Mike from Quest for Four Pillars shares his spreadsheet, which shows that it takes a long time for non-match RRSP with low-MER funds to catch up with a group RRSP with an employer match but offers only high-MER funds.
Last week’s post on a survey that indicated how a lot of employees who have the opportunity of getting an employee match on some of their retirement account contributions don’t take advantage of it attracted a few comments to the effect that if the mutual funds that were offered had a high MER (management expense ratio) then perhaps the matching contribution wasn’t such a great deal after all.
I decided to try and do a simple analysis (spreadsheet) to figure out if it was possible for high MER fund options to counteract the benefit of the free money contribution. I thought it was pretty unlikely that the money saved with low cost investments would make up for the free money but it’s good to run some numbers and make sure.
The scenario I choose is the extreme case where the employee who contributes to the company group retirement account (such as a RRSP or 401(k)) to get the match, cannot transfer their money to a low cost discount broker as long as they are still working at the company.
First of all – let’s look at the scenario:
One worker who starts off making $100,000 per year enrolls in the group plan and contributes $3,000 per year and gets a 100% match on 3% of salary per year. Unfortunately the average MER of the funds is 3.0%.
The second worker making the same starting salary, decides to invest in low cost index funds and he enjoys an average MER of 0.5%. This worker contributes the same $3,000 each year and does not get the matching 3% contribution.
Now let’s look at the multitude of assumptions:
- Gross rate of return of both investors is exactly 8.0%. If you believe that managed funds outperform index funds then read this.
- Net rate of return for the matching investor is 5% (8%-3%).
- Net rate of return for the non-matching investor is 7.5% (8% – 0.5%).
- All contributions including the company match are made on January 1 of each year.
- The contributions increases 3% each year.
- The investor who buys low cost index funds has his payroll tax reduced so they are making the same gross contribution as the matching investor.
- Both employees only contribute up the match amount (3%) and no more.
Results
The employee that invests in the account with the company matching contribution does much better than the employee who invests in low costs investments with no match.
At first the employee with the matching contribution does much better than the low expense investor (with no match) but later on when the difference in the portfolio expenses becomes larger than the matching contribution, the low cost investor starts catching up and surpasses the employee match investor in the 46th year.
Anybody here planning to work 46 years for one company? Anybody planning to work 46 years period?? I didn’t think so!
Other scenarios
What if you can do periodic transfers of your group retirement money, including matching contributions to a discount broker? In that case the cost savings of the matching investor would be decreased significantly and that would make the company match even more attractive.
What if the MERs of your employer investments are less than the 3% used in the example? Then the employer match account is even better than with the higher MER investments.
What if you contribute at a rate higher than the company matches for? i.e. the company matches 3% of your salary but you contribute 10%. In that case, the contribution that is getting matched (3%) gives you the same benefit as in my example. For the remaining 7%, there is no benefit to contributing it to your company employee plan unless it provides low cost investing options.
Summary
In most cases an employee will be far better off taking advantage of any kind of company matching contribution in their group retirement account regardless of the fees charged in the company plan and regardless of any transfer-out restrictions.
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