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Schwab Forges Index Trail for Retirement


Charles Schwab's Retirement Plan Services unit in January made waves by going passive.

The business, which acts as a 401(k) plan provider to some 1.5 million participants, launched Schwab Index Advantage, which allows participants to invest in mutual funds and exchange-traded funds that mimic the performance of a specified index.

Schwab touted as "a one-of-a-kind 401k plan offer designed to lower costs, simplify investing and help workers better prepare for retirement."

What's The Catch?

The plan helps drive costs down by employing index mutual funds from Schwab and other larger fund providers, according to Schwab.

These have relatively low operating expenses compared to actively managed mutual funds found in most 401k plans, because managers don't have to try and outperform benchmarks.

The plan also includes an independent advisory service, managed by GuidedChoice Asset Management, and an interest-bearing, federally-insured savings feature through Schwab Bank.

All in, the combination of index fund-based portfolios with an independent investment advisory service will cost plans 65 basis points to 70 basis points of assets under management each year, or about 25 basis points less than what an average mutual-fund-based 401(k) plan costs, according to data provided by the company.

"Through such low-cost investments, fund operating expenses could be cut significantly,'' said Steve Anderson, head of retirement plan services at Charles Schwab. "For the average worker in a 401k plan, that can mean nearly $115,000 more at retirement."

Schwab's initiative is also ahead of the Department of Labor's long-awaited final rule on 401(k) fee disclosures, rule 408(b)(2), which has been extended three months to July 1. On a conference call with reporters in February, Phyllis Borzi, assistant secretary of the department's Employee Benefits Security Administration, warned that service providers such as Schwab not in compliance as of July 1 will be in violation of Employee Retirement Income Security Act rules on prohibited transactions. They could be subject to penalties under the Internal Revenue Code.

At launch time, Jim McCool, executive vice president and head of Institutional Services at Schwab, urged plan sponsors to "rethink the 401k plan and pay closer attention to workers who, now more than ever, are worried about their retirement savings".

Sounds like a good deal for everyone involved? Let's look at the fine print. According to the firm's marketing materials, at the plan sponsor's direction, the plan can also include a self-directed brokerage feature, dubbed the Schwab Personal Choice Retirement Account. However, the product requires that plan sponsor select three proprietary Schwab funds including large cap blend, small cap blend, and foreign large cap blend, as part of the five required asset classes in the plan's fund lineup. Sponsors are also required to buy the Federal Deposit Insurance Corporation -insured deposit feature.

Sponsors On The Sideline

According to CEO Walt Bettinger, several hundred clients have expressed interest in the program, and 10-12 have committed to it so far. "We expect that to continue to accelerate very rapidly," he said, during Schwab's interim business update on April 26.

"It's very attractive to fiduciaries, relative to trying to select actively managed funds, because it uses all indexed products. For participants, in my opinion, it delivers a better experience [in terms of] lower costs and advice for them far more customized that a blend of instruments like target-date funds that only look at participants' age and treat every participant exactly the same."

The San Francisco-based firm is also planning to launch a version of Schwab Index Advantage that will use only index-based exchange-traded funds in 2013. Eric Hazard, a spokesman for the firm, said Schwab is building out its own recordkeeping platform for both the Index Advantage and the ETF plans.

But are sponsors looking to jump on the either index-based plans just yet? Brenda Biggers, Manager, Retirement and Leave Programs at Stock Building Supply 401k Savings Plan, said: "This is something that is not on our radar." Building Supply's $188 million plan currently serves some 4,300 participants and is administered by Prudential.

A current Schwab plan sponsor client, which manages some $41 million in 401(k) assets for some 980 participants, said that its investment committee "is always reviewing funds but at the moment, there are no immediate plans to add any new funds to the line-up."

On the advisor front, one industry executive said there are still a lot of advisors who don't like index funds because "they don't do anything; it's robot investing." He said that Schwab's rendering of active managers useless by making advice the most important aspect in 401(k) plans is a road less traveled because "you can't bypass the advisor community or investment consultants."

Overall, ETFs aren't prevalent in 401(k) plans, according to Jeanne Thompson, vice president of retirement insights at Fidelity, the largest 401(k) plan administrator currently serving some 12 million participants. "There has been a lot of noise about it but not a growing demand," she said, in an interview.