Administrative Fees on Personal Retirement Accounts Can be Low

Commentary by Pete du Pont

President Bush's Social Security reform commission has completed its work. Rather than putting all its eggs in one basket, the commission has developed the broad strokes of three reform plans and will now leave it up to the administration and Congress to fill in the details.

While the commission did produce three different options, the general direction for saving the nation's retirement system is the same. Workers will be allowed to own and control a portion of their Social Security taxes - ranging from 2 to 3.5 percentage points - and invest it in the market through a personal retirement account (PRA).

As expected, the usual suspects have already come out of the woodwork to deride the commission's work. One of the most-used arrows in the critics' quivers is the charge that PRAs will be too expensive to manage, and low-income workers will be wiped out by oppressive administrative fees. This criticism is off the mark. With a little effort, we can devise a system that allows workers to harness the higher returns of the stock market while keeping administrative fees down.

First of all, it is important to note that the overriding drive to keep administrative costs low means Social Security PRAs - at least initially - won't be like a traditional 401(k) plan with all the bells, whistles and features that 401(k) account holders currently enjoy. Why is that so? We know that higher administrative costs are associated with giving investors more options, allowing them to modify account holdings often and providing constant, updated access to account balances. As a result, a Social Security PRA system that keeps account fees low will necessarily have fewer options than a traditional 401(k) plan.

For example, according to the Employee Benefit Research Institute (EBRI), the average 401(k) plan offers nine actively managed investment options. A PRA plan, on the other hand, would have few choices - possibly as few as one, at least initially. In addition, 401(k) plans typically allow investors to modify their contributions on a regular basis, while a PRA system would be more likely to allow these shifts only once a year.

Another factor in high administrative costs is the price of information. The cost commonly associated with a simple phone conversation with an investment house is $10 per conversation. 401(k) plans with higher administrative fees can afford to offer daily access to investors via phone or Internet, and can provide information updated on a daily basis. By contrast, a PRA plan most likely would initially only be able to offer an annual account statement and would be unable to offer personalized education and investment advice.

There are other steps the government could take to further protect the accounts of low-income workers or new investors with small balances. Small accounts could be pooled into large, generic funds until they hold enough money to move into investment funds with more options. Another provision that would aid low-income workers would be to implement a flat percentage administrative fee on all account balances. That way, lower-income workers with smaller accounts would pay smaller fees, relatively, than higher-wage workers.

If the PRA system is responsibly devised, then administrative fees will not be excessive. State Street Global Advisors, a private investment firm, estimates that accounts can be administered for about 0.18 to 0.34 percent of assets over the first five years. And the administrative costs for privately managed index funds average 0.19 percent.

There are many issues to be resolved that will affect administrative costs. Among them: How many options will investors have? How will benefits be paid out at retirement? How will employers make contributions to employees' accounts? The sheer number of accounts will magnify all these difficulties. After all, according to EBRI, a national system of PRAs with full participation would have at least seven times the number of currently active 401(k) accounts. Add to that the fact that many companies don't use automatic payroll systems or direct deposit, which will make it even more difficult to administer PRAs.

There's no question we have quite a challenge ahead, but that doesn't mean we should shy away from it. After all, none of it compares to the draconian measures we'll have to undertake if we don't act.

Just remember this as the debate heats up in Congress next year: With a little foresight and planning, we can devise a PRA system that protects investors' accounts - especially those of low-income workers - and that also allows investors to reap the rewards of the higher returns provided by the markets.