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Three’s A Crowd Regarding IRA Rollovers

By W. Andrew Larson, CPC

The Securities and Exchange Commission (SEC) finalized new rules (known as Regulation Best Interest or Reg. BI) that address, in part, IRA rollovers for broker-dealers.  This commentator questions the wisdom of inserting now a third governmental agency into the retirement space, which, historically, was overseen by the IRS and Department of Labor (DOL). It seems that if Congress had wanted the SEC in this regulatory mix it would have said so in the first place. I wonder if the SEC has such ample resources it feels impelled to expand their regulatory purview or if, perhaps, this is an attempt to obtain additional funding for these new endeavors.

Under Reg. BI, broker-dealers are held to a best interest standard when making a recommendation to a retail customer. In this context, a “retail customer” does not include a plan sponsor, but it does include plan participants with regard to recommendations to take distributions or roll over assets to IRAs. Arguably, advisors are required to demonstrate how they arrived at a best interest finding and recommendation. Effectively, this regulation is a watered-down version of the vacated DOL fiduciary rules and, while the objective of protecting consumers is admirable, my concern is the propriety of injecting another federal agency into the arena of Employee Retirement Income Security Act (ERISA) enforcement.

The General Obligation of Reg. BI has four components:

  • Disclosure of the relationship and fees (Disclosure Obligation);
  • Duty of care (Care Obligation),
  • Mitigation and disclosure of conflicts (Conflicts of Interest Obligation); and
  • Establishment, maintenance and enforcement of policies and procedures (Compliance Obligation).

The SEC has noted certain considerations are not considered determinative in and of themselves to warrant a rollover recommendation. For example, having more investment elections available within an IRA vis a vis the qualified plan is not considered enough rationale to conclude a rollover would be in the best interest of the investor according to the SEC.

Factors to consider when contemplating a rollover should include items such as, but not limited to, the following:

  • Fees and expenses;
  • Level of service available;
  • Availability of retirement income products and other investment options;
  • Ability to take penalty free withdrawals;
  • Protections from creditors and legal judgments;
  • Administrative convenience;
  • Beneficiary considerations (some qualified plans don’t allow the full range of beneficiary options permitted under statute);
  • Availability of net unrealized appreciation (NUA) opportunities with employer stock,
  • After-tax contributions and the potential for Roth conversions;
  • Required minimum distribution (RMD) requirements (e.g., Designated Roth accounts in 401(k) plans remain subject to RMD requirements); and
  • Any special features of the existing account.

Ultimately, I believe Reg. BI will result in a more nuanced IRA rollover recommendation process where “all or nothing” rollover events will become less common. Future recommendations involving plan distributions and rollovers will require advisors to have a greater understanding of their customers’ retirement plans, and the options and choices among the various money types within the plans. For example, 401(k) arrangements are highly variable by sponsor, each having multiple money types, features and provisions. Clearly, the first step in the Duty of Care process is having a thorough understanding of the distributing plan’s applicable provisions and features, and securing documentation that would support the basis for making any recommendations. But sources for detailed plan information are limited.

Retirement Learning Center (RLC) has a library of over 6,000 plan documents it has analyzed and summarized as “Plan Snapshots,” which can give advisors important plan information necessary to feed the Duty of Care process. Use of RLC’s plan information not only saves time but can be part of the crucial documentation necessary to support a recommendation.

With oversight from the IRS, DOL and now SEC, the rollover landscape is changing and will result in advisors taking a more subtle, thoughtful and documented approach with investors when recommending retirement plan distributions and rollovers.

 

© Copyright 2019 Retirement Learning Center, all rights reserved
Governance
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What is plan governance?

What is plan governance?

By W. Andrew Larson, CPC

It is our view that the goal of retirement plan governance is two-fold. First, plan governance should ensure that a business’s retirement plan is operated in compliance with Federal laws and regulations.  Second, plan governance should position participants to maximize their chances for successful retirement outcomes. That’s what plan governance should do.  But what is plan governance? Plan governance is a consistent, flexible, ongoing process that is well documented and transparent. This blog will explore, at a high level, what a plan governance process looks like; the make-up and role of the plan governance team; how to deal with service providers; and what it means to be a good consumer of fiduciary services.

No one aspect of plan governance is inordinately difficult; what is difficult is the ability to remain focused, and consistently execute and document the governance process. Typically, plan committee members have day jobs and their plan duties are usually far down on their to-do lists. Given this reality, committee members must diligently help each other create and follow accountability strategies, plus leverage service providers for assistance when needed.

What does a plan governance process look like?

A good governance process includes the following key elements.

Charter

The charter is the blueprint for what is done when and by whom with respect to the retirement plan. Many plans don’t have governance charters. Creating one is essential for establishing a good governance process. The charter addresses details such as who is on the plan committee, the frequency of committee meetings, roles, assignments and expectations, lines of authority and decision-making responsibilities.

The first step in creating the charter is a careful review of the governing plan document to ensure the charter is consistent with the plan in terms of provisions, terminology, lines of authority and reporting. Frequently, any governance provisions that may appear in plan documents are sparse; hence the need for a more robust document in the form of a charter. That said, the charter must be consistent with the plan document or the committee risks not following the terms of the plan, which would be a violation of legal requirements under the Employee Retirement Income Security Act of 1974 (ERISA).

Master Calendar

A master calendar is the plan committee’s essential “must-do” list. It is an important tool to make sure the committee is timely addressing its responsibilities. Standing annual calendar items can include the following items:

    • Review the plan document for needed amendments;
    • Review and assess service providers;
    • Benchmark and evaluate assets;
    • Schedule educational sessions for committee members;
    • Assess the adequacy of the plan’s fidelity bond; and
    • Evaluate committee members based on skill sets needed.

Documentation Protocol

Having detailed documentation of plan committee activity and decisions is a vital part of any liability containment strategy. Plan notes should be thorough and identify the rationale for key decisions made.

Payroll Log

This is a record of all payroll withholding and remission dates and amounts. One of the top concerns of the Department of Labor and IRS in plan operations relates to the timely deposit of employee salary deferrals.

Who’s on the plan governance team?

The make-up of the plan governance committee is one of the least discussed aspects in the realm of plan governance. And it often seems that committee membership comes with lifelong tenure. As we work with committees, we frequently inquire why “so and so” is on the committee. The typical response is something to the effect of “Well, they’ve always been on the committee.” We urge committees to conduct a periodic reset exercise where they identify the skill sets needed for a successful committee. Once the skills are identified, we then ask them to identify specific individuals—including those who may not be current committee members—who fit the skill set profile. This creates discussion of who could or should be on the committee.

It has been our experience that we often find the wrong people on plan governance committees. In many cases, there are people within the organization who want to be on the committee—and should be—but are not considered for membership. Let me share a personal experience illustrating this. I was on the plan governance committee of a former employer. Most decisions we made were second guessed and challenged by one particular noncommittee member employee. This guy read every bit of plan information that was provided. Not only did he read it, he studied it and complained about everything. He was a pain in our rear. However, it became clear this guy had a passion for plan stuff and a real willingness to study, learn, understand and question. He was “the guy” other employees sought out if they had plan questions. We began to discuss adding him to the committee. At first there was considerable pushback because he had been such a nuisance, but it was clear he did his homework and took the subject matter seriously. We added him to the committee on an interim basis, despite some trepidation. Now the end of the story—he became the hardest working and, arguably, the most educated and dedicated committee member. He wanted to do the legwork, was willing to be a team player and, ultimately, was the biggest fan of the plan and supporter of its governance team.

What does the team or committee need to know?

The short answer to this question is the plan governance team must know enough to successfully run the plan. ERISA requires plan committee members be held to an expert standard in terms of their decision making with respect to the plan. This does not mean the committee members have to be expert in all topics, but they need to understand what they don’t know and when they need to enlist additional, expert-level support to make prudent decisions. At a minimum, committee members need a general understanding of the following tenets:

  • ERISA governance requirements;
  • Key plan document provisions;
  • Service providers duties, costs and contractual expectations; and
  • Reporting and compliance requirements.

Understanding what plan service providers do and don’t do is commonly a mystery to many plan committees. More service provider training and understanding is a common recommendation we make to plan committees.

Why are we hiring a fiduciary?

In recent years, many organizations have begun to offer various fiduciary services to retirement plans. Plan committees have many fiduciary support options from which to choose. One of the most important governance decisions a plan committee will ever make is whether to retain an outside fiduciary. There are right and wrong reasons to retain an outside fiduciary, and plan committee records and/or minutes should articulate the rationale for any fiduciary-related decision made by the committee. For example, a committee retaining an outside fiduciary to reduce committee members’ liability may be selecting a fiduciary for the wrong reason. Retaining a fiduciary to reduce the committee’s workload may be a valid reason to retain a fiduciary. Effectively, hiring a fiduciary doesn’t limit the committee’s liability; retaining a fiduciary merely changes the nature of the committee’s responsibilities to overseeing the retained fiduciary.

And it is important to remember that all fiduciaries are NOT created equal. There are important differences among providers that should be discussed and documented in the decision-making process, and reflected in service agreements. This is what I mean by being a good consumer of fiduciary services.

Conclusion

Good governance comes down to having the right people, with the right support following a consistent process, and documenting decisions and actions. It means asking probing questions and realizing when outside, nonconflicted support is necessary. The rationale for key decisions and the recording of such is as important as the decision itself.  Maintaining a solid governance process is the best strategy to help minimize the liability of the plan sponsor and plan committee, and provide participants with the best opportunity for successful retirement outcomes.

© Copyright 2019 Retirement Learning Center, all rights reserved
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Much Ado About MEPs

by W. Andrew Larson, CPC

Multiple employer plans (MEPs) are consistently in the news. Their proponents, which include a bi-partisan Congressional group, claim MEPs can offer small and mid-sized employers the advantage of lower administrative and investment costs as they relate to offering employer-sponsored retirement plans, and would expand worker access to such savings arrangements. One would think that an arrangement that helps expand affordable, employer-sponsored retirement plan coverage would be a no-brainer and encouraged at all levels. Alas, policy issues are rarely this simple.  In light of the heightened level of industry interest, we thought it timely to discuss MEPS, including what they are, where they came from and prognosticate on where they might be going.

A MEP is a retirement plan adopted by multiple employers. (Not to be confused with a multi-employer plan, which is a plan maintained pursuant to a collective bargain agreement between more than one employer and a labor union. These plans are sometimes referred to as “Taft-Hartley” plans. Please see our “Case of the Week” Multi and Multiple Employer Plans–What’s the Difference? for a more in-depth comparison.)

A MEP is a qualified plan adopted by multiple business entities none of which are part of a “controlled group of businesses.” Understanding the controlled group dimension is important because multiple businesses may adopt a plan and yet the arrangement would NOT be considered a MEP if the businesses where part of a controlled group of businesses. Essentially, a controlled group of businesses exists when multiple business entities have a certain level of common ownership among them.

Another element in understanding the MEP environment relates to the various Federal entities involved with MEP oversight and regulation. Retirement plans are subject to oversight by the IRS, the Department of Labor (DOL) and, in some cases, the Securities and Exchange Commission (SEC). Each agency is focused on its own policies and rules, and coordination is often lacking. Much MEP confusion (and contention) occurs because of the lack of regulatory coordination between these entities. This results in odd situations; for example, a MEP arrangement can satisfy IRS rules and, simultaneously, run afoul of DOL or even SEC requirements. Next, let’s explore how the confusion with the rules that govern them arose and what might be some possible resolutions.

Traditionally, the IRS was comfortable with, if not supportive of, MEP arrangements. In fact, this author was involved in obtaining approvals from the IRS for MEPs in the 1980s. If certain criteria were met, the IRS considered a MEP a single plan requiring one Form 5500 filing and audit despite the fact many employers were participating in the arrangement.

Historically, the DOL had little involvement with MEPs. Things changed, however, starting around 2010. The DOL became increasingly concerned about MEP arrangements and possible abuses. It didn’t help MEP supporters when, at about the same time, a high-profile, politically-connected, California-based MEP provider was found guilty of embezzling MEP assets.

In 2012, the DOL issued MEP guidance that had a major impact on these arrangements (see Advisory Opinion 2012-04A). First, the DOL decreed that a MEP arrangement must have a “nexus” or commonality between the adopting employers in order to be considered a single plan. For example, if all adopting entities were dental offices a nexus would exist. The origination of the nexus requirement is obscure as nexus is neither mentioned nor alluded to in the IRS MEP code or regulations [under IRC Sec. 413(c)]. I have heard it said the nexus requirement is important to prevent abuses yet, when pressed, the proponents of this view could neither articulate the abuses nor explain how nexus would solve them. For terminologies sake, a MEP without a nexus is commonly called an “open MEP,” and a MEP with a nexus is a “closed MEP.”

Why is open or closed MEP status important? Recall the IRS considers a MEP a single plan and subject to a single Form 5500 and audit requirement. The DOL’s view is, unless a nexus exists, the arrangement is considered a combination of single employer plans and each employer would need to file its own Form 5500 and audit report, when applicable. The IRS was comfortable with treating a MEP as a single plan regardless of nexus, while the DOL insists on nexus if the arrangement is to be considered a closed MEP and treated as a single plan.

And let’s not forget about our friends at the SEC. They may want to play in the MEP regulatory sandbox. Recall that under a MEP, unrelated employers pool their retirement assets in the plan’s trust. This pool of assets might be considered a mutual fund for purposes of the Investment Company Act of 1940, and subject to registration and reporting requirements.

Another MEP requirement that draws concern is the “bad apple” rule. The bad apple rule calls for disqualification of the entire MEP if just one of the adopting employers fails to satisfy the IRS compliance rules. Losing qualified status means the participants are taxed on vested benefits and plan sponsors may lose deductions. Yes, the “bad apple” rule sounds scary, but let’s consider what has happened in the real world. It is not the policy of the IRS to disqualify plans except in the most egregious situations of plan sponsor malfeasance. The IRS prefers plan problems be fixed via its Employee Plans Compliance Resolution System (EPCRS). To my knowledge, a MEP disqualification because of the bad apple rule hasn’t yet occurred and I don’t think that it will.

It seems clear MEPs have the potential to create economy of scale and help place small employers on more equal footing with larger employers in terms of administrative costs and features. Industry benchmarking data is clear that small employers’ plan operation costs are higher than larger employers’ costs, and one solution could be a MEP. A MEP allows employers who were not part of a controlled group to participate in a single retirement plan and save money on plan costs and get better pricing from investment providers.

Clearly challenges remain. For example, several years ago a large trade association was fined millions of dollars by the IRS because the IRS contended the nature of the  MEP arrangement was such that the trade organization was in control of the MEP and could, and did, set its own compensation from the arrangement. This was clearly abusive, yet solutions exist to mitigate these types of abuses.

In this era when expansion of retirement plan access and coverage is becoming a common call in public policy, and many efforts are being made to expand retirement plan availability while reducing costs to employers, the author is perplexed at the seemingly artificial impediments to MEP creation. In fact, several bills before Congress would enhance the attractiveness of MEPs. The bills make it clear no nexus would be required, and they would also do away with the all or nothing bad apple testing requirements. At the time of this writing, the fate of these bills is unclear. We sincerely hope legislation that expands retirement coverage and reduces costs for small employers and their participants can be something both political parties support.

© Copyright 2019 Retirement Learning Center, all rights reserved
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Beware of Dull Tools in Retirement Planning

By W. Andrew Larson, CPC, Retirement Learning Center

Retirement planning is complex, emotional and can be a time sucker. Deciding on the vision of what retirement will look like requires a commitment to time and honest reflection.

We as an industry have deployed a veritable host of tools to support individuals and couples in the retirement planning process

Have the plethora of tools created misconceptions in minds of consumers? Obviously, we need to encourage practical retirement planning. Maybe we have tried to make it too simple in an effort to get more people engaged in retirement planning. We have encouraged people to use tools. In fact, the entire “robo advisor” industry has sprung up advocating tool use. And the easier the tool the better–right?

Consumers seem to implicitly trust tools and their output. I have been surprised at the level of trust placed in retirement planning tools. There seems an almost magical quality about a friendly and colorful retirement planning widget. It’s so simple. Just enter the right data, select the right retirement age and rate of return and *POOF* we are on our way to a happy and blissful retirement. We are in awe of the fancy print outs, and colored graphs and charts. They look so good, they must be accurate.

I met a couple who, to reward themselves for being “on-track” in their retirement planning (according to their retirement planning widget), purchased an airplane!

Their trust in the tool may have been misplaced.

Maybe we need to take a step back and help consumers understand the limitations of virtually all retirement planning tools. Let’s discuss frankly an aspect, and limitation, of every retirement planning tool ever developed. At the core of every retirement planning tool are one or more life expectancy tables or algorithms. Enter your age and the software tells you how long you have to live—on average. Couples enter their information and we have their joint life expectancy! Let the planning begin.

Why should we be concerned about the accuracy of life expectancy tables? Are the tables really that inaccurate? The short answer is life expectancy tables are accurate and inaccurate; the accuracy is based on the timeframe and number of individuals involved. The use of longer time frames and more people to develop the tables equates to greater accuracy. Fewer people and/or shorter time frames mean less accuracy. Actuarial tables were never intended to forecast individual outcomes. Let’s explore this seeming paradox.

Life insurance companies engage actuaries to develop life expectancy tables in order to set premiums for insurance and annuity products. For this purpose, life expectancy tables are well suited. The tables tell you, on average, how long a group of people are expected to live. Obviously, some will live longer than the average and others will not. Insurance companies use the tables to price their products, realizing that, in the long term, the numbers will end up close to the average.

But, the concern is using a tool—the life expectancy table—which is designed to predict average life expectancy of a group to calculate the life span of an individual.

The tables are not accurate in predicting a specific individual’s lifespan. In fact, an individual tool is accurate about five percent of the time. Five percent!

Let’s review again why life expectancy tables are so inaccurate on an individual basis. Let’s say the life expectancy table tells us the group’s average life span for a 62-year-old is 20 years (age 82). An average life expectancy of 20 years at age 62 clearly doesn’t mean the group lives exactly 23 years longer (to age 82). Some will die before that age and some will live beyond age 82.  In reality, only about five percent of current 62-year-olds will die on or about age 82; about half of the group will die sooner and about half the group will die later. Remember, the 20 year life expectancy is an average figure and varies due to many factors including current age, gender, race, and geographic location. Any retirement planning software is an approximate tool. The life expectancy calculations are, by their nature, inaccurate on an individual basis.

What are the solutions? In my view, awareness is the first step. Understanding the inherent limitation of life expectancy calculations is necessary in order to prevent excess dependence on a tool with limited accuracy. One solution is to consider the use of alternative tables. For example, David Blanchett, head of retirement research at Morningstar Investment Management, has proposed using annuity purchase tables (which are more conservative) to more accurately project life expectancy and plan accordingly (“How To Better Estimate Life Expectancy,” Investment News, February 12. 2015).

Perhaps we need to slow down the planning process to make sure individuals are aware of the inherent limitations of the tools they may use, and foster the understanding of what a life expectancy table is and how it works. Life expectancy tables tell us on average how long a group of people can be expected to live.

Perhaps we should ask our clients if they understand how the tools work. Maybe we should ask them about the appropriateness of specific tools. Maybe we should discuss the tools’ limitations. Again, I am not against tools, not at all. In fact, I have helped build and develop planning tools. But I believe we have an obligation to help clients understand the proper use and limitations of planning tools.

© Copyright 2019 Retirement Learning Center, all rights reserved
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Fiduciary Enforcement: A Camel’s Nose Under the Tent?

By W. Andrew Larson, CPC

Retirement Learning Center

We closed our eyes. We held our breath. June 9, 2017, came and passed, and the new Department of Labor (DOL) fiduciary rules for financial advisors became applicable, albeit subject to a relaxed transition period that runs through July 1, 2019. Gee, it didn’t seem so bad after all. Perhaps the new regulations aren’t the media event many of us made them out to be. Or is there more to the regulations than we realize that will lead to more serious and less desirable consequences down the line. Is there a camel putting its nose under the tent?

Clearly, the new regulations have resulted in broker-dealers implementing significant changes to their platforms, pricing, processes and products. These changes will have long-term effects for consumers, advisors and broker dealers. Originally, the concern over the regulations focused on the application of certain Employee Retirement Income Security Act (ERISA) rules to IRAs and rollover transactions. Under the new rules, previously commonplace transactions, such as recommending a rollover to an IRA, become a prohibited transaction and, potentially, subject to penalty unless an advisor follows an exclusion (e.g., providing education not advice) or the Best Interest Contract exemption (BICE) from the regulations. One immediate impact of these changes for advisors is increased oversight and the need for intensified documentation of IRA-related transactions—in particular—rollovers. One immediate impact on consumers seems to be reduced choice with their IRA accounts.

What about enforcement of the new rules? Well, according to DOL Field Assistance Bulletin No. 2017-02 and the DOL’s extension to the special transition period, until July 1, 2019, under a temporary enforcement policy, the DOL will not take any enforcement action against, “… fiduciaries who are working diligently and in good faith to comply with the fiduciary exemptions.” Likewise the IRS will not IRS will not apply § 4975 and related reporting obligations with respect to any transaction or agreement to which the DOL’s temporary enforcement policy applies. But, I am less concerned about the DOL and IRS, and their enforcement and reporting initiatives. The good news regarding federal-level initiatives, whatever they may be, is that they create a level playing field applicable to all players in essentially the same manner.

No, my concern with the new regulations is not at the federal level but rather at the state level. Under the regulations “state camels” may be placing their noses under the retirement tent. What could possibly go wrong? Before we explore the new state level issues let’s review the traditional ERISA and the Internal Revenue Code (IRC) enforcement environment.

The governance and control of retirement plans sits with the Federal government and courts. The DOL writes the rules for both retirement plans and IRAs. The DOL has enforcement authority over retirement plans under ERISA, and the IRS has enforcement authority over IRAs through the IRC. While there is no private right of action for IRAs, the IRC’s prohibited transaction provisions generally prohibit IRA fiduciaries from self-dealing, enforced through an excise tax.

The Federal venue offers several significant advantages. Federal law is uniformly applicable in all 50 states: One set of rules; one level playing field. In general, Federal rulings result in consistent interpretation (usually!) of the applicable laws. Next, Federal litigation is expensive. This means the issues brought forth are usually legitimate and not frivolous. Litigation occurs with significant issues when the plaintiffs believe they have a winnable case.

How are states able to become involved in retirement enforcement and litigation? Let’s examine how the regulations bring state courts into the retirement arena. Recall many IRA providers and advisors will utilize the BICE to avoid prohibited transactions. The BICE is a contract between the client (e.g., an IRA owner) and the advisor or other service provider. Contract law is based at the state level. Thus, if a plaintiff believes the advisor, provider, etc., has violated one or more elements of the BICE contract he or she can seek relief in state court. As the rule stands today, a BICE contract is enforceable under state law, and must provide for the right to sue in a class action.

And it gets worse. Each state’s contract law is unique. Much contract law is similar but not completely so. Thus, a BICE contract violation in one state may not be a BICE contract violation in another state. Theoretically, large retirement vendors will need to concern themselves with 50 sets of state ERISA BICE contract rules.

I would argue the States are not well versed in, nor facile with, the complexities of the Federal retirement regulatory environment. At a recent conference, one of the speakers was the official responsible for launching a state-run retirement program for small businesses. This state program requires most small businesses to offer a Roth IRA retirement program to employees. Again, this was an IRA-based program. I was, honestly, appalled at the official’s lack of insight and understanding of IRA programs, retirement plans and retirement regulations. Perhaps this is unfair of me, but I don’t see why states should commit resources to an area where the federal government and its agencies have done a credible job with enforcement and the protection of workers and their retirement benefits and rights. Another level of enforcement will simply increase costs that ultimately are paid by investors. I fail to see the benefit or the need for this new level of enforcement.

© Copyright 2019 Retirement Learning Center, all rights reserved
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401(k)s−The Magnificent $4.8 Trillion Dollar Failure

By W. Andrew Larson, CPC

Retirement Learning Center

 

Independent thought leadership—it’s not just a lame tagline to us. At the Retirement Learning Center, we believe thought leadership must go beyond simply parroting the common media narrative. That’s why in this and future blog posts, as well as elsewhere, we strive to rise above the inane chatter to explore and challenge the real retirement-related issues and trends facing consumers and the industry in general.

In a previous blog we alluded to what some have called the supposed failure of the 401(k) experiment to provide retirement income security to U.S. workers. Let us now honestly explore the purported shortcomings of the 401(k) plan, and discuss possible enhancements to help the plan better meet the needs of the current workforce.

Have 401(k) plans failed? Hardly! According to the Investment Company Institute (ICI), 401(k) plans hold $4.8T.[1]  That amount represents a doubling of 401(k) plan assets in the last 10 years. I contend $4.8T is a magnificent failure, and is a lot of money earmarked to support millions in their retirement. In addition to supporting retirees and their families, 401(k) plan distributions will provide significant tax revenue to the Federal and many state governments.

Let’s take a look at how much money is accumulating in participant accounts. According to EBRI/ICI Participant-Directed Retirement Plan Data Collection Project[2] the average balance by age group is as follows:

Age                        Balance

20s                         $26,428

30s                         $61,757

40s                         $117,863

50s                         $176,922

60s                         $171,641

Perfect? No, but 401(k) plans seem to be working for the traditional, full-time employee segment. But there is always room for improvement.

Imagine for a moment a counter reality where 401(k) plans did not exist. Assume further that Congress never contemplated any other type of self-contributing, tax-favored retirement savings arrangements [e.g.,  IRAs, Roth IRAs, 403(b)s, 457s, Savings Incentive Match Plans for Employees (SIMPLEs), etc.]. You get the idea. In this counter reality where would the $4.8T of 401(k) assets be today? I suspect most of the money would not have been saved for retirement. It probably would have been spent on the myriad of earthly consumer delights tugging at our wallets.

401(k) plan participation rates among full-time employees are good. Eighty-two percent of workers are making employee pre-tax contributions to 401(k)-like plans.[3]  This is a good start. Can we do better? Certainly; for example, part-time workers were not on Congress’ mind when it enacted the Revenue Act of 1978, which created 401(k) plans. And, if a plan is available, the average percentage of income contributed to 401(k) plans—6.8%[4]−could be higher.

But notice it’s not the plan’s fault. 401(k) plans do not succeed or fail. Claiming 401(k) plans have failed is, frankly, foolish. As my esteemed colleague Nevin Adams succinctly opined, “Blaming the 401(k) for the retirement crisis is like blaming the well for the drought.” 401(k) plans don’t fail – we fail. Success is a choice.

Saving for retirement is a personal choice. Not saving enough or at all for retirement, ultimately, is a reflection of personal priorities. Recently, my spouse and I had dinner with friends of many years. The couple related their newly married daughter and her new husband just got back from a trip to Ireland, are busy decorating a new home and looking to purchase motorcycles. Both work for large corporations with good retirement programs. However, neither is participating in his/her respective company’s 401(k) plan. Plan participation is not a priority for them at this time.

But better retirement outcomes through increased plan participation is in the best interest of our society overall. Several policy changes come to mind that could address the mindset of this young couple and make the 401(k), no to make us, more effect in building retirement readiness.

First, let’s take a page from many state and local governmental plans that mandate employee contributions as a condition of employment. Many governmental plans mandate employees contribute 5 , 6, 8 or even 10% or more of compensation to their plans as a condition of employment. These contributions are irrevocable, and the money remains in the plan until retirement or separation from service.

Perhaps a national mandate requiring all employees (and independent contractors) to contribute a certain percent of compensation to a retirement plan would be a sensible step to improving retirement outcomes. Every time I mention this strategy I get the, “What if they can’t afford it,” objection? My response: They (and ultimately all of us) can’t afford not to have more people save for retirement.

It’s not about affordability; it’s about priorities. When retirement readiness is a priority people save for retirement. Let’s not overthink this. To illustrate the shift of priorities over time, let’s take a look at housing. According the June 2, 2016, edition of the Wall Street Journal, the median square footage of a family home is 61% larger than the median size of a family home 40 years ago, and is 11% larger than a decade ago. The larger home decision is based on priorities.

In addition to contribution mandates, a coordinated public policy initiative focused on savings and retirement readiness is essential. Let’s quit bashing 401(k) plans and push public policy initiatives to change investor behaviors and priorities.

We as a society are effective at changing mores and behaviors through public policy initiatives. A great example is smoking. The effective messaging of smoking’s ills created an all but smoke-free public environment; and we did it rapidly. Those of us over 40 remember when smoking was ubiquitous. Our younger colleagues may find it shocking to discover that people once smoked in airplanes, restaurants, theatres, hotels and cars. Smoking was cool and sexy. Anyone remember when the airline industry began to offer “No Smoking” sections on planes?

Let’s move the retirement readiness needle through the same type of public policy messaging. The campaign’s focus is one of encouraging saving and retirement readiness. It’s doable. It’s not political. Congress tends to listen to those who speak up.  You can contact your senators and representatives directly and, to make your voice even louder, join with trade groups like the National Association of Plan Advisors (NAPA). It’s in everyone best interest.

[1] 2017 ICI Fact Book, Figure 7.9

[2] ICI Research Perspective, September 2016, Vol. 22, No. 5

[3] Bureau of Labor Statistics, National Compensation Survey-Benefits, 2016 https://data.bls.gov/cgi-bin/dsrv

[4] Plan Sponsor Council of America, 59th Annual Survey, 2016

© Copyright 2019 Retirement Learning Center, all rights reserved
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The Golden Age of Pensions: Another Fairy Tale

By W. Andrew Larson, CPC

Retirement Learning Center

 

Independent thought leadership—it’s not just a lame tagline to us.  At the Retirement Learning Center, we believe thought leadership must go beyond simply parroting the common media narrative. That’s why in this and future blog posts, as well as elsewhere, we strive to rise above the inane chatter to explore and challenge the real retirement-related issues and trends facing consumers and the industry in general.

“We are in a retirement crisis!” “401(k) plans have failed!” Media outlets frequently chant both of these mantras. Often underlying these assertions is the subtext that we need to return to the good old, defined benefit pension plan days when retirees lived happily ever after, supported by their generous pension checks.  Images of contented pensioners enjoying their golden years with golf, gardening, shuffleboard and an occasional game of bingo may warm the heart—but are not accurate.

Sadly, this vision of a blissful, pension-supported retirement world is—for the most part—a fantasy. Very few, lucky individuals actually experienced the good old pension days. It’s time to face reality and dispel some long-held myths associated with defined benefit plans so that we can get on to real-world solutions.  

Myth #1. Once upon a time most people retired with a pension.

  • Reality check: As with many myths, this one contains a grain of truth. Until the late 1970s, a larger percentage of the workforce was, in fact, participating in defined benefit plans over other types of retirement savings arrangements. According to the Employee Benefits Research Institute, the high-water mark of defined benefit plan coverage in the private sector probably occurred in 1980 when nearly 35 million workers were covered by defined benefit pension plans. This represented 46 percent of the private sector workforce. Since that time the overall pension coverage rate has declined. The Bureau of Labor Statistics reports fewer than 18 percent of private sector workers are currently covered by pension plans.
  • The important take away is the misleading nature of the pension coverage statistic. Pension coverage does not necessarily equate to ultimately receiving a pension benefit. Many workers may have been covered by pensions in the past, but few ever received a benefit.

Why?

One simple answer is the pension rules were different back in the 70s and 80s than they are today.  Let me illustrate with a personal example.

In the 1970s, I worked at a grocery store stocking shelves and carrying out groceries. Despite the part-time status of the job I participated in the Amalgamated Meat Cutters Pension Plan. I was one of the 46 percent of workers covered by a pension plan. However, after I left employment at the store I received no pension benefit. I didn’t work there long enough and had to leave my benefit behind. My former employer used this “left behind” amount to help pay for benefits of participants with 30 years of service. These amounts became what are now called forfeitures.

Under the old defined benefit plan rules, in some cases, eligibility to receive a benefit required 30 years of service and employment with the plan sponsor through the retirement age of 65. Workers leaving before retirement usually got nothing, and their accruals were used to fund benefits for those who retired and earned a benefit. In fact, only about 10 percent of the covered workers ever stayed long enough to receive a benefit. If you made it to age 65, and had enough service—congratulations—you got a monthly check!

The forfeitures helped control plan costs by reducing the size of employer contributions. So, while fewer people received benefits in the old days, the dollars left behind helped keep plans more affordable for employers. As a result of modern-day vesting and accrual rules, many more employees who separate early—even before retirement age—still receive at least some benefit.  Consequently, with fewer forfeitures today plan sponsors need to increase their contributions. Do you see the trade off? Under the modern rules, because less money is left behind, the plan is more expensive for the plan sponsor (and less appealing). There is no such thing as a free lunch.

Myth #2. Pension benefits were generous back in the good old days.

Actually, benefits were quite modest. According to study by Walter Kolodrubetz, published in the Social Security Journal, the average pension benefit was about $137 a month up until 1970. The Pension Rights Center’s research indicates the current monthly benefit today is approximately $781 a month.

Adding insult to injury, most pre-1970s retirees lost half their purchasing power during the inflationary surge of the 70s and early 80s. As an example, a retiree with a $1,000 monthly pension check in 1970, by the early 80s had about $160 of inflation-adjusted buying power. In other words, during this period, inflation eroded about 86 percent of retirees’ buying power.

This brings us back to reality. There never really was a golden age for pension plans.  And, today, defined benefit plans are becoming too expensive for employers to continue. Pensions are not coming back. So, what should be done?

First of all, we need to challenge proponents of the “let’s bring back pensions” notion. Demographics and economics make that idea a nonstarter.

Next, we should propose and advocate modern 401(k)/IRA enticements, designs and products to enhance retirement readiness, such as

  • Automatic enrollment,
  • Automatic escalation,
  • Automatic investment,
  • Lifetime income options,
  • Availability of saver’s credits,
  • Expansion of multiple employer plans (MEPs), and
  • Incorporating HSAs into retirement planning.

So let’s focus on developing strategies and policies that fit in the real world.

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