A Thankful Thanksgiving

Thanksgiving has been called a “uniquely American” holiday, and though that is perhaps something of an overstatement, it is unquestionably a special holiday, and one on which it seems appropriate to reflect on all for which we should be thankful.

Here’s my list for 2017:

I am thankful that – for the moment, anyway – it looks as though retirement savings will be largely spared tax reform’s ravages (though I’m not convinced that we’re out of the woods – yet). 

I’m thankful that participants, by and large, continue to hang in there with their commitment to retirement savings, despite lingering economic uncertainty and competing financial priorities, such as rising health care costs and college debt.

I’m thankful for the strong savings and investment behaviors emerging among younger workers – and for the innovations in plan design and employer support that foster them. I’m thankful that, as powerful as those mechanisms are in encouraging positive savings behavior, we continue to look for ways to improve and enhance their influence(s).

I’m thankful for qualified default investment alternatives that make it easy for participants to create well-diversified and regularly rebalanced investment portfolios — and for the thoughtful and on-going review of those options by prudent plan fiduciaries.

I’m thankful that those reviews are guided, in a growing number of situations, by the thoughtful input of advisors who are ERISA fiduciaries.

I’m thankful that so many employers voluntarily choose to offer a workplace retirement plan — and that so many workers, given an opportunity to participate, do.

I’m thankful that the vast majority of workers defaulted into retirement savings programs tend to remain there — and that there are mechanisms (automatic enrollment, contribution acceleration and qualified default investment alternatives) in place to help them save and invest better than they might otherwise.

I’m thankful that figuring out ways to expand access to workplace retirement plans remains, even now, a bipartisan focus – even if the ways to address it aren’t always.

I’m thankful that so many employers choose to match contributions or to make profit-sharing contributions (or both), for without those matching dollars, many workers would likely not participate or contribute at their current levels — and they would surely have far less set aside for retirement.

I’m thankful that the on-going “plot” to kill the 401(k)… still hasn’t. Yet.

I’m thankful to be part of a team that champions retirement savings – and to be a part of helping improve and enhance that system.

I’m thankful that those who regulate our industry continue to seek the input of those in the industry — and that so many, particularly those among our membership, take the time and energy to provide that input.

I’m thankful for all of you who have supported – and I hope benefited from – our various conferences, education programs and communications throughout the year.

I’m thankful for the constant – and enthusiastic – support of our Firm Partners and advertisers.

I’m thankful for the warmth with which readers and members, both old and new, continue to embrace the work we do here.

I’m thankful for the opportunity to acknowledge so many outstanding professionals in our industry through our Top Women Advisor, Top Young Advisor (Young Guns) and Top DC Wholesaler (Wingmen) lists. And thankful to have had such a tremendous response to the newest addition here - our Top DC Advisor Team list.
 
I am thankful for the blue-ribbon panels of judges that bring so much expertise and insight to those evaluations.

I’m thankful for the prospect of expanding the reach and impact of our work here to plan sponsors via the contemplated combination with the Plan Sponsor Council of America.

I’m thankful to be part of a growing organization in an important industry at a critical time. I’m thankful to be able, in some small way, to make a difference.

But most of all, I’m once again thankful for the unconditional love and patience of my family, the camaraderie of an expanding circle of dear friends and colleagues, the opportunity to write and share these thoughts — and for the ongoing support and appreciation of readers…like you.

Thanks for all you do to help make our nation’s retirements better.  

Have a VERY happy Thanksgiving!

- Nevin E. Adams, JD

4 Retirement Savings Benchmarks That (Generally) Miss the Mark

Behavioral finance tells us that human beings are prone to relying on heuristics – mental shortcuts, if you will – to solve complex problems. While these may not be very accurate, survey data and anecdotal evidence suggest that participants often rely on these benchmarks.

Here are four that workers use more often than we’d perhaps like to admit.

The Company Match

Survey data and academic research have long suggested a link between the employer match and the level to which workers contribute. Indeed, there has been evidence (frequently invoked by advocates of the so-called “stretch” match) that it’s not the amount of the match that motivates, but the existence of the match at any level.

There is, in fact, evidence that a lot of people save only as much as they need to receive the full employer match (unfortunately, there’s also evidence that many don’t take full advantage – particularly lower income workers – and confusion about how much you need to save to get the full match.

There are, of course, a number of factors that go into determining the amount and level of the match; how much individuals need to set aside for their own personal retirement goals is almost certainly not one of those factors.

Saving to the level of the employer match is certainly a good starting point, but unless it’s truly extraordinary – well, it’s likely not “enough.”

The Automatic Enrollment Default

While you see surveys suggesting that a greater variety of default contribution rates is emerging, the most common rate today – as it was prior to its codification in the Pension Protection Act more than a decade ago – remains 3%. There is some interesting history on how that 3% rate originally came to be (it’s been the standard default for such programs going back to when they were still called “negative elections”), but the reality is that it has become that default because it is widely seen as a rate that is small enough that participants won’t be willing to expend the time and energy to opt out (if they even notice the withholding).

Little wonder that in automatic enrollment plans at Vanguard, more than half (55%) are contributing below the match initially, and one in five (21%) is still below that level after three years.

For those who worry that a higher default would trigger a higher rate of opt-outs, surveys indicate that the “stick” rate with a 6% default is largely identical to 3%. And though there are indications that the default savings rate is moving up from the traditional 3%, there is one thing that you’d like to think everyone knows.

Saving at a 3% rate, unless you have alternate financial resources, is definitely not “enough.”

The Pre-tax Cap

At the height of the Rothification “scare” (and make no mistake, we’re not out of those woods yet), there was a sense that existing automatic enrollment programs might be affected. Specifically, that plan sponsors wouldn’t be comfortable simply continuing to auto-enroll above whatever pre-tax cap was established by legislation ($2,400 was the rumored level at that moment) without some independent approval by the participant (setting aside the irony in turning to an automatically enrolled participant for some direction). Moreover, some providers had echoed that sentiment, saying that they would feel obliged to place that cap in the plans they recordkeep with automatic enrollment provisions — at least until plan sponsors told them otherwise. And if plan sponsors aren’t comfortable making that switch with their automatic enrollment programs — well, you can see how that Roth limit could in short order actually become a limit on retirement savings.

But one of the more unique arguments I heard against Rothification at the time was that that a pre-tax cap, whatever it turned out to be, would be viewed by workers as some kind of de facto sign from the government that the amount they would allow you to save on a pre-tax basis would be seen as a proxy for the “right” amount to save for an adequate retirement.

And just about the time you find yourself thinking, “there’s just no way anybody could be that stupid” – the sad reality sinks in.

A Guess

In the 2017 edition of the Retirement Confidence Survey, just 4 in 10 workers (41%) report they and/or their spouse have ever tried to calculate how much money they will need to have saved so that they can live comfortably in retirement (the all-time high was 53% in 2000). Not surprisingly, workers reporting that they or their spouse participate in a retirement plan are significantly more likely than those who do not participate in such a plan to have tried a calculation (49% vs. 15%).

Now, over the quarter-century (and change) of its publication by the nonpartisan Employee Benefit Research Institute, the Retirement Confidence Survey has produced any number of interesting, compelling, and even startling findings. And yet, the one that continues to puzzle me is not the percentage of workers who say that they have ever tried to calculate how much they need to save for a comfortable retirement – but the proportion of those who say that evaluation was based on… a guess. That’s not a finding included in this year’s RCS, but in the past, it was as much as 45%.

Several years back, those individuals were asked how much they need to save each year from now until they retire so they can live comfortably in retirement; one in five put that figure at between 20% and 29%, and nearly one-quarter (23%) cited a target of 30% or more. Those targets are larger than one might expect, and larger than the savings reported by RCS respondents would indicate.

All of which brings to mind the following; were the savings projections so high because so many workers didn’t do a savings needs calculation — or did participants avoid doing a savings needs calculation because they thought the results would be too high?

Or both.

Benchmarks can provide a ready and relevant measure of progress against goals. But if the goal is short of the need, the benchmark may be of little use.

There’s an old saying: “If you don’t know where you’re going, you’ll probably end up somewhere else.” And indeed, for many retirement savers who are relying on unreliable benchmarks, that “somewhere else” could be a pretty unpleasant destination.

- Nevin E. Adams, JD

4 Reasons Why an Average 401(k) Balance Doesn’t ‘Mean’ Much

In recent days, we’ve gotten updates on average savings rates and 401(k) balances, and while for the very most part the reports have been positive and “directionally accurate,” I’ve always taken such findings with a grain of salt. Not so many in the press.

Indeed, the press coverage of those reports is generally quite negative, in the “how can people possibly retire on those small amounts” vein.

Here are four things to keep in mind about those “average” 401(k) balances.

Your average 401(k) balance may not be based on very many plans or participants.

Some reports of plan design trends and average balances may do so based on a relatively small customer base, and/or homogenous plan size. That doesn’t mean the results are without value – but let’s face it, sample size matters in discerning trends. The average 401(k) balance in a universe of 50 plans is surely less instructive than one that is a hundred times that size. In all surveys, sample size matters. And when it comes to averages, it matters a lot.

Your average 401(k) balance includes some very different people and circumstances.

Your average “average 401(k) balance” includes a broad array of circumstances: participants who may (or may not) have a DB program, who are of all ages, who receive widely different levels of pay, who work for employers that provide varying levels of match, and who live (and may retire) in completely different parts of the country. You might even have situations where ex-participants (who have zero balances in this plan, but might have balances elsewhere) are included in the mix. Those are all factors with enormous impact in terms of evaluating retirement income adequacy, and yet, because it is an average of so many varied circumstances, the result is almost never “enough” to provide anything remotely resembling an adequate source of retirement income.

This conclusion that the average is woefully inadequate as a retirement income measure is the main point, and often the only point, that is reiterated somewhat incessantly (and generally without the caveats about its somewhat tortured compilation) in the press.

Your average 401(k) balance doesn’t include the same people.

People change jobs all the time, and with astonishingly persistent regularity. High-turnover plans and plans in high turnover industries, almost by definition, will pull down averages. And when workers change jobs, they “start over” in their new employer’s plan. The bottom line is that the average 401(k) balance from a year ago almost certainly doesn’t include exactly the same participants. So exactly how valid are trendlines in average balances among completely different individuals?

Mitigating the distortions inherent with these averages, the nonpartisan Employee Benefit Research Institute (EBRI) makes a point of reporting on consistent 401(k) savers, specifically in its most recent analysis, participants who were part of the EBRI/ICI 401(k) database throughout the five-year period of 2010 through 2015. Their report finds that this consistent group had median and average account balances that were much higher than the median and average account balances of the broader EBRI/ICI 401(k) database. How much higher? Nearly double at the average, and consistent participants had nearly four times the median account balance of the broader group.

Makes you wonder about all those conclusions based on the averages of inconsistent participants…

Your average 401(k) balance doesn’t include the same plans.

It’s not just workers who move around – 401(k) plans change providers all the time. And when they change providers, their plan and participant balances move as well. So, if in 2015 your plan (and 401(k) balances) were being recordkept by Provider A, those balances would be picked up in their report of average 401(k) balances. Now, you change to Provider B in 2016. All of a sudden your plan’s account balances “disappear” from Provider A’s reporting – and now show up in the numbers reported by Provider B. The net effect? Well, that could mean that the average balances as reported by Provider A decrease – not because of any change in savings behaviors, but simply because a plan (and its accompanying balances) have moved to a different provider’s base.

Yes, I’d say that your average 401(k) balance is, generally speaking, mathematically accurate – and, at least in terms of ascertaining the nation’s retirement readiness, nearly completely useless.

- Nevin E. Adams, JD

Tax Reform – ‘Tricks’ or Treat?

A few weeks back, my wife and I went to see the updated version of It. Now, I’ve been a fan of King’s work ever since a friend shared a copy of Salem’s Lot with me, though his work doesn’t always translate as well to the big screen. “It” is a malevolent entity that emerges about once every 27 years to feed, during which period it takes on various shapes designed to lure its prey – generally children, and then it returns to a hibernation of sorts. “It”’s most notorious incarnation is, of course, Pennywise the Dancing Clown (the lovely visage below).

Ironically, tax reform too seems to be a once-in-a-generational thing. It’s been 30 years since the Tax Reform of 1986 cut tax rates1 – and cut into retirement plan saving and formation with the creation of the 402(g) limit (and its tepid COLA pace), not to mention the cost and timing issues associated with multiple iterations of the nondiscrimination testing that often produced problematic refunds for the highly compensated group. There’s little question that those changes (and others) did what they were designed to do – generate additional tax revenue by limiting the deferral of taxes. But what did those constraints do for retirement security?

Much of that damage wasn’t repaired until – well, 2001 with the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) – which, somewhat ironically, introduced the concept of the Roth 401(k).

Rothification Response

While tax reform has wrought its damage on retirement savings before, this time around a new way to raise revenue has emerged – “Rothification,” loosely defined as the limiting or elimination of the current pre-tax contribution limits.

We don’t really know what workers would do confronted with that kind of change (the surveys that are available – though not completely on point suggest that the response might be modest) – though we do know that if current participants continued to save at the same rate, retirement readiness would likely improve. There are also signs that it would be seen as a big enough change that some, perhaps many, plan sponsors would want to rethink, if not reconsider, their current automatic enrollment assumptions.

We may not know with certainty those outcomes, but there are lots of reasons to be nervous, if not downright fearful of change to retirement plans, particularly one that seems likely to give plan sponsors – and plan participants – a reason to rethink their current savings rates. Granted, surveys show that most plans already offer a Roth option, and more recent surveys indicate that most plan sponsors would continue to offer a plan even if the current pre-tax option for 401(k)s was reduced and/or eliminated (and how sad would it be if a plan sponsor decided to walk away from offering a plan just because the pre-tax savings option was clipped).

We also know that more than half of current 401(k) contributors would be affected by a $2,400 pre-tax contribution limit, based on data from the non-partisan Employee Benefit Research Institute (EBRI), using their Retirement Security Projection Model® (based on information from millions of administrative records from 401(k) recordkeepers), and that the impact reaches down to some very moderate income levels.

That said, we don’t yet know – and this is significant – if the tax reform proposals that emerge this month will include some version of Rothification, nor at what level the Rothification restriction might be imposed (as it turns out, Rothification was NOT included in this first round!).

‘Pass’ Tense?

Consider the recent “unintended” consequence of a proposed tax break for pass-through entities (i.e., partnerships, S corps, and small business limited liability corporations). More than 320,000 of these entities sponsor a retirement plan (with the average size being 75 employees) – unfortunately, many of these businesses may reconsider adopting or maintaining a qualified retirement plan because of significant financial disincentives woven into the fabric of the tax reform proposal, which would establish a 25% maximum pass-through rate on that business income, versus the 35% top rate on ordinary income (as well as the favorable tax rate on capital gains income at 20%) that would be assessed when the money is withdrawn at retirement. In other words, the small business owner’s plan contributions and accumulated earnings will be taxed at 35% instead of the 25% pass-through rate and the 20% capital gains rate on accumulated earnings.

There are some things about tax reform proposals that we do know. One, that lawmakers – and sometimes regulators – often seem to operate on the assumption that employers will, and indeed must, offer a workplace retirement plan no matter what changes or cost burdens are imposed on plan administration. With an eye toward narrowing the benefit gap between higher-paid and non-highly compensated workers, limits are imposed that often outweigh the modest financial incentives offered to businesses, particularly small businesses, to sponsor these programs. This, despite the striking coverage gap among those who work for these small businesses, and the potentially burdensome administrative requirements and additional costs that the owner must absorb, alongside a pervasive sense that their workers aren’t really interested in the benefit (or, perhaps more accurately, would prefer cold, hard cash).

The debates about modifying retirement plan tax preferences – or the notion that these preferences are “upside down,” and thus may be dispensed with – are bandied about as though those changes would have no impact at all on the calculus of those making the decisions to offer and support these programs with matching contributions. In other words, while some attempt is made to quantify the response of workers to changes in their incentives, most studies simply assume that employers will “suck it up.”

Well, this week the GOP is slated to unveil its proposal for tax reform in the House of Representatives, and shortly thereafter we should see a separate GOP proposal emerge in the Senate. Those will have to be reconciled, and these days that’s no slam dunk.

It remains to be see what tax reform – with all its laudable objectives – might mean for retirement plans this time around. But here’s hoping that, if tax reform turns out to be “Pennywise,” it won’t be “pound” foolish.

- Nevin E. Adams, JD

Footnote

1. And the time before that was 1954… with the creation of the Internal Revenue Code.