prestige of being allowed to invest alongside wealthy elites.
Clinging to the status quo
In theory, the benefit services expert shouldn’t care whether the funds offered are active or passive as long as he is paid the same either way. But if employees are impressed by star money managers and a pitch based on index funds causes fewer employees to sign up for the group RRSP, the benefit services expert will have failed to achieve the employer’s goals.
In theory, the group RRSP provider shouldn’t care whether the funds are active or passive as long as the provider gets paid the same either way. However, the group RRSP provider also serves as the institutional money manager for some of the funds offered in the group RRSP. So, the provider has an incentive to maintain fat fees.
A possible compromise
Offering both active and passive options would cause problems because employees would notice the glaring differences in fee levels. The likely explanation for the expensive index fund in my plan is that a very low fee would make the other choices look bad. The benefit services expert worked hard to compare our fees to typical mutual funds and declare that we were saving money. Huge fee differences among funds make it clear that much higher savings are possible.
In the end the only way there would ever be a shift to low-cost index funds in my group RRSP is if someone convinces my employer to insist on this change. I’m not holding my breath.