What should you do if your Vanguard 403(b) account is getting access to Admiral shares?

Workplace 403(b) retirement plans are, very roughly speaking, the non-profit and public sector’s answer to the 401(k) retirement plans offered by private companies. If your workplace 403(b) account is administered by Vanguard, you probably recently received a letter explaining some changes to your account. The most important changes are:

• a change in fee structure from a $15 annual fee per fund held in the account to a $60 annual fee regardless of the number of funds held;
• access to low-cost Admiral shares with no minimum investment requirement.

My understanding is the changes will go into effect in early November for plans affected by the change.

Why it matters

Previously, like 401(k) accounts held at Vanguard, 403(b) accounts only had access to higher-cost Investor shares. Combined with the per-fund fee, that meant many investors were best off investing in a single target retirement date fund or fixed-allocation LifeStrategy fund in order to pay as few per-fund fees as possible. Since those funds hold higher-cost Investor shares, they’re a bit more expensive than a 3-fund or 4-fund portfolio built with Admiral shares or Vanguard ETF’s, so many investors prefer to assemble lower-cost portfolios with those instruments in their personal accounts.

That wasn’t possible in 403(b) accounts until now.

Who wins?

There are two ways 403(b) participants might benefit from this change:

• People with balances below $50,000 who already held 4 or more funds with Admiral shares in their account by definition will save money after the changeover: they were paying $60 or more per year ($15 per fund) for higher-cost Investor shares. Now they’ll pay a flat $60, plus save money by paying lower expense ratios on each fund they hold, as long as it has Admiral shares.
• Anyone who held funds with Admiral shares that are sufficiently cheaper to offset any increase in annual fees. For example, if your only holding is Vanguard High-Yield Corporate Fund Investor Shares (hopefully as part of a diversified portfolio) you’re currently paying $15 plus a 0.23% expense ratio. Admiral shares have an expense ratio of 0.13%, so if your balance is over $45,000, you will pay less in combined annual fees and management fees after the changeover.

Who loses?

The biggest loser in this changeover is folks with over $50,000 held at Vanguard and who intend to remain in funds that do not offer lower-cost Admiral shares. Previously, having Flagship status with Vanguard waived their per-fund fee in 403(b) accounts, so folks with $50,000 or more in assets at Vanguard paid no annual fees no matter how many funds they held in their accounts.

Now, they’ll pay a flat $60 annual fee no matter how many funds they hold or how many assets they have with Vanguard. As explained above, folks who hold Admiral shares in their accounts will see an offsetting reduction in fund expense ratios. But target retirement date and LifeStrategy funds are popular as simple, one-and-done investment allocations, and neither kind of fund offers lower-cost Admiral shares. That means folks exclusively invested in those funds will be paying higher annual fees (unless they were invested in 4 different funds for some reason), but still won’t benefit from access to Admiral shares.

How to play it

I’ve laid out all of the above because of my unfortunately literal tendency, and the fact that money is one of the fews things in life that benefits from being taken literally. I think there are basically two ways a 403(b) participant can react to these changes:

• Do nothing. Remember, the absolute maximum you’ll be paying in additional annual fees is $45 per year, since you were already paying $15 per fund in your account. If you are holding funds that offer Admiral shares, you’ll see your Investor shares automatically converted and you’ll make back some of the additional fees in lower expense ratios. If you aren’t holding funds that offer Admiral shares, you’ll remain in your Investor shares and pay the higher annual fee without seeing any benefit. Obviously it doesn’t feel great to pay an extra $45 above what you were paying before, but that still only works out to what, four and a half bananas a year?
• Convert from a loser to a winner. If you are currently holding target retirement date, LifeStrategy, or other funds that don’t offer Admiral shares, you can convert your current holdings into an identical allocation to the individual funds, which do. So instead of $10,000 in a Lifestrategy Growth fund, you could move to $4,780 in Total Stock Market, $3,210 in Total International Stock, $1,410 in Total Bond Market, and $600 in Total International Bond, all of which offer Admiral shares. Then you’d also want to tell your 403(b) administrator to change your payroll contributions to reflect those ratios. Between once a year and once a quarter you’ll also want to log on and rebalance your account to reflect changes in the market value of those securities (I don’t see any benefit to rebalancing more often than quarterly. Don’t peek).

Finally, if you have other investments outside your workplace 403(b), you may benefit by being able to use Admiral shares to create a more appropriate overall asset allocation than you currently have. For example, if you previously held LifeStrategy or target retirement date funds in your 403(b), you may have struggled to appropriately allocate risk in your IRA’s and taxable accounts taking into account that fixed asset allocation.

Now, by holding the underlying securities, you can more finely tune your asset allocation across all your accounts. Of course, whether or not you actually benefit depends on how much time you want to spend micromanaging your investments!