Group RRSP Fees Matter
The high MERs charged by some employers’ group RRSPs can be frustrating. But these fees seem small compared to the employer matching of employee contributions. A recent guest on The Wealthy Barber podcast said “those [group RRSP] fees aren't going to eat that [contribution matching] up over time.” Challenge accepted! People, including experts, consistently underestimate the corrosive effect of high MERs over long periods of time.
It’s not my intention to be overly critical of David Chilton or his guest Brian Orlando. They gave some great information for helping Canadians with their finances. But I do want to explain how high fees can consume an employer match faster than we might expect.
An example
The podcast segment began with the example of 2.5% MERs in the group RRSP. So, let’s compare two scenarios for a hypothetical employee Evan:
Group RRSP
- Evan’s contributions are invested in a crappy closet index global stock fund with 2.5% MER.
- Evan’s contributions are matched 50% by his employer.
Personal RRSP
- Evan’s contributions are invested in the ETF VEQT with a 0.19% MER.
- No matching.
There are other relevant factors, such as internal fund trading costs, commissions, trading spreads, foreign withholding taxes on dividends, and whether or not the quoted MERs include HST. A publicly available fund such as VEQT must include HST in its advertised MER, but the quoted fees in a group RRSP may be just management fees that exclude HST. This was the case with my most recent employer.
Let’s suppose that after taking into account all of these factors, Evan’s group RRSP investments earn 2.3% less each year than VEQT in his personal RRSP.
How long does the employer match survive?
The question now is how long it will take for the high fees to eat up the 50% employer match. The answer is
ln(1.5) / (-ln(1 - 0.023)) = 17.43 years.
So, after Evan’s contributions have sat in the group RRSP for 17.5 years, the entire employer match is consumed by excess fees. Somehow it doesn’t seem possible for such a seemingly small cost to consume the entire employer match, but it does. The employer match is given only once on each dollar of contribution. But the excess fees are charged on every dollar every year, and they’re charged on both Evan’s and his employer’s contributions. These excess fees add up faster than our intuition tells us they should.
Solutions to the problem
The best solution would be for employers to offer better fund options with much lower fees. However, deeply entrenched interests aren’t going to give up these fees easily. This battle will rage on, and in the meantime, Evan has to make choices.
The next best solution that I used in my career is to pull money out of the group RRSP regularly. Chilton mentioned this possibility. My employer’s group RRSP allowed me to transfer money from my group RRSP to my personal RRSP once per year. So, I did. This eliminated almost all of the potential excess fee buildup.
I’ve heard of group RRSPs that placed restrictions on withdrawals. In some cases, employees had to wait for some sort of vesting period to end before they could make a withdrawal, or else they’d forfeit the company match. In such cases, the best they could do was to transfer whatever amounts were permitted to their personal RRSPs. This usually significantly reduced the excess fee buildup.
If Evan really can’t make any withdrawals before retirement, things become more difficult. Any contribution that sits in the group RRSP for more than 17.5 years loses all the company match anyway. So, the best Evan can do in this case is to invest in his personal RRSP until he thinks he’s 17.5 years away from retirement, and then start investing in the group RRSP. However, I’ve never heard of a group RRSP that is this restrictive. The solution of making occasional transfers to a personal RRSP without losing any employer match usually works well.
How much of a difference does it really make?
Suppose that over Evan’s 30-year career, stock returns beat inflation by 4% per year. Suppose further that if he had invested only in his personal RRSP, he would have ended up with $500,000 saved (inflation-adjusted to today’s dollars). In the group RRSP, he would have had $510,000. Even better, if he had invested in his personal RRSP for 12.5 years and then let that ride while all new contributions went to the group RRSP, Even would have ended up with $548,000. But, this still is a far cry from the $750,000 you’d hope for given the employer’s 50% match.
The real story is that if Evan had used the group RRSP for the whole 30 years, but had transferred amounts from the group RRSP to a personal RRSP every few years, his final portfolio value would have been over $700,000. This is a substantial win. The details in your case are unlikely to be the same as Evan’s, but what stays the same is the benefit of avoiding high fees.
Conclusion
The moral of this story is that it’s a good idea to take advantage of employer matching in group RRSPs, but if the investment choices are expensive compared to what you can get in a personal RRSP, you should consider transferring savings to your personal plan when your group RRSP allows you to do so without significant penalty.
Makes you wonder how much of the fees is kicked back to the employer. How do you explain why these plans haven't kept with the times and include ETF options
ReplyDeleteIt's certainly possible that in some cases there are kickbacks to the employer. I was fairly close to the decision-making on the introduction of a group RRSP at my last employer. The people making the decisions for the company did their best, but didn't seem to understand fees much. Their main focus was for the details of the plan to make the employees happy, and for it to run smoothly without much effort required by the company. The bank that ran it promised these things and even claimed that the investments choices were low cost. In reality they were very high cost, but not the worst available. I don't believe there were any kickbacks.
DeleteAnother possibility is to make sure that you don't stay with a company for more than 17.5 years. ;)
ReplyDeleteAlso, the math you propose only applies to the contribution made 17.5 years ago (or farther back). High MERs have not eaten up employer match on contributions in recent years. Nonetheless, the option to withdraw from the group RRSP on a regular basis does make sense.
Most group RRSPs allow employees to transfer assets from their personal RRSPs to the group plan (with the understanding that there will be no employer match on these extra funds). Some employees do this for convenience of having all assets in one plan. This works well when the group RRSP has low fees, but is a bad when fees are high.
DeleteIt's true that it takes longer before the company match of all contributions get consumed by excess fees (about 32 years in my example). The main point is that most people, including experts, seem to think that this point could never be reached, but this isn't true. The drag of fees accumulates tremendously over the decades.
DeleteAs a long time poster on your website, this has been a big pet peeve of mine. I lived through this, I kept pushing management to review exactly this situation, and finally was even made lead on our company pension committee I suggested. We had about 75 employees at the time.
ReplyDeleteNumber one advice is to shop around until you find a broker of record that is willing to give you the right fee structure because they are in fact very variable. I got ours down from those 2.5%+ (one was 2.9) to between 0.3 to 0.5%, except one real estate style fund was 0.7%. IA was the provider of the funds. Our broker chose good quality funds, and the returns were good. They conducted yearly reviews, and made changes if a fund was underperforming benchmarks for a long period. (which was very rare).
Another thing which gives a company leverage to get better rates is their accumulated AUM. When your getting up there in money managed by the provider, and you threaten to move it all elsewhere, you will be surprised at the motivation to reduce MER's that creates.
Anonymous above is correct by the way, the way they sneak these rates in is through unsuspecting well meaning high level employees that have no idea about the drag of the fees. These plans are typically coupled with health benefits so they offer "Management" that is in charge more perks on the health side "included" in the overall account". Private room, hospital stays, fully covered prescriptions and dental plans (even fully covered implants in our case), special LTD privilege's, etc., many added perks vs. general employees having less benefits, deductibles, and less coverage.
It's basically a veiled bribe for a small no. of employees that don't even realize they have screwed themselves with the fees.
Anyway Michael, have a good day.
Yes, AUM is the best leverage for lowering fees.
DeleteDC company pension funds work the same way except you are not allowed to transfer out until you quit the company. Charges are higher than ETFs but in (my experience) they offered a couple of Canada/US index funds with around 0.2% MER. The options were limited; it was through Sun Life.
ReplyDeleteMER of 0.2% is quite good. Over 25 years, that's about 5%.
DeleteYes, definitely worth having even though S&P500 is relatively expensive at 0.2%. Company contributed 4% of salary so not using this wasn’t smart.
DeleteThat said, being limited to a small bunch of segregated funds I wouldn’t normally buy was an irritant and added unnecessary complexity to the overall portfolio.
They also had a scheme subsidizing the purchase of company shares which was also “free money” but a bit painful in practical terms. Most people didn’t use it because they didn’t understand it. Their “pension” vehicle had a much better uptake because staff know that pensions are good.
My compensation at my last employer was complicated as well. Stock options, SARS, group RRSP, 11 different types of bonuses, and a weird spot award type thing where you could buy crap from a catalog. The only reason base pay mattered was because most of the other things scaled to base pay. I liked it as an incentive structure, but most employees just focused on base pay and a little on the group RRSP and one of the bonuses, so the company was mostly wasting money on all the other stuff.
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