The Most Compelling Challenges in 401k Education
(This article is part of a series of articles addressing education for 401k participants and trustees.)
According to the Profit Sharing Corporation of America’s most recent Annual Survey of Profit Sharing and 401k Plans, nearly one in four eligible employees do not contribute to their 401k plan. It’s hard to believe 25% of American workers are independently wealthy, but that’s pretty much the only reason they shouldn’t be actively contributing to their company’s 401k plan. In addition, the survey also reveals only 63% of the assets are invested in equities. In terms of old school financial planning, this implies the average age of all participants is 63 years old, another doubtful conclusion.
How can something so right be so terribly ignored?
The problem can start right at the top. “If the plan sponsor says it’s not important, it’s awfully hard to convince them otherwise,” says Courtenay Shipley, President of Shipley Capital Advisory in Nashville, Tennessee. “You might be able to explain that it’s the “right” thing to do, it helps with limiting their liability, or it’s in their best interest for employee morale-building and attracting and retaining employees theoretically. But, it’s not required by ERISA,” she continues.
How do you convince a reluctant plan sponsor of the importance of education? “Show them a sample from the many studies illustrating the abysmal state of financial literacy among adults,” says Duane Thompson, Senior Policy Analyst at fi360 in Pittsburg, Pennsylvania. Thompson agrees with Shipley when he says, “if they have a strong interest in reducing employee turnover, this is one of the ways to differentiate themselves from other employers. Of course,” he adds, “in the current economic climate, employee turnover is probably not a big problem.”
Thompson’s insistence and going the financial literacy route has its merits given it appeal to the fiduciary duty of the 401k plan sponsor. “If a plan sponsor knows most of her employees do not have enough basic knowledge to begin being successful – and decides to skip education – is that decision in the best interest of participants?” says Dennis Ackley, President of Ackley Associates in Lees Summit, Missouri.
Once the plan sponsor overcomes the threshold of reluctance regarding education, things don’t get any easier. The first challenge is to determine the right syllabus. “In the early 1980s,” says Ackley, “many supplemental savings plans were renamed ‘401k retirement plans.’ To support these plans, mutual fund sales materials were modified and also renamed – ‘retirement education.’ No adult-education experts were involved, no pilot testing was done and no successful education programs were used as models. That’s how it started. That’s how it stayed.”
The second challenge is finding the proper teacher to discuss savings and investing. James Watkins, III, CEO/Managing Member at InvestSense, LLC in Atlanta, Georgia says, “Unfortunately, most 401k education programs I’ve reviewed have presented by employees of service providers whose conflicts of interest prevent both proper disclosure of and education on such topics.” Watkins feels investment discussions fall prey to a generic cookie-cutter approach. “Most education plans I have reviewed just parade a bunch of meaningless, multi-color pie charts before plan participants and say ‘pick one,’ with little, if any, explanation of the importance of using correlation of returns to reduce overall portfolio volatility,” he says. He also worries the issue of fees isn’t framed properly. “Again,” says Watkins, “based on my experience, this information is not discussed. At best, the education program simply advises participants to try to reduce costs. Again, the participants lose in the battle of best interests.”
Even if the plan sponsor finds the perfect teacher, a 401k education program can fall victim to common misconceptions employees have about their 401k plan? Worse, as Steven Kaye, President of American Economic Planning Group, Inc. in Warren, New Jersey points out, these misconceptions can infect even the highest levels of the company. Kaye says the most common misconceptions of plan sponsors include “their responsibilities as a sponsor, as fiduciaries, embedded costs, their potential liabilities, committee expectations, focus of DOL audits and how much more education participants need.”
Thompson adds a further worry. “Some small plan sponsors have the impression they are getting administrative services for free,” he says. Fortunately, the DOL’s new Fee Disclosure Rule might address that. Thompson says “When 408(b)2 disclosure kicks in mid-summer, that impression will change.”
At the employee level, the greatest misconception is ignoring the need to save for retirement. Even those who do participate in their 401k plan often do not contribute enough to secure an adequate retirement, although they’re quick to ask advice on how much to defer “Most financial pros say it’s 17% – if employees wait to age 45 to save,” says Ackley. “The Center for Retirement Research says it’s 31%. Obviously, contributing for a future income could be one of the most difficult financial efforts employees will ever make. The inconvenient truth about 401ks is that employees must be personally motivated to learn how to use the plan and to take the difficult steps to fund their account.”
What can be done to help employees and plan trustees “unlearn” common investment mistakes and illusions?
“We insist on trustee education and bring in an ERISA attorney every 2 to 5 years depending on the client,” says Kaye. “For the participants we offer one-on-ones (free half hour consultations) with CPF® professionals who are IAR’s (fiduciaries).
Watkins believes it’s important to address the problem of di-worse-ification. “I think the biggest ‘unlearn’ 401k educators face is getting plan participants and trustees to think of diversification in terms of ‘effective’ diversification,” he says. Watkins would prefer investors looks at “reducing portfolio volatility through the use of correlation of returns, instead of the commonly held perception of diversification in terms of just the number and the classification of investments in the portfolio.”
On the opposite end, we have investors, frightened by recent news, fleeing the market at just the wrong time. Thompson would “point to the huge market downturn in 2008, and rebound six months later.” He says “it probably wasn’t pretty, looking at year-end statements for either year, but if you panicked and left the market before March 2009, you missed a huge opportunity to recover a significant part of your losses.” More generally, Thompson thinks an overactive investor does not serve himself well. As an example, he would point out “the huge gap between overall mutual fund performances and that of investors making market-timing mistakes by chasing returns.”
If employees should chase returns, what should employees chase? A practical goal-oriented target focused on the investor’s precise retirement needs might be a better alternative. Why don’t we see education programs emphasizing goal-oriented targets? “One reason,” says Ackley, “is the old mutual fund presentations and supplemental thrift plans – the framework of 401ks – never focused on account targets.” He says “don’t employees need to discover that a $100,000 account is likely to generate less than $400 a month in future income. Isn’t it best to know this at age 25 – not 65?”
Ackley cannot contain his passion on this issue. He continues “Show them if they had $100,000 at age 65 and they wanted it to last 25 years, say to age 90, they can get a realistic idea of the annual income by dividing 25 into $100,000. How much is that a month? Is this advice or just grade-school math? Is it something employees need to know to help them get a good start? I realize I’ve ignored inflation, investments and a host of other things. But we’re just getting started. And shouldn’t the key question be, ‘Is this realistic and understandable?’ not ‘Is this precise?’ We need more 35-year-olds – and fewer 65-year olds – with $50,000 401k accounts.”
“For beginners,” he says, “I believe we need to focus more on contributing and much less on investing. Certainly, investing is important…but it should come in the second phase of the education.”
Finally, what happens when an employee mentions he has a personal adviser that offers conflicting advice? Thompson has yet to see specific examples of this. “My sense is this happens rarely, since the vast majority of plan participants do not have a personal advisor, and most plans have not yet begun to offer advice under the new fiduciary adviser safe harbor,” he says.
But such a conflict will eventually occur if it hasn’t already. “One best practice is to encourage participants to use outside advisors (and educate the difference between a sales relationship and a fiduciary relationship and to check credentials – registered rep vs. registered advisor) and stress that the plan education is general concepts and not customized to the individual … and everyone is different,” says Kaye.
Ackley doesn’t fear this potential conflict. In fact, it appears he invites it. “Actually, I think it’s fine,” he says. “It reinforces what I believe they should be discovering – there is no single-right answer and no risk-free future. Hiding risks is a left-over idea from a paternalist past. It’s unfair to allow employees to believe they can find a precise, correct number and a risk-free approach. The Society of Actuaries has a list of a couple dozen serious risks – any one of them could derail a person’s retirement.”
Now that we’ve identified some obstacles, the obvious question is how do we overcome them to create a successful 401k education program. The answer lies in our final installment of this series.
Part I: The 4 Critical Elements of a Successful 401k Plan Education Program
Part II: The Primary Objective of a Successful 401k Education Program
Part III: The Most Compelling Challenges in 401k Education
Part IV: Successful 401k Education Programs – Does Yours Measure up?