Sunday, August 27, 2006

Goal Oriented

I only discussed retirement investments with my dad once, and the conversation didn’t take place until he had already decided to retire. He had a pretty good idea about what he wanted to do – he just couldn’t figure out how to accomplish that via the all-too-typically complicated distribution request form. Consequently, at my mother’s instigation, he called in an “interpreter” – in this case, the son with the law degree.

It was a complicated discussion. Since hundreds of miles separated us, he had to read the form to me (I suggested faxing, but that was “more trouble than it was worth”; I chose to assume that was a reference to his difficulty with operating the fax machine on his end, and not the quality of advice he was hoping to get from mine). Fortunately, there is something of a boilerplate design to most of these forms and, in reasonably short order, I was able to wrest an English version of his options from the document.

Having outlined the options for him, I asked him if he knew what he wanted to do. Much to my consternation, he wanted to go with an annuity. Now, the market was still on its way up, and while, even then, we all “knew” a pop was coming, it was hard for his financially astute son to accept that he would want to trade the upside potential of having the money in his own hands/account and the ability to draw down that sum at a pace commiserate with his needs for relinquishing that to the notoriously expensive and somewhat inflexible option of an annuity. But what my dad wanted – more than anything else - was the certainty of a regular income stream. If I couldn’t guarantee him that result with the other options, he wasn’t interested.

Goal “Tending”

Ultimately, regardless of how (or when) we get there, the goal of saving for retirement is to have an income in retirement - a regular, secure paycheck that continues even after we are no longer gainfully employed. On the other hand, today’s approach to retirement savings is largely predicated on accumulating enough money to be able to, after retirement, have enough to live on. The problem, of course, is that if you get to retirement with the “wrong” amount of savings, it is darned near impossible to right the wrong.

Still, if what you ultimately want to wind up with is regular retirement income - an annuity, essentially - why wait 40 years to do so? Why “gamble” on the potential upside of making investment choices in a retirement plan – particularly when you don’t know how much it will cost or how much money you will have at retirement to purchase that annuity?

There are reasons, of course. Participants frequently don’t have any appreciation for what their income wants – or needs – will be in retirement. Indeed, that is what makes retirement savings so problematic for many; they lack a specific goal and, thus, tend to save what they think they can afford, rather than what they may need. But if participants really are weary of having to make, and revisit, all those investment and savings decisions, then perhaps we also need to rethink our traditional approach to helping them achieve their goal. Perhaps their retirement savings investments should be directed, not to the selection of mutual funds from a retirement plan menu, but to a more direct investment in a retirement income stream.

Work to Do

Not that we don’t have work to do. Most of the offerings out there at present are even more complicated than the retirement plan decisions participants already struggle with. Participants still will need help setting goals, evaluating choices and, no doubt, managing an accumulation of these investments over time. Imbedded under the auspices of employer-sponsored retirement offerings, plan sponsors also will doubtless be presented with significant challenges, both administrative and fiduciary, as we work toward a new goal-based solution.

Still, there are already a few firms that have applied this notion to retirement plan savings – that allow participants to invest in an annuity as an option in their 401(k) plan. If our goal truly is to help the participant achieve retirement income security, perhaps it is time we actually figured out the best way to help them make that investment sooner, rather than later.

- Nevin Adams

Saturday, August 19, 2006

Happy Returns

One of the “promises” of the newly enacted Pension Protection Act of 2006 (PPA) is that it will foster, if not encourage, greater levels of retirement plan participation. And while there are several areas that ostensibly facilitate this growth – notably the removal of EGTRRA’s sunset provisions and the expansion of investment advice – the thing that is really supposed to make a difference is automatic enrollment.

So, how does the PPA encourage automatic enrollment? First, it resolves the current dilemma faced by plan sponsors in states that prohibit (or appear to) deductions from a worker’s pay without their explicit permission. While this has been a relatively recent concern, the certainty that federal, not state, law governs these transactions is a welcome relief, and one that is provided immediately. Will it persuade employers who were not already actively considering automatic enrollment? Probably not.

The PPA also lays the groundwork for some much-anticipated clarity from the Department of Labor on the issue of an appropriate default investment election. Still, there seems little doubt that, when we do see the final rules, the DoL will officially embrace the use of some form of asset allocation vehicle. Of course, we were expecting this even if the PPA didn’t pass. Consequently, it will help tidy things up, but isn’t likely to transform current trends. This will be effective for plan years beginning in 2007.

Ironically, the biggest change – and it won’t take effect until 2008 – is the creation of something called a “qualified automatic contribution arrangement.” Implementing this special version of automatic enrollment exempts a plan from both top-heavy and average deferral percentage (ADP) testing (ACP - average compensation percentage – testing as well, if applicable). To qualify, a plan has to implement the program for all eligible workers prospectively; automatically defer in accordance with a schedule stated in the law (see Pension Reform Influences Automatic Enrollment Designs ); match those contributions (the law specifies a schedule); 100% vest those matching contributions within two years; give participants notice of the program, the default options, and their right to opt out in a timeframe that gives them an opportunity to do something different – oh, and it must provide for that initial contribution to be increased annually in accordance with another provision in the law.

In my initial reading of the law, this was the provision that I found most questionable. Not in its ultimate result, or goal – but it struck me as making things just complicated enough mathematically to slow, not speed, the adoption of automatic enrollment. Why? Not the match requirement itself, or the vesting applied to that match – both are comparable in effect to the current safe harbor provisions (there are differences, however). No, what may make a difference to many plan sponsors, IMHO, is the requirement to increase those employee deferrals – and, at least potentially, the employer match associated with those deferrals.

The impact of the latter is obvious – and cost concerns alone may well keep plan sponsors from taking advantage of the option. The former – the decision not only to take money from workers’ paychecks without their involvement, but to increase that initial deferral – could be just as problematic. While I have found that plan sponsors generally are in favor of the concepts behind automatic enrollment, they are less inclined – at present, anyway – to combine that decision with taking even more from those paychecks without “permission.”

On the other hand, workers retain the ability to opt out at any time. They don’t appear to do so very frequently – but that option remains for anyone who truly can’t afford it (or thinks they can’t). But one of the larger concerns for plan sponsors with automatic enrollment is the accumulation of small balances – those deferrals that workers don’t notice until three paychecks later, at which point they stop the deferrals, but then discover that “I wasn’t paying attention to the automatic enrollment notices” doesn’t qualify as a reason for hardship withdrawal.
That’s why, IMHO, one of the real gems in the PPA is the ability, within 90 days of that first contribution, to return those contributions to the worker. In my experience, the inability to do so under current law has been perhaps the largest impediment to these programs – and its inclusion in the new law may make all the difference in the world.