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15 responses to “401k 2.0 – A Proposal”

  1. Nevinesq

    Wow, Chris – talk about creative destruction. I’m sure the IRA provider community is licking their chops at the prospect of all those retail IRA fees, but I am COMPLETELY unable to see this being good for retirement savings or retirement savers.

    We already know how people save outside of these workplace retirement plans. They don’t. I happen to think that employers add a lot of value to these programs – they contribute matches, lend oversight, permit wholesale buying/pricing, and basically encourage the entire process of saving for retirement.

    Taking them out of the equation would, IMHO, be an unmitigated disaster.

  2. Chris Johnson

    Sorry but this article is absurd and misinforming those who are not experts in pension design and administration. I am a top expert in the field. I’ve managed 17 pension plans (primarily 401k pensions) over 17 years, 4 of which have held over $1 billion and up to $3 billion in assets. To state that there is a cumulative advantage to IRAs over 401ks is absurd, at best naive, and more likely self-serving. First, the vastly lower investment management expenses charged to account holders by fund managers in large and mega-401ks. IRas do not offer privately manegd accounts, insitutional mutual funds and commingled funds that charge much lower fees to investors. The second key advantage is the fiduciary oversight given to these types of 401k plans that is untainted (in most cases) by conflicts of interests of financial service firms such as investment management firms or IRA providers. This oversight includes robust quarterly analysis to select, offer and maintain only top performing fund managers. Third, the quality of the educational campaigns and investment advice offered to employees and other plan participants which are offered free of conflicts of interest, and the tools and resources made available to participants far exceed the quality of IRA provider communications and advice that would be riddled with high fees and conflicts of interest. The list goes on, but I’ll stop there. To use words like “honest” in your article, your article and that word don’t belong together.

  3. Michele V.

    i think it’s great to have these conversations and hope we find a way to bring the entire 401k community into it. i also think we have to look at it from everyone’s perspective. It seems true that employers want these types of benefits to be more predictable and if they do not become more predictable, they likely will become more interested in moving away from these promises. But, clarity cannot mean an employer can buy any product and have no other responsibility. If we want employers to stay in the game, we should find ways to make the game clearer for them.

    Workers mainly want safe retirement investment options. They like winning, but not at the risk of losing. And that’s the real challenge. In a market of 10,000+ investments can folks agree on the elements of what a retirement product must contain. The rules can always be set up to permit the risk-takers to opt for other investments.

    The industry wants to make money. And everyone by and large wants to retire at some point. Social Security will not be enuf. Home equity has taken a hit. If 401k investments are to be the main supplement in retirement, they need to be prudently invested. Can the industry agree that retirement investments are held to a different standard than other investing?

  4. Alison Farrin

    Chris Johnson makes valid points that were also on my list. Three that he did not cover are 1. the need for participant education in the management of their individual IRA, 2. Vesting schedules on employer contributions that would require funds to stay in the 401(k) plan until fully vested, and 3. and MOST IMPORTANT from a fiducuary and administrative standpoint; What happens when the inevitable account error occurs? As a TPA, part of our service is the reconciliation of what was deferred to what was deposited. Every year, we move funds around at year end when the reconciliation reveals that participant A received participant B’s deferral. Now, in your scenario, participant A had those funds deposited directly to his IRA account. In the best tradition of Murphy’s Law, it will be Participant A that immediately removed the funds from his IRA because he wanted a new boat. The employer is not going to get the money back, so every employer error translates to an unintended employee bonus.

    From an investment standpoint, the great asset of a 401(k) plan is the multiple fund option at very little extra cost to the employee. For 50 basis points a year (plus the mutual fund fees – which are cheaper in my 401k than in my IRA) my financial advisor has the ability to day trade 1200 funds with no transaction cost. That is true if my 401k has a $1, $10,000 or $1,000,000 in it. A level playing field that benefits the small investor greatly. In an IRA, you are stuck with one fund family or $15 to $20 transaction fees every time you make a change. Personally, my 401(k) account was rebalanced to multiple different funds about 8 times in 2010. At $15 a transaction, 6 funds times 8 rebalances is 48 times $15 or $720 in transaction fees. That assumes I did it all myself and did not pay a financial advisor to fugure out what I should do. That would cost an additional 100 basis points, so for a hypothecital $10,000 investor (assuming that small an investor can find a financial advisor at all!) , his IRA just got very expensive.

    You want to fix 401(k)? Ditch all the stupid participant notices that no one reads. Deliver the SPD once a year and put the full fee disclosure in it, using third grade math. Auto default EVERYONE into the QDIA and let those who have the knowledge to make good decisions about their investments move their money out. Make the HCE limit the Maximum Comp limit and delete the Owner = HCE requirement. Now the only people you are penalizing and testing are those that we’ve all kind of identified as “wealthy” those earning over $250K a year. This will encourage employers to let everyone participate. Allow Employers to restrict Employer contributions to full time employees if they wish. Everybody else earning under $250K actually gets to save a lot for their retirement.

    The real percentage of saving required each year to maintain your working lifestyle in retirement approaches a 25% average annual savings rate. Since almost no one manages an even 25% every year, raising the DC annual contribution liimit and the deferral limit to $75,000 would also help. Remove the loan and hardship provisions from plans and require that distributions on termination in excess of $1000 roll to an IRA or new qualified plan.

    Now you have an easy to use retirement plan that you can only access at retirement, with minimal fiduciary liabiility.

  5. Alex Assaley

    Chris – While I have appreciated many of your previous blogs & commend your creative efforts to improve retirement savings for our workers, I believe you are WAY off the mark with this concept and dangerously naive in many of your assumptions.

    It is trued that there are considerable issues facing the retirement plan industry, however I actually believe that service providers and non-profit advocacy groups have made tremendous strides during the last several years to provide a system that protects plan participants and improves their benefits. There is no questions that many “problem plans” exist with high fees, unsuitable investment vehicles and poor fiduciary oversight, however the initiatives for full fee transparency, separation of recordkeeping / administrative costs from investment expenses, open platforms and fiduciary advice are all advancements that lead to the benefit of plan participants, when properly applied. And the fact is, it is much easier to apply these features today, than to phase into an individually managed arrangement that fails to address the overwhelming behavioral finance problems investors and plan participants face. With that said, the two primary problems (in my opinion) that retirement plans and their participants face, are the improving plans to today’s design and structure quickly enough (their are still many plans that still operate under some of the problems of 5, 10 years ago with high fees, wrap charges and reactive oversight), and, most importantly – getting participants to actually SAVE for retirement.

    The statistics on “undersaving” are staggering. the problem we face isn’ the 65 yr. old employee earning $60K per year who pays 1.5% in annual fees instead of 0.75% (sure this might be imprudent), it is the fact tha this participant only has $100K saved for retirement. And as Nevin put it so bluntly above, once you remove the employer’s onus to provide education, advice and method of automatic savings in the 401(k) – people do not save.

    With that, I think you statement that, “retail investors regularly invest on their own… handle all personal accounts directly through a fund or brokerage platform” to be a bit optimistic. Fact is, most investors are extremely confused on how to invest and what to invest-in and therefore the employer-sponsored arrangement provide a primary retirement tool with expectations of suitable investment options and access to education and advice. The number of sophisticated investors who actively manage their IRA and personal investment appropriately is the exception, not the vast majority.

    Just briefly, I think you fail to recognize some of the inherent transaction and maintenance costs of IRA rollover accounts that would additionally eat into retirement savings, including mutual fund ticket charges, individual position trading costs and annual maintenance fees. Also, who would be in charge of determining the IRA rollover custodian. Inevitably, participants are going to rely upon the employer to direct them to the appropraite custodian. Is this a fiduciary function? and would plan sponsors be responsible for negotiating the costs for custody and trading? I won’t get into detail on my concerns around this type of proposal opening up the swath of unscrupulous and fraudulent brokers and sales professionals that would sell to participants en masse the “next best investment vehicle” and saddle them with high commission or complex investments.

    One of the biggest (less the obvious) benefits of the 401(k) are the plan’s ability to protect participants and investors from themselves – eliminating emotional, untimely and ultimately poor decisions. Let’s work with plan sponsors – who have some working knowledge (in general, but agreed not always) of their fiduciary responsibility to provide these resources to participants in a vehicle that is worth while, as opposed to “throwing them to the wolves” to become active investors – something that has just not happened.

    Finally, outside of the Middle Class Task Forces automatic IRA initiative, there is no requirement to offer a retirement plan. Organization offer this as a “benefit” and while we can read articles about the strength of an employer match v. why employer matches don’t work, in the same day, I know firsthand across the tens of thousands participants we work with, that many have successful built a meaningful nest egg from this benefit and the objective advice that people like you, me and others have provided. Again, instead of pushing for participants to navigate the vast spectrum of financial service providers (including honest fiduciaries and ponzi scheme masterminds) on their own, let’s work with service providers, advocacy groups and the federal government to simplify our approach and provide the benefit to employees through the current framework that, not without its problems, has worked relatively well.

  6. Timothy R. Yee

    Many thanks for the thought-provoking comments, Chris, and my thanks to all of you who commented. I enjoyed following this thread.

    Rather than rehash, I would simply offer this: I know a financial advisor who sells all of his clients a variable annuity regardless of needs. I know an insurance agent who holds himself out to be a fiduciary and able to give advice when he is/ can do neither.

    By way of explanation, I also do offer variable annuities to clients depending on need and thus am very familiar with them. I also have my insurance license, and a Series 66 covering advice. I guess I am saying I have some background on which to base my comments.

    I can’t help but wonder whether 2.0 opens the door to more investor abuse.

    Again, my thanks.

  7. Nevinesq

    Chris, couple of followups on our earlier exchange:

    You say “…First and foremost, 401k plans will still exist, companies will still collect salary deferrals, companies will still match and companies will still over investment options for automatic enrollment. In other words, the existing savings mechanism will remain unchanged. As a result, there will still be a need for 401k service providers.”
    First and foremost, I don’t care about service providers, I care about employer sponsorship of 401(k) plans. Your proposal that, as I read it, basically sends any account > $10,000 out from under the auspices of employer/fiduciary oversight and into an IRA will, IMHO, bump employers out of the mix in just a few years. Why would an employer “bother” getting involved? How would payroll redirects to random IRAs be facilitated? Why would an employer kick in their $$ as a match on a program that will look/act/feel like an employee’s individual savings account? Your proposal – like the federal government’s recent mandatory IRA proposal – blithely assumes that employers will just play along. I don’t think they will.

    You say “As far as IRA providers licking their chops – they’ll do that with one side of their tongure and lick their wounds with the other side. Those same mutual fund companies that will benefit from the proliferation of 401k-IRAs will be hurt by the movement of assets out of the 401k side of their business. My guess is they’ll just transfer people from the losing department to the winning department but net employees will not be changed”.

    Again, my focus isn’t on the service provider side of the equation. IRA providers will lick their chops because of all the money your proposal will line their pockets – and the mutual fund companies will benefit as well…they probably won’t lose money (though I would argue that the larger, better-known companies will profit at the expense of those who manage to find their way onto 401(k) menus thanks to the diligence of that process) – they will GAIN revenue, because those IRAs with their smaller balances will be more likely to pay retail fees. So, they will make more money on the same investment. It’s a sweet deal for them – not for the participants.

    You say “Regarding “bulk fees,” I’m not sure of that advantage because we’ve been inundated with articles claiming the investment management fees are too high. As past Fiduciary News articles attest, the claim of “high fees” – particularly when it comes to investment choices – seems at most a red herring. Besides, any advantage of “bulk fees” will probably be more than overcome by the elimination of the administrative costs, which exist only because the plan exists and add no investment value to the investor. Additionally, by resolving the issue of the definition of fiduciary, many of the potential “high fee” problems you’re probably worrying about will go away.”

    I happen to be in the camp of thinking investment fees are too high – that all of us are overpaying for investment services while everyone’s attention is focused on those 12(b)1 revenue-sharing arrangements – a classic misdirect of worrying about the 20% while the 80% is treated as valid. As for the elimination of administrative costs – that’s in the 20%. The high fee I am worried about – monies paid for investment management – will only go higher.

    You say “Finally, to say this proposal would be an unmitigated disaster assumes the correct IRA structure is an unmitigated disaster. It appears, however, there are more complaints about the 401k side of things than on the IRA side, for what it’s worth.”

    I happen to believe that the complaints on the 401(k) side are a proof statement for the better environment of oversight, knowledge and protection afforded on that side. There is no collective sense on the IRA side, and no one but the individual investor to hold himself accountable. Of course, that’s a reason that employers might like the path – but that doesn’t mean it will be good for participant-savers.

    In sum, I found your proposal to be the kind that is generally flogged by personal finance writers and retail financial advisers – both of which want to tell you how to manage your money without the “impediment” of a qualified plan structure. I think it’s misguided, if well intentioned. Actually, I think it’s dangerous.

  8. Chad G.

    I won’t repeat many of the issues discussed here, but there are some simple points that seem to be fundamental:
    1) Sending $10k investors out to the IRA market is leading the sheep right into the wolves’ den. It would be a massacre. We see this often with brokers that will ‘manage their 401k for them.’ We see these ‘portfolios’ after the participants limp back from the relationship and see the complete lack of asset allocation (investment recipe) that exists. I won’t even get started on the windfall of profits this would bring to the mutual fund, insurance and broker market.
    2) From a behavioral finance standpoint, this makes zero sense. Like Nevin said, the vast majority of investors do NOT save outside of their plan, regardless of their honest intentions. The simplicity of automated savings in the 401k is a great thing, and we see its positive impact with thousands of employees for plans which have these automatic features baked in to their plan design.
    3) While being a plan fiduciary requires education and diligence by those with the responsibility, it is a challenge, but not a unsolvable problem. Many firms such as ourselves have served as fiduciaries from day one, and plan sponsors are seeking us out not out of fear of liability, but for the benefit of their participants. Enforcing higher standards for plan fiduciaries is not something trustees are fearful of, but instead realize that all participants (including themselves) will benefit from better processes for decision making, examination of applicable fees, plan design, and service options.
    4) And the ‘all equity fund’ option…as an asset allocation purist, I am unsure as to how to even respond to that one. Having absolutely NO vested interest in target date funds, I find arguments that while the asset allocations of some target date funds led many participants to a false sense of security in ’08, that does not mean they do not have a place in 401k plans. They are a tool for specific investors, and we all have learned a lot from ’08 which should lead to better evaluation of these tools for future market cycles.

  9. Paul Cronin

    Hi,

    My company helps people 50+ on personal transitions, we are not with in the transactional or financial consulting world, yet our clients do have these plans and concerns. As an individual investor who left corporate America some time ago, I love the freedom of my IRA, but to be honest, I think most workers actually want guaranteed income in retirement, not guaranteed assets. The reason is simple, most people can manage their expenses a lot better that their investments. History has shown that many workers under-save, so 401-k 2.0 would need to be mandatory, but maybe version 2.0 could include a rollover into guaranteed income. I believe the UK has something similar; long-term savings are rolled into annuities at retirement. If fees are an issue, we should mandate more clarity and make fund companies compete on value. Perhaps even allow “buying groups” or affinity groups of investors, much like insurance pools in the insurance P&C market. People would need clear plans to reach a savings goal, that would yield an income stream in retirement (ages 62, 65, 70, etc.). Over a typical 40-year working life, a person could roll certain funds into annuities (or similar products), to lock in some income streams every ten years or so. That might give them flexibility due to job change, marital status, family obligations, health, etc..

  10. Barnard Walsh

    Until a few years ago, I was able (as a one man shop with a par-timer) to administer a few 401(k) plans with a recordkeeper who maintained Particpants’ balances, exchanges, allocations, etc. through his “mainframe” with internet service. The testing and required notices and paperwork became so onerous that I had to get rid of the plans–let a bigger firm do it all….a firm with an administrator, a compliance officer,etc.

    In the qualified plan business since BEFORE ERISA, we were finally “done in” by the Pension Protection Act. Uncle Sam just makes it impossible and rediculous for one person and a part-timer to do it. So much for the Federal Government and its agencies helping smaller bussinesses.

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