How Do 401k Annuity Options Increase Plan Sponsor Fiduciary Liability?

(Part three in a three part series)

With much regret and sadness, we must report the very likelihood of a sudden impact with a brick wall. We’ll offer our best to warn, but, unfortunately, the speed at which some 401k plan sponsors are moving may be too fast to have enough braking room. Worse, as we enthusiastically beg these 401k plan sponsors to slow down their exposure to fiduciary liability, government regulators are actually encouraging them to step on the accelerator.

What is this awful omen and why is it critical when it comes to fiduciary liability? We’ll answer the last question first through the lens of metaphor.

Let’s talk about something no one wants to talk about: underage drinking between the years of eighteen and twenty-one. Why specify that age range? Because individuals at that age are considered adults. That means they can make their own decisions. Unfortunately, the age of maturity does not necessarily coincide with the age of wisdom, and people from the ages of eighteen and twenty-one often make wrong choices. It’s clear wrong choices often lead to unhappy consequences, but who should be held liable for such actions?

No one will disagree the legal responsibility of poor decision making should fall primarily upon the shoulders of the decision maker. But in the case of underage drinking, local laws will often hold the purveyor of said beverages accountable for the activities of the decision maker. The purveyor can be a bartender or a homeowner (even an absent homeowner). The fact is if you accidentally serve someone under the age twenty-one alcohol, you’ll be held just as liable as if you had knowingly served alcohol to someone under the age of twenty-one.

In this same sense, 401k plan sponsors have a fiduciary duty to help prevent employees from making poor investment decisions. Plan sponsors accomplish this in part through education. But there is a better way to prevent poor decision making: take the option right off the table by not offering it in the first place.

Which brings us to the aforementioned omen. In February, the IRS and the DOL inaugurated the permissibility of “longevity” annuities as options within retirement plans. Thus, in one press conference, sweeping away the main intent of the 2006 Pension Protection Act. If you recall, one of the priorities of the 2006 PPA was to discourage 401k investors from placing too much of their assets into stable income or guaranteed income funds. The lack of growth in those funds had eaten away at the long-term value of retirement assets. Now, we have come full circle.

There is one age demographic where this issue stands as most threatening: the young 401k investor. Unhappily, recent surveys indicate this very cohort seems to prefer to invest their retirement assets in guaranteed income funds rather than traditional growth funds. This concerns professional fiduciaries. “Young investors should invest for growth,” says Charles C. Scott of Pelleton Capital Management, Ltd. in Scottsdale, Arizona.

Similarly, Mathew Goldberg, President of Manhattan Wealth Management Group in New York City, says, “Young investors should invest their retirement assets in a diversified portfolio of equity based mutual funds and bonds that should be assessed and rebalanced regularly.” He’s concerned these surveys only prove retail investors are “counter-intuitive when it comes to investing.”

For young 401k investors, Roger Wohlner, CFP®, a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Illinois, believes there’s only one thing that really matters. He says “younger workers have the greatest retirement savings gift of all: time.” Anything else can distract them from making the correct decision. “Various studies have shown that the biggest determinant of the amount of retirement accumulation is the amount saved,” he says. “Beyond that, younger workers can afford to take more risk with their investments, and I generally suggest they do so.”

“Young investors should invest consistent with their time horizon,” says Nick Richtsmeier, Regional Vice President at Trilogy Financial Services in Denver, Colorado. Specifically, he says, “If they can tolerate risk, a balanced portfolio of asset classes that have historically outperformed inflation by a significant margin (primarily the stock market) is where they should be investing their retirement assets.”

But, with memories of the much lamented “lost” decade dancing in their heads, it appears young investors have let their emotions rule. “Most investors are loss averse – not necessarily risk averse, but definitely fear large losses,” says Courtenay Shipley of Shipley Capital Advisory in Nashville, Tennessee and Alexandria, Virginia. She explains, “After a particularly bad period in the market like we saw in the early 2000s (or even more recently), there’s a tendency for investors to pull back and go towards the guaranteed side.  Conversations with investors during both these times for me yielded a response similar to ‘I understand it might not grow enough and I probably won’t have enough to fully retire, but at least I’m not going to lose what little I have.’” Shipley says this demonstrates that recency matters, and, as a result, for young investors loss aversion is emphasized.

Are the contradictory demands of younger investors an indictment on the entire “everybody wins” self-esteem movement they grew up in? If this is the case, Richtsmeier thinks these investors might be in for a rude dose of reality. He says, “I don’t necessarily see young investors looking for guaranteed products as much as they have become increasingly risk-averse over the last five years. In the area of investments (much like in so much of their lives) they want to have their cake and eat it too. Most young investors ask me questions like: where can I get way better returns than the bank but I’m not going to lose a bunch of money and I’m not going to lock it up? The answer in this interest rate environment is: practically nowhere.”

Rich Winer, President and CEO of Winer Wealth Management in Woodland Hills, California, has witnessed this first-hand and blames lack of education. “I have seen teachers in their 20s and 30s with their retirement plans in money market funds or fixed annuities. In every case, they were inexperienced and unsophisticated investors, were never educated about investing and the financial markets and they were often sold inappropriate financial products. No wonder there’s a lack of trust in the financial services industry.”

For Shipley, “financial and investing literacy continues to be low in the country overall.” The 2006 PPA tried to get around financial illiteracy by attempting to nudge 401k investors into more appropriate long-term investment vehicles. As luck would have it, the 2006 PPA was implemented just as the market peaked and before the dramatic fall from 2007-2009.

Perhaps we should have guessed this would have been the outcome. “You cannot legislate financial know-how,” says Richtsmeier. “People will still be a product of the prevailing rhetoric,” he says, adding, “The content of that rhetoric has far more to do with general (not financial) media than it does with the regulations surrounding retirement plans.”

“Financial literacy in the U.S. is very low, and employers don’t make education available to their employees,” says Hilary Martin, a financial planner at The Family Wealth Consulting Group in San Jose, California. “Unfortunately,” she adds, “people don’t seek it out and don’t trust the evidence when they DO find it. It’s very sad.”

Seeking answers in legislation, regulation or even popular opinion surveys may just be a wild goose chase. But that doesn’t mean one possible answer isn’t staring at us square in the face. “Why would you take advice from anyone who isn’t an expert?” asks Martin. “If you want relationship advice, you should probably ask someone who is happily married,” she continues, “If you want brain surgery, you should probably talk to a brain surgeon. If you want investment advice—why in the world would you trust some sort of general survey?? No, you should ask an investments expert. I don’t care how old they are!”

In the end, maybe the best advice comes for this moment of self-reflection/self-definition offered by Timothy Yee, of Green Retirement Plans, Inc. Oakland, California. Yee says, “It is my role as an advisor to help investors – young and old.”

Until 401k plan sponsors can guarantee each and every employee can receive expert investment advice, it’s their fiduciary duty to help prevent employees from making poor investment decisions with their retirement investments. For younger employees, they may be old enough to make their own decisions, but they may not yet be wise enough to make the correct decisions. With this in mind, it might be safer in terms of fiduciary liability to limit menu options to clearly appropriate long-term investment. Plan sponsors should not serve what should not be drunk, lest they soon find themselves heading towards the brick wall of fiduciary liability.

Part I: Will Plan Sponsors Leave the Under 30 Crowd Doomed to Repeat 401k History?
Part II: Does Guaranteed Income Really Make Sense as a 401k Option?
Part III: How Do 401k Annuity Options Increase Plan Sponsor Fiduciary Liability?

Interested in learning more about this and other important topics confronting 401k fiduciaries? Explore Mr. Carosa’s new book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans.