A 'Cure" Worse than the Disease?

Last week, a trio of academics rolled out a plan to “save” Social Security—by undermining the 401(k).

Their “plan” is diabolically simple, though not unique. They’d just take away the tax preferences that support and encourage employment-based retirement plans—and “give” that money to Social Security. 

It was admittedly an odd combination—Alicia Munnell, director and founder of the Center for Retirement Research at Boston College (which often has pretty negative things to say about the private retirement system[i]), and Andrew Biggs, a senior fellow at the American Enterprise Institute, who has traditionally been a voice of reason on such matters—pointing to actual tax filing data to refute claims of a retirement crisis. Then again, Biggs, a former principal deputy commissioner of the Social Security Administration, and now a Senior Fellow at the American Enterprise Institute, has recently been nominated by President Biden to serve on the Social Security Advisory Board.       

Now there’s no question Social Security needs help if it’s to provide the benefits promised generations of American workers into the future.      

Some Assumptions

That said, their underlying premise in crafting this “solution”[ii] is that the tax incentives of the current private retirement system do little, if anything, to encourage participation. This conclusion seems to be based on “an economist’s lifestyle model”—previous reports by the CRR—and (now old) data from a study of Danish workers in a system that bears little resemblance to our own in terms of baseline assumptions and workplace demographics to conclude that savings behaviors won’t be impacted. 

They also choose to ignore the enormous opt-out rates among the state-run IRA programs that are three to four times that of those in the private system—state-run IRA programs that, it bears noting, lack the tax incentives of the 401(k). Oh, and then certain assumptions (SO many assumptions) are applied to estimate the “cost” to the government of the tax deferrals. 

That—and they completely gloss over the reality that these preferences are a DEFERRAL, not a forbearance of tax liability—unlike the tax preferences that riddle the federal income tax code at present, and which represent an actual, permanent “loss” to the federal government in terms of tax revenues.  

And Some Presumptions

But the biggest assumption they make—and it’s a BIG one—is that the lack of tax incentives will have no impact on the decision of employers to offer these programs, or to contribute to them. This happens to be a common assumption among those who reside in, or commune with the Beltway environs, most of whom it appears have never actually spoken to an actual employer.

Let’s face it, on an individual level, the incentives for higher-income workers, though real, are relatively modest. But then, and at odds with the assumptions of this paper, the true behavior subsidized by the tax preferences isn’t those individual contributions, but the very creation and maintenance of these plans by employers—that would otherwise be disinclined to take on such burdens in the first place, much less support and incentivize participation with things like the employer match. Ignored as well are the non-discrimination testing mechanisms that bound in the contributions of higher paid relative to the so-called non-highly compensated[iii]—and encourage dynamics like the employer match.

Remember as well that actual data supports the notion that even modest income workers—those making between $30,000 and $50,000 a year—are somewhere between 12 and 15 times more likely to save for retirement if they have access to a plan at work versus doing so on their own. Sure, perhaps the wealthiest would save on their own regardless—but without the plan established by the employer, those in the lower income brackets almost certainly would not. 

Let’s be honest; the 401(k) is the only way we have ever gotten working Americans to save for retirement—and they, and the employers that underwrite those programs, have done so voluntarily. Those who have access to those programs are doing well. The only problem with the 401(k) is that not enough working Americans have access to one. 

Common sense dictates that you don’t fix something that’s broken by breaking something that’s working. And this “solution” would likely do just that.

- Nevin E. Adams, JD

 

[i] … and has a record of relying on questionable data to craft conclusions.

[ii] The Case for Using Subsidies for Retirement Plans to Fix Social Security

[iii] See "Upside" Potential

‘Nothing’ Doing About Social Security?

Despite long being called the “third rail” of American politics, Social Security—or more precisely its viability—has reemerged as an issue in the 2024 presidential campaign.

It came up most recently in a mini-GOP debate between former U.N. ambassador/South Carolina governor Nikki Haley and Florida governor Ron DeSantis. Haley reaffirmed her previous statements that changes would be required to shore up the financial viability of that system (and, arguably more critically, Medicare)—taking pains to emphasize that she wasn’t calling for changes that would impact current/close-to-retiring individuals. 

For his part DeSantis—to whom the question was initially posed—maintained that there was no need to raise the age for full retirement benefits (apparently due to COVID’s impact on life expectancy), as though that were the only potential remedy required[i] (he did express confidence that something would be worked out long-term). And both former President Trump and President Biden have locked in on a “no changes” stance—criticizing any notion of reform as doing a disservice to seniors.[ii]

What’s weird to me[iii] is that those who seem to blithely embrace the “no changes needed” mantra aren’t getting the follow-up question; “but if we don’t change anything, won’t benefits have to be cut?”

Look, I’m now on the collection side of that equation—having contributed to that system what the law said I (and my employer(s)) had to in order to receive a certain benefit decades in the future. The notion that I would have done that for more than four decades only to then have my “promised” benefits reduced does NOT appeal to me in the slightest. Particularly since, going back to the 1980s, my withholding taxes were increased, my full retirement age extended, and my ultimate benefits are now means-tested (a.k.a. “reduced”)—ostensibly to avert a current and future such crisis.

But if the math that we’re presented with is accurate, there’s no way we can maintain the “status quo” on benefits without some change(s)—presumably to those who, like I was in 1983, are several decades away from collecting benefits. In fact, the Social Security Board of Trustees has projected that the looming 2037 “shortfall” means that changes equivalent to an immediate reduction in benefits of about 13%, or an immediate increase in the combined payroll tax rate from 12.4% to 14.4%—or some combination of these changes—would be “sufficient to allow full payment of the scheduled benefits for the next 75 years.”  

Without a doubt, Social Security is most certainly the biggest retirement assumption—by individuals, retirement planners and legislators alike. At a time when we’re working to broaden coverage, to expand the impact of automatic plan design features, and the reach of state-run IRA programs, we know that as valuable, even essential, as those steps might be in broadening and deepening the success of the private retirement system—they won’t be “enough” if we don’t shore up the baseline foundation upon which the nation’s retirement security is currently predicated. Those who oppose “reform” without acknowledging the need for change may find that a popular point of view—but it’s really just whistling past the proverbial graveyard.    

That said, and whatever the presidential aspirants espouse, it will be up to Congress to remedy the situation. That’s not a recipe for hope, mind you—but it is a reality check. 

While Social Security reform may not be at the top of your list of candidate considerations, I’d argue it should be on that list—for those you support, those you love—and you.

- Nevin E. Adams, JD

 

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[i] Outside the debate hall he has previously supported making those benefits tax free—essentially eliminating the “means-testing” provisions currently in place that tax benefits above certain income levels.

[ii] Vivek Ramaswamy (while still a candidate) basically says no cuts for seniors—and even hints at a reduction in current levels of “means” testing—but ultimately positions that as a boon for the economy, which will help put Social Security on a firmer financial setting, and then at least partially privatize Social Security.  

[iii] What’s also weird to me is that it’s hard to find anybody who seems to think the problem won’t get fixed at some point—though the definitions of “fixed” vary—and nobody is willing to hazard a guess on who’s going to step up, much less when or how.

Is It (Finally) Finally Time?

Two headlines on NAPA Net caught my eye this past weekend—provocative “what if” type questions.

I’m talking about “Will Retirement Income Solutions Finally Break Through in 2024?” and “Will Managed Accounts (Finally) Take Hold as QDIAs?” Both, of course, included the word “finally” in the title(s)—no doubt because the underlying premise has been touted in previous years, but (mostly) come to naught.  And yet even now, both were basically based on predictions of organizations/individuals that have—as my friend John Sullivan put it—“a dog in the fight.”

More specifically, the former finds heightened plan sponsor interest expressed (in an annuity-friendly trade survey)—and provisions in the original SECURE Act. And the latter finds a similar level of interest by plan sponsors in trading out target-date funds as QDIAs for managed accounts—on a premise that fees in the latter will decline and that recordkeepers will be able—and plan participants willing—to incorporate more personalization in their models.[i]      

Not that having a vested interest in the outcome precludes one from accurately assessing future trends—though it seems prudent to accept those particular forecasts with a grain of salt. Indeed, one might argue that the current disappointment in adoption—and take-up rates—of these programs is, at least to some degree inspired by what often seems the unbridled optimism of firms/organizations on those prospects reported as a fait accompli!

Don’t get me wrong; there’s little argument that both developments could represent a significant enhancement in the retirement prospects of 401(k) savers—if properly designed, priced and implemented. 

All of which leaves the industry at large proclaiming the need for these “evolutions”—and yet scratching our collective heads wondering why the take-up rates are so…disappointing. Now, you can’t really be surprised that product advocates are inclined to see a bright future for their wares—indeed, predicting an "expansion" of interest seems like a no-brainer (particularly if one demurs on a specific definition as to how much). But let’s be honest; plan sponsors will NOT be sued for not offering retirement income—there is, quite simply, no legal obligation to do so. On the other hand, managed accounts that aren’t truly personalized will—and have—been sued for costs that exceed allegedly comparable target-date fund options.     

Indeed, where things often fall apart lies in the reality department in those details—or in skepticism about the realities of those details. Retirement income as a concept is a laudable goal of retirement plans—but concerns remain about the efficacy of the solution, not to mention its cost and portability.  Ditto managed accounts which, in any number of situations, appear to be little more than an expensive target-date fund—so much so that advisor-respondents to the 2023 NAPA Summit Insider characterized them as a negative game changer. 

That said, and to the premise of the articles cited above, this is not the first time that those bright futures have been predicted.[ii] There are, of course, any number of reasons/rationalizations for those past disappointments—but I’m not sure this time will actually be any different (feel free to push back in the comments section). More's the pity because I think your average participant could surely use help on these fronts.

Let’s face it; TDFs were "easy" (arguably easier than they should be)—and they solved a here-and-now problem. Retirement income remains "hard"—and (eventually) solves a problem for workers, but not plan sponsors. Quite the opposite—as it creates difficulty for the plan sponsor in the here-and-now. There's progress on that front, for sure—but likely not (yet) enough to matter. 

As for managed accounts—it seems to me their prospects rely on two developments: (1) plan sponsor willingness to replace their TDF QDIAs with managed accounts (and that’s by no means certain, despite Wilshire’s enthusiasm); or (2) the realization of the personalization promise of those options. At that latter point, it would seem to speak not only to the expressed need of participants, but to the ability for plan fiduciaries to provide more than the “blunt instrument” of a target-date fund. What remains to be seen is if plan fiduciaries will be willing to trade en masse the “comfort” of the pack’s TDF adoption for the variability of truly individualized portfolio management in a default option?     

What It Will Take

Despite what may seem pessimism on those prospects, I think the key to shifting the needle of adoption against those impediments will require that plan sponsors who HAVE made those adoption decisions be willing to talk about it. Consider IBM’s recent announcement regarding trading off its matching 401(k) contribution for an employer cash balance contribution. While it’s an innovative shift, it’s not likely to be widely adopted—and yet for weeks after that one plan sponsor announcement, the industry was all a buzz for the possibilities…of a return to defined benefit plan designs. 

So, if you are—or have—a plan sponsor client that has embraced, adopted (and hopefully implemented) a vibrant, highly personalized managed account solution—or a retirement income option for participants on the menu—we want, no need, to hear from you. We need to know that it’s more than just a good idea; we (all) need confirmation that it’s practical, efficient and appreciated. 

Failing that, we’re likely to continue to wonder if it’s (finally) finally time…again.

  - Nevin E. Adams, JD

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[i] The trends report here also envisions an uptick in interest in retirement income options.

[ii] It might help to set (more) realistic expectations. Rather than these periodic surveys/reports which “transform” mere expressions of interest into presumptive action, we need to acknowledge (as most of us do, at least in person) that these are complicated decisions—and decisions that are being made in the midst of a highly litigious environment.

(Not-So) ‘Common’ — Wisdom

There is a “common wisdom” in our business that suggests that all plan sponsors are, more or less, alike; that large plans are the inevitable early adopters of trends that, sooner or later, trickle down to plans of all sizes.

Consequently, those who make their living trying to discern trends and patterns frequently focus on the behaviors in evidence at larger programs—figuring that, in three years or so, those same characteristics will emerge across the spectrum.

There’s some logic to that perspective—and at least anecdotal evidence to support it. Human beings—including plan fiduciaries—frequently draw comfort and solace from the experience of others, and smaller programs can hardly be faulted for adopting plan designs and approaches that have been “vetted” by programs with more copious resources.

Sure enough, there are areas in which larger programs once dominated—but over time those variances have disappeared. For example, according to the Plan Sponsor Council of America’s 66^th Annual Survey of Profit-Sharing and 401(k) plans, there is now essentially no difference in the availability of Roth options (more than 90% across the board do), and no longer any difference in permitting catch-up contributions (also about 90% for both the largest and smallest plans)—and just about the same percentage of workers took advantage of this feature. Nearly all plans of all sizes accept rollovers from other plans—while just under half of plans of all sizes encourage roll-ins. And while it’s hardly common, in-plan annuity options are to be found at about 1 in 10 plans, regardless of size.

That said, I have always found it dangerously simplistic to assume that small plans will, inevitably, follow along eventually in the footsteps of their larger cousins.

‘Less’ Likely

On the other hand, consider that—and this has long been the case—that the smallest employers (those with less than 50 employees) were significantly less likely to offer automatic enrollment than the largest programs—those with 5,000 or more workers (28.9% versus 71.8%), according to the Plan Sponsor Council of America’s 66^th Annual Survey of Profit-Sharing and 401(k) plans.[i] 

There’s also a big gap in opening the door to participation; more than three-quarters (77.9%) of those larger employers now offer immediate eligibility, versus just 30.4% of smaller employers, and 37% of those with 50-199 workers. Indeed, the most common for smaller employers remains a year. Similarly, to receive matching contributions, two-thirds (62.2%) of the largest plans allow them immediately, while just 28% of smaller employers do—and 45.7% overall. Therein lies some of the danger in relying solely on the aggregate responses in discerning trends—like averages in any assessment, they can obscure considerable variances in the underlying responses.

Note that the largest plans were also significantly more likely (93.1%) to report having an investment policy statement (IPS) than were the smallest plans (though more than two-thirds of those did). There’s some irony to be found in the reality that while just over a third of the smallest employers have 26 or more fund options available on the menu, only half as many (17.1%) of the largest have that many (roughly a third have 11-15). Smaller plans were also notably less likely to review those options; only half did so on a quarterly basis, compared to 81% of the largest programs.

Advisor Attributes

There were also differences in advisor compensation; the vast majority (81.1%) of the largest programs are using a fixed fee, while only about a quarter of the smallest are (60% of those are using a percentage of assets basis). Robo-advisors were much more typical (28%) at the largest plans than the smaller programs (7.8%). The smallest plans were notably more reliant on advisors[ii] for retirement committee plan education (75.9%), while the largest plans were more likely to lean on an ERISA attorney (68%) than an advisor (37%). 

The largest plans were notably more likely (6.4%) to be considering a change to provider or advisor in 2024 than the smallest (2.7%). On the other hand, 6% seemed to be a pretty solid response across the board.

Having worked for huge firms—and considerably smaller ones—I can tell you that, when people come together in groups, they are not as different as you might think (or hope, as the case may be). That said, resources and priorities differ and often diverge. Those who target specific niches—be they industry, geographic or plan size—are well advised to be alert to the potential divergence from the “common wisdom” of industry trends.

After all, we may all be alike—but that doesn’t mean we’re all the same.[iii]

- Nevin E. Adams, JD 

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[i] Though that’s likely at least partially attributable to the preponderance of safe-harbor plan designs—73.5% of smaller employers were safe harbor plans, compared with 36.7% of larger employers.

[ii] This actually was the case for all plan sizes other than 5.000+, with somewhere between three-quarters and two-thirds of responding employers noting that the advisor provided that education.

[iii] Of course, to see those plan size breakdowns, you need the full report—details on how to obtain it can be found at https://www.psca.org/research/401k/66thAR