401k 2.0 – A Proposal
The debate has been intensifying among regulators and within the industry. A year ago, the media carried obituaries to the 401k plan. Today, 401k plans have recovered, but remain under a cloud of a compliance morass, regulatory indecision and industry self-interest. It’s as though we’ve forgotten the real reason for our existence – the employee, the worker who seeks to live a comfortable retirement and the business owner who wants to attract the best staff.
The fiduciary has only one objective: Secure the beneficiary’s good will.
Service providers, government regulators and politicians seem to have forgotten this. This is not to say their actions are overtly malicious, it’s more like they’re just victims of their own public relations. They’ve created and embellished a bureaucratic monstrosity that, with each iteration, becomes further removed for the world of the investor. And with increasing complexity comes increasing apathy. Ironically, then, the very people who 401k plans were created to benefit have decided it’s easier to ignore the maze than to constructively participate.
How can we make the 401k simpler?
First, let’s take a look at the biggest issues facing the industry right now. They all fall under the rubric of “fiduciary liability.” In no particular order, we have: plan sponsors being held accountable for excessive fees, plan sponsors being held accountable for investment selections and plan sponsors being held accountable for increasingly intricate compliance requirements. Worse, each regulatory attempt to improve the standing of these issues only tightens the noose around the 401k plan sponsor’s neck without addressing the real needs of the plan investors.
Next, let’s consider why we find ourselves where we are today. Recall the era in which the 401k originated. Three decades ago, pensions ruled the world. These dinosaurs quietly (and rightfully) succumbed to a 1986 meteor and the more nimble 401k warmed the blood of the American worker ever since. But, back then, mutual funds barely existed. In fact, professional investors worried the number of mutual funds would exceed the number of actual stocks (roughly 9,000). Personal computers existed, but were hardly prominent outside the workplace. The internet? Unless you worked in the defense department or in academia, you would have had no idea what it was.
Today, retail investors regularly invest in any number of tens of thousands of mutual funds. They often do so through the internet. At home. On the family computer. Sometimes they personally invest through a broker platform (and pay for the privilege whether they realize it or not), sometimes they invest directly with fund (and save on the middle-man fees). Sometimes they invest by hiring a broker or an investment adviser (or an insurance agent or a banker or a…). They handle all their personal accounts this way, including personal taxable, trust and IRA accounts.
But not their 401k – ironically where the vast bulk of an individual’s investment assets reside.
Because thirty years ago, when 401k plans blossomed, today’s technology did not exist.
The laws and regulations promulgated in the 1980’s could not conceive of today’s investing environment. Many of the “problems” with 401k plans today exist only because of the mandated existence of intermediaries. Worse, instead of addressing the problem head on, regulators merely add more intermediaries.
Here’s an out-of-the-box suggestion: Why not eliminate the intermediaries?
Of course, to accept this, you’d have to believe people can act in their own interest. But, even if they don’t, wouldn’t be easier to solve that problem directly without involving the investor’s place of employment? After all, we don’t see the same type of complaints about IRAs that we see about 401k plans. I’m sure we can name if few if pressed, but the point is those same issues likely already exist in 401k plans, so let’s take care of one set of challenges at a time.
Finally, how do we make the 401k simpler without disrupting the whole industry?
In phases. We need to acknowledge that such changes will necessarily disrupt any current business model that relies taking pecuniary advantage of the various issues confronting 401k plans today. By definition, we want to eliminate those business models, but, let’s be charitable. Let’s give them a few years to unwind. That’s why we have phases. We’re not talking about eliminating the 401k, we’re talking about the natural evolution of the 401k plan – 401k 2.0.
Phase I (Immediate):
Existing Workers: Allow all 401k investors with more than $10,000 in their plans to roll over their 401k assets into a personal IRA. Employees with less than $10,000 would continue to stay within the 401k plan. Once assets have been rolled over, the next rollover won’t be allowed until the assets again exceed $10,000.
Reason: There’s no reason to continue to saddle plan sponsors with the fiduciary liability of maintaining a worker’s retirement assets and educating employee’s about investing for retirement. There are plenty of investment professionals more than willing to take on this liability and help educate their clients.
New Workers: In addition, change the automatic enrollment permissible investments by eliminating all balance options (including balanced portfolios and target date funds) and by putting all automatic enrollment assets into one value-based equity fund or one growth-based equity fund depending on the age demographics of the entire plan.
Reason: Clearly, the great Target Date Experiment has failed. In fact, although behavioral economics suggests opt-out (i.e., automatic enrollment) provisions offer the best way to encourage workers to save, the permitted investments aren’t geared correctly to (mostly) new workers. The original purpose of the rule was to discourage investors from using low return investment vehicles. Advocating balanced portfolios or target date funds mistakes the needs of new workers for older (or retired) workers. By using only equity-based funds for automatic enrollment assets, we’d recognize the original purpose. By allowing plan sponsors to choose between value (i.e., more conservative) and growth (i.e., more aggressive) equity funds recognizes the two long-standing disciplines of investment management. Finally, by making this choice a function of plan demographics, simple actuarial mathematics will direct the plan sponsor whether to use a value fund or a growth fund, further reducing the plan sponsor’s liability.
Grandfather Clause: Any existing automatic enrollments can stay in their existing fund for a period not exceeding the number of years that automatic enrollment option has been available within the fund.
Reason: A lot of money is in automatic enrollment options (like Target Date Funds) right now and to cut them cold turkey may disrupt markets.
Phase II (3 years):
Existing Workers: Employees will now be required to rollover all 401k assets in excess of $10,000 into a personal IRA Rollover account. Employees (who already have IRA Rollovers) now have the option to direct deposit all salary deferrals and employee matches into their IRA Rollover, therefore bypassing the use of the corporate 401k vehicle as a temporary holding bin.
Reason: Remember, we’re doing this in small easy-to-chew bites. We already have direct deposits for employee salaries, so why not for their retirement plans, too?
New Workers: Employees (who already have IRA Rollovers) now have the option to direct deposit all salary deferrals and employee matches into their IRA Rollover, therefore bypassing the use of the corporate 401k vehicle as a temporary holding bin.
Reason: Same as above.
Grandfather Clause: Any existing automatic enrollment options will have been replaced by the new options.
Reason: Three years ought to be enough for the market to absorb this shift.
Phase III (5 years):
Existing & New Workers: Employees will now be required to have the option to direct deposit all salary deferrals and employee matches into their personal IRA Rollover, therefore bypassing the use of the corporate 401k vehicle as a temporary holding bin.
Reason: This is the goal. Eliminate the fiduciary liability of plan sponsors with regard to the investments of the plan. In addition, employee’s retirement assets will no longer be subject to administrative and regulatory fees of the 401k plans.
There you have it. It may sound like other ideas, but, unlike those, the phased approach should help current service providers by giving them time to evolve their business model. Still, lots of folks will complain about 401k 2.0. ERISA consultants will complain because a lot of their work is being taken away from them. Accountants will complain because they no longer will have plans to audit. ERISA attorney will complain because there’s a lot less law to keep abreast of. Investment professionals catering to the 401k plan market will complain because they won’t have anyone to sell to anymore. Regulators will complain because their kingdom has been slashed in size.
Who won’t complain?
The honest fiduciary.
Of course, having said that, this proposal is, admittedly, a straw man. Please leave a comment telling our readers what you like about it, what you’d change and what you’d eliminate. Thanks!