Monday, December 05, 2005

SIMPLE IRA Transfers

As the year ends, I am about to execute my annual trustee-to-trustee exchange of assets in my SIMPLE-IRA to my personal Traditional IRA. (Once one has participated in an employer’s SIMPLE plan for two years, dated from the time of the first deposit into the plan, the IRS grants the right to transfer the funds accumulating in the SIMPLE IRA to a Traditional IRA.)

An examination of the investment options and the costs involved in the funds available in my employer’s SIMPLE IRA, will I hope, make my annual exchanges understandable. The SIMPLE IRA is invested with AIM, a load fund group, who we should recall, has been prosecuted in the recent market timing scandals. I invest my salary deferrals and employer matches in the only no-load offering made available by this fund complex: the money market fund.

The SEC mandated mutual fund cost statement will help us examine the logic behind my transfers. The appropriate cost comparison metric is the tabulation of fund costs assuming a hypothetical 5% return. This enables an apples-to-apples cost comparison between funds. A

The AIM money fund has a dollar cost (assuming 5% growth) of 5.11/thousand. This compares to the 1.53/thousand cost of a Vanguard money market fund. While a 3.58 dollar return differential may not appear very significant for a thousand dollar investment, the telling statistic comes when we apply the costs to my invested capital value. With AIM, my current annual cost would siphon 127.75 dollars from the fund’s returns, as opposed to the 38.25 dollars a Vanguard money market fund would cost. It is important to realize that this cost differential is a single annual figure and that the cost differential increases and compounds over time as invested capital increases. John Bogle refers to this process as the "tyranny of compounding costs.”

I hold the AIM money fund for minimizing transfer costs. A more accurate comparison of plan costs would be to apply the cost comparison to the asset class I ultimately select for these dollars, namely inflation indexed treasuries, implemented with Vanguard’s Inflation Protected Bond Fund. AIM does not have an inflation bond fund, but they do offer an intermediate government bond fund which would be the closest comparable asset class I would be using if I were forced to invest in the AIM SIMPLE.

The AIM bond fund is a load fund. Class A shares can be bought with a 4.75% front end load, and a 1.19% annual expense ratio; or alternately, one can invest in Class C shares, which have no upfront load, but which carry a 1.94% annual expense loading. The Vanguard fund is no-load and sports an annual expense ratio of .17%.

The following table reveals the dollar expense loadings for these three alternative investments. The first column shows the annual dollar cost per one thousand dollars; the second column shows the annual costs on accumulated capital. These costs do not include the front load commissions on A Shares.

Fund Cost Comparison
Fund Expense @5% Growth
Cost on Cumulative Investment

Vanguard
0.76
19.00

AIM Class A
6.30
157.87
AIM Class C
10.04
251.00

A clearer focus on cumulative cost loadings can be seen by examining the annual costs of each option as funds are annually invested.

Fund Cost Comparison
Year
Vanguard Expenses AIM Class C Expenses AIM Class A CommissionsAIM Class A Expenses
Year One
4.94
65.28
308.75
40.99
Year Two
9.88
130.52
308.75
81.97

Year Three
14.44
190.76
308.75
119.80

Year Four
19.00
251.00
308.75 162.63
Cumulative
48.26
637.54
1235.00
405.39



The above cost analysis should render the rationale behind executing trustee-to-trustee transfers readily apparent.

A procedural note: while both institutions involved in a transfer should be queried on correct transfer procedures, I have found that mutual fund groups, most of which are engaged in asset gathering, facilitate transfers with relative ease. In my case, I fill out a Vanguard transfer request form, notating on the form that the transfer involves a SIMPLE IRA, and include a copy of a quarterly statement from the AIM SIMPLE plan. Vanguard then executes the trustee-to-trustee transfer.

The bottom line: All employees investing in a SIMPLE IRA should closely examine the costs and investment options available in the employer selected fiduciary, and if the fiduciary is found wanting, take the initiative to execute transfers to an individually held Traditional IRA with a fiduciary of the employee’s choosing (assuming one has passed the two year holding requirement.)

2 comments:

Ryan said...

Interesting breakdown between the costs of each funds. My employer just recently introduced a SIMPLE IRA and before that I'd only done the low cost index fund with Vanguard. Thanks for laying this out.

Ryan @ Planting Dollars

George said...

Simple IRA’s permit participant tax delay flexible employer contributions and minimal paper work and tax filing. For plan participants, simple IRA’s provide creditor protection at both the central and state levels.