Employer Matching in Group RRSPs
My employer didn’t get much uptake when it first brought in an insurance company to offer a group RRSP because there was no employer matching. However, this has just changed. The question is how valuable is the employer match balanced against the high MERs on the pooled funds offered in the plan.
My new group RRSP plan is fairly generous: they match half of my contribution up to a maximum of 5% of my base pay. So, if I contribute 10% of my base pay, my employer will kick in another 5%. That’s the good part.
The bad part is that when I poked around in the investment options, the cheapest fees were on an index fund of Canadian stocks. The fees were listed as 1.401% per year (very high for an index fund). However, fee reporting on pooled funds is not the same as with mutual funds. As it happens, this percentage includes both the fund’s fees and the insurance company’s cut, but does not include HST or trading costs. I have no data on trading costs for this fund, but presumably it is very low on an index fund.
Comparing this fund’s fee (plus HST) to the MERs I pay on the ETFs in the rest of my portfolio plus commissions and spread costs, this group RRSP will cost me about 1.43% more per year than my ETF portfolio costs me.
Fortunately, the rules for this group RRSP permit me to transfer the account balance to my self-directed RRSP once per year without any extra charges. So, on average, my money will only sit in the expensive pooled fund for 6 months. The gap between the group RRSP fees and the fees in the rest of my portfolio is only about half of 1.43%, or 0.72%.
Enough with the percentages. Let talk dollars. Suppose my base pay is $100,000. Then my yearly contribution is $10,000, the company’s match is $5000, and the extra cost of 0.72% (on the whole $15,000) amounts to $108. So, the $15,000 contribution in the group RRSP gives me the same result as contributing $15,000 minus $108, or $14,892, to my ETF-based RRSP. To me, the employer match looks like $4892 rather than a full $5000. That’s still a very good deal for me.
But what would things look like if I had to leave the money in for 10 years before pulling it out of the group RRSP? In this case, money would stay in the expensive fund 10 times longer. The result is that the employer match would look like about $4000 per year instead of $5000.
With a more expensive group RRSP held for several decades, the higher fees would build up to the point where they consume the entire company match and more. It seems hard to believe that a small percentage like 2.5% could overwhelm a 50% company match, but it can. The reason is that the 50% is calculated only on the new contributions, but the 2.5% keeps hitting the entire account balance every year. After 30 years, the first month’s contribution has been bled by 2.5% 30 times!
The moral of this story is that free money from your employer is a good thing, but pay attention to fees.
My new group RRSP plan is fairly generous: they match half of my contribution up to a maximum of 5% of my base pay. So, if I contribute 10% of my base pay, my employer will kick in another 5%. That’s the good part.
The bad part is that when I poked around in the investment options, the cheapest fees were on an index fund of Canadian stocks. The fees were listed as 1.401% per year (very high for an index fund). However, fee reporting on pooled funds is not the same as with mutual funds. As it happens, this percentage includes both the fund’s fees and the insurance company’s cut, but does not include HST or trading costs. I have no data on trading costs for this fund, but presumably it is very low on an index fund.
Comparing this fund’s fee (plus HST) to the MERs I pay on the ETFs in the rest of my portfolio plus commissions and spread costs, this group RRSP will cost me about 1.43% more per year than my ETF portfolio costs me.
Fortunately, the rules for this group RRSP permit me to transfer the account balance to my self-directed RRSP once per year without any extra charges. So, on average, my money will only sit in the expensive pooled fund for 6 months. The gap between the group RRSP fees and the fees in the rest of my portfolio is only about half of 1.43%, or 0.72%.
Enough with the percentages. Let talk dollars. Suppose my base pay is $100,000. Then my yearly contribution is $10,000, the company’s match is $5000, and the extra cost of 0.72% (on the whole $15,000) amounts to $108. So, the $15,000 contribution in the group RRSP gives me the same result as contributing $15,000 minus $108, or $14,892, to my ETF-based RRSP. To me, the employer match looks like $4892 rather than a full $5000. That’s still a very good deal for me.
But what would things look like if I had to leave the money in for 10 years before pulling it out of the group RRSP? In this case, money would stay in the expensive fund 10 times longer. The result is that the employer match would look like about $4000 per year instead of $5000.
With a more expensive group RRSP held for several decades, the higher fees would build up to the point where they consume the entire company match and more. It seems hard to believe that a small percentage like 2.5% could overwhelm a 50% company match, but it can. The reason is that the 50% is calculated only on the new contributions, but the 2.5% keeps hitting the entire account balance every year. After 30 years, the first month’s contribution has been bled by 2.5% 30 times!
The moral of this story is that free money from your employer is a good thing, but pay attention to fees.
Though a conclusion is clear a valid, the math is a bit off to me: "on average, my money will only sit in the expensive pooled fund for 6 months" does not fit to $108 of annual excessive cost, which is fee for the whole amount for the whole year.
ReplyDelete@AnatoliN: The excess fees are 1.43% per year. This means that over 6 months, the excess fees would be only 0.72% of the (entire) amount ($15,000). If you prefer, you could think of it as 1.43% of half the amount ($7500), but you'll get the same result either way.
DeleteMy mistake. Have not checked all numbers.
DeleteFollowing your post I checked rates on the funds offered by my wife's employer's investment company (GWL) and found that they are well in line with what I can get on "free" market: Can Equity Index - 0.305%, US Eq Index - 0.306% and so on. Not all investment companies are vicious :) Probably this generosity has something to do with the fact that she works for a major, though barely known, financial institution in Ontario.
ReplyDelete@AnatoliN: You may have to dig to make sure that you're accounting for all the fees. In a savings plan I had many years ago, the reported fees on the pooled funds were very low, but they didn't include the fees added by the insurance company. The fee I reported includes the total of the fees charged by the insurance company and the fees charged by the underlying fund.
DeleteMy employer is with GWL too, and there are no options for index funds :(. All of our rates are in the 1.5%-2.5% range. And with no option to transfer out to an RRSP. Double :( And they only match up to a fixed $ amount. Triple :(
DeleteNeedless to say, I'm putting in the min to get employer matching, the rest goes in the RRSP / TFSA
Sorry, we are able to purchase a CAD Index fund, at 1.5% MER.
Delete@Paul T: Your situation doesn't sound very unusual, except for the inability to transfer out to your own RRSP. Those who run group plans discourage transfers out because it costs them income. This leads to such rules as only being allowed to transfer out once per year and administrative roadblocks. Disallowing transfers out entirely seems highly unusual.
DeleteIn my case transfers out of the plan are possible with termination of employment contract. At least this is what I was told by plan administrator.
DeleteAs to fees, GWL has several levels of those, the one I quotes seems to be the final - it includes both fund fee and investment company fee. I do not know how to confirm this with numbers.
@Michael, we can transfer out some. The way the program is setup, we contribute, company matches to a certain level $ for $. We can withdraw / transfer our own contributed funds at any time, but not the company's part. The real catch is if we do take our money out, we can't get the $ for $ matching in the next year, unless we put BACK any of our money we transferred out.
DeleteFor Example: I put in $100, the company matches $100. If I turn around and transfer to my RRSP, I can only take $100 I put in. The following year, I can only get another $100 matching by putting back the $100 I already took out, and contribute an additional $100.
The only out: We can withdraw / transfer all the funds when we are no longer working for the company. (including the employer portion).
So basically we're handcuffed on our part and the employers part.
@Paul T: That's an interesting form of disincentive to withdraw your savings. I'd say that it was a good way to encourage long-term savings except for the problem of excessive fees.
DeleteAnd that is exactly the intention of the company. But it (sort of) punishes the rest of us savers. In the grand scheme of things, we're pretty lucky to have any sort of incentive. DB > DC > nothing. And there seem to be a lot out there with nothing.
DeleteI have 1-1 matching, up to 5%.
ReplyDeleteFees are about 0.50% and has choice of all major index.
Can transfer out every year.
@Anonymous: This sounds like a good deal. As I said to AnatoliN in response to his second comment, be sure that you are seeing the total of both the plan administrator's fees and the fees of the underlying funds.
DeleteWatch the fees closely. One thing my co-worker noticed is that the returns they quoted (in chart form) were NOT net of fees. So be sure to ask the question if the returns quoted include the MER and other fees.
DeleteI tend to agree with some other posters: you aren't getting a very good offer from your employer. One of our DC plans had MERs all under .5% and there were no other fees. (Our employer picked them up as part of our benefits.) It was clear to see what the math was from the transaction history. Because the funds were index ones, you could compare the distributions we received with the return the various indexes had posted for the year.
ReplyDeleteEither I"m misunderstanding something (quite possible!) or your math is a wee bit misleading. If the MER+fees of the fund was 3.333% or 2.61% over the .72% MER to invest elsewhere, the entire first year matching contribution would be wiped out after 30 years. But it wouldn't be wiped out entirely for each of the matching contributions for the following 29 years. If I'm adding correctly, you'd still have about $72,000 more money invested after paying for the MER+fee differential entirely out of the employer contributions. While that's a lot less than the $150,000 you think you're getting from your employer over those 30 years, it's still a good chunk of change especially since in theory it will be earning some income over those 30 years.
Or did I just do that wrong? (quite possible!)
@Bet Crooks: I agree that there are far better plans. The Canadian part of my company is only a little over 100 people; we don't have much pricing power. However, it's also the case that many people simply don't know the full extent of the fees in their group plans. If yours has low fees, that's great.
DeleteI'm not sure I understand you, but let me try again. My group plan's fees are about 1.57% per year (after adding in the HST and accounting for compounding). This is about 1.43% per year more than I pay on my ETF portfolio (I pay only about 0.14%). The 0.72% figure is just half of 1.43% and was relevant to the discussion of money held for only 6 months.
For a more expensive plan with fees of 2.5% per year, the excess fee over my costs is about 2.36%. Over 30 years in the plan (or really 29.5 years, on average), the first year's contribution plus employee match of $15,000 is effectively reduced to $7415, which more than wipes out the company match. Subsequent years' contributions are harmed less. If we assume a real return of 4%/year (and assume that contributions grow with inflation), the final portfolio value for the group RRSP is $571,412 (inflation-adjusted). If the $10,000 had been invested in my ETF portfolio without a company match and had made the same real return of 4% per year, the final portfolio value is $571,956 (inflation-adjusted). We see that over 30 years, the entire 3 decades of company match has been consumed in excess fees.
I knew I was forgetting something! I forgot to apply the impact of the higher fees charged as a percentage of the *entire* growing portfolio against the match. Sorry about that! Next time I'll wait until my brain's working better before I try to do any math.
Delete@Bet Crooks: No worries. I'm always happy to have someone checking my math. You might be the one to catch me out next time. I'm too old to get defensive when I make mistakes. I just want to know the right answer.
DeleteMichael, would you share examples of your "0.14%" portfolio?
ReplyDelete@AnatoliN: I don't plan to reveal my exact portfolio mix -- people should spend time learning if they're going to be DIY investors. But to get an idea, just look at Vanguard ETFs in both Canada and the U.S.
DeleteI did not expect you to reveal the portfolio, indeed it takes a lot of efforts to create one. I was only hoping to hear some fund names ... and I've heard them. Thank you.
ReplyDeleteDo you have a post on comparison between ETFs and Index funds?
@AnatoliN: I don't recall writing a post specifically comparing ETF indexes to mutual fund indexes. I'm not aware of any truly low-cost index mutual funds in Canada. The best I know of are the TD e-series funds with MERs in the 0.5%/year range. In the U.S., Vanguard has many low-cost index ETFs, but they are not available to Canadians.
DeleteTD's e-series are now under 0.35%
Delete@AnatoliN: I just had a quick look at the e-series funds. Stock indexes for Canadian and U.S. stocks (without currency hedging) are 0.33% to 0.35%. All the rest (including the bond index) are 0.50%+ with most of them very close to 0.50% except for the managed funds which are far more expensive. So, the main funds that I'd consider using are now cheaper than 0.5%, as you said.
Delete