Friday, June 6, 2014

How to Fix the 401(k) - Wall Street Journal's thoughts

Earlier this week an article was published in the Wall Street Journal and the topic of the article was on how to fix the 401(k).  This is a favorite topic of mine, although based on the title one would assume that the 401(k) is broken which I do not agree with.  Not to say that the industry doesn't have its problems, it does, but to paint the whole tax code section as broken is a little too far.  Linked below is the article.

Within this article there is the usual anti-401(k) rhetoric from the usual suspects, Monique Morrisey of the Economic Policy Institute calls the system broken and then opines that the issue with the system is one of confidence; that people will save more if they are confident in the outcome.  This is a very Ivory Tower opinion from someone whom, I suspect, has never conducted an employee enrollment or education meeting or actual sat with participants and observed first hand what the inhibition to adequate savings actually was.  The savings issue, in my experience, is not one of confidence, but rather one that has two primary obstacles. 

1.) Affordability - Participants who do want to save, may not actually be able to afford to save.  So they put away what they can afford, and often that isn't enough.  Is that a confidence issue?  Not to me it isn't.

2.) Behavioral issues such as inertia, procrastination, distractions, etc. inhibit people from giving the retirement plan benefit the importance it deserves.  This is especially prevalent with younger workers, workers new to the workplace or transient workers.  Again, not a confidence issue, something else entirely.

The author of the article suggests Five Ways to "Fix the 401k".  Here they are in order.

1.) Simplify Fee Disclosure - Can't argue this point.  I agree, a simplified method for clearly and plainly stating all fees is a good idea.  In fact, this was what 408(b)-2 was supposed to do, but the regulation left too many loopholes and many of the providers are highly motivated to keep fees opaque.   While this is true, I don't think that fee clarity (or lack thereof) is an inhibitor of plan formation or of participation in plans.  Nonetheless, it is a good idea. 

But the article goes too far, it cites data that big plans pay a lower percentage than small plans, but doesn't show the math that the big plans pay a HUGELY larger dollar amount for service than small plans.  Simple math will tell you that $1000 cost on a $1m plan is 0.1%, but $1000 on a $100k plan is a full 1%.  Same dollars bigger % for the smaller plan.  The article even cites the Center for American Progress to require that funds carry a warning label akin to cigarettes or alcohol.  Are we trying to scare people into not saving or not investing?  REALLY!?  Actually, maybe this would be a way to get the 18-21 year olds into a plan (tongue firmly planted in cheek).

2.) Require plans to offer low-cost index funds - I/we would generally agree that index funds are a good idea to put into retirement plans.  The selection of which ones to use and in which asset classes index funds are most useful is a matter of debate, but good process will generally lead to a good selection in this area.  My issue is with the mandate of offering them.  Question: which ones do we use, I'm sure Vanguard will want to weigh in on this debate.  Which asset classes?  All of them?  I'm sure there would be lots of arguments among investment professional regarding where passive investing makes sense and where it doesn't. 

***By the way, this is really an extension of the first "fix", which is an effort to reduce fees***  How about instead, we require that all 401(k) plans use institutionally priced investments with a uniform conformity (call them K shares) which are no-load, don't have revenue sharing or other embedded distribution fees and level the playing field.  I'm sure this would accomplish the same thing while leaving choice in place.

3.) Require plan features that nudge people to save more - This is a good idea.  Employ Automatic Enrollment and Automatic Savings Escalators with employee opt out provisions.  We suggest these ideas to virtually every client we meet with.  However, before forcing a plan design feature with a mandate that requires additional administration (and the additional mistakes that come with it), we should tread lightly and acknowledge that not every plan sponsor has the practical capabilities to handle these types of designs. 

4.) Have those providing guidance be fiduciaries - This isn't new ground.  This has been getting thrown around for years and, at this point, most of those of us that are serious in this industry are already acknowledged fiduciaries or at least act like them even if they can't say that they are.

5.) Start a national 401(k) Plan for small employers - Again this is all back to the first issue, fees.  Fees, fees, fees, fees, fees!!!!!   It seems to be the only thing that critics can really focus on which is a shame b/c, we operate in a free market.  The private industry has its "cheap fee" providers, it's expensive providers and those in the middle.  Just like in the auto industry, the telecom industry and every other industry.  If a 5 person company with no employees really wanted to start a 401(k) plan, buy cheap recordkeeping and pick Vanguard index funds for their employees.....that service is out there already!  It's only when they want to start adding services, like advice, custom plan design, fiduciary services, etc. that fees go up.

The govt. option will be another burden to the tax payer, many of which would not benefit from this new system.  I don't disagree that small plans should be allowed to pool together somehow to gain economies of scale, perhaps in a Multiple Employer Plan (MEP) format.  But again, that can be handled by private industry, just need the rules to allow such things.

So, did this WSJ article do its job in "fixing" the 401(k).  Hardly, this was a weak effort by a highly respected periodical. 

1 comment:

  1. Nice analysis of this WSJ article - I can easily agree with everything but number 5.