Fighting Words

“[T]he complaint is a rambling 38 page collection long on legal argument, public policy rhetoric and repetition, but vague in its allegations of facts which might be relevant to the claims alleged.”

With all the tact of a law professor dressing down a first-year student, U.S. District Judge John Shabaz of the U.S. District Court for the Western District of Wisconsin last week dismissed one of the so-called 401(k) revenue-sharing lawsuits brought by the St. Louis-based law firm of Schlichter, Bogard & Denton – and did so in just 18 pages. And he did so “with prejudice and costs.”

It was the second such case to be dismissed. In an even more succinct dismissal in February (two-pages), U.S. District Judge John Darrah said that the 401(k) participants in the Exelon Corp. plan failed to make a "link between the administrative fees they were charged and their market-based losses" (see Court Tosses 401(k) Participants’ Request for Investment Losses Relief).

Not that there weren’t elements of plan structure that might raise eyebrows in some quarters in the most recent case—the agreement between the plan sponsor (Deere & Co.) and the provider (Fidelity) to limit the fund menu to funds managed by Fidelity, for one thing (23 of the 26 funds on the menu were Fidelity’s). And then there is the judge’s matter of fact assertion that “Defendant Deere could have negotiated lower fees with Fidelity Research, or could have selected different funds from different providers with lower rates but has made no effort to do so.” One could readily imagine those exact words being uttered as a stark condemnation of a fiduciary that had failed to live up to its duty—but this court recounted it as a statement of fact, nothing more (and, for the record, there’s no fiduciary bar to doing what Deere did, so long as their motivations were solely in the best interests of plan participants/beneficiaries, and the fees and services so obtained were reasonable). Besides, the plan did offer access to a brokerage window. If participants wanted something beyond a Fidelity offering, they could tap into some 2,500 other alternatives.

Reasonable Doubts?

Furthermore, IMHO, Judge Shabaz was too willing to conclude that, since Deere participants were paying the same for their mutual investments as other investors, the fees must be reasonable. On the surface, the fees weren’t obscene—fees ranged from .07% for the Spartan Fund to 1.01% for the Diversified International Fund, according to the ruling. Still, it’s one thing to conclude that those fees were reasonable; quite another, IMHO, to assume that they are reasonable simply because others (and retail investors, to boot) are willing to pay them.

Still, Shabaz was clear in refuting the notion that the plan had any obligation to delve into the specifics of any revenue-sharing arrangement (“recent proposals to amend the regulations…to require revenue-sharing disclosures in annual reports make it apparent that present regulations do not require it”), and clearer still in rebuffing the notion that there was an obligation to share those details with plan participants (“Nothing in the statute or regulation directly requires such a disclosure”). Additionally, Shabaz concluded that the fee disclosures included in the Summary Plan Descriptions (SPDs) and prospectuses were sufficient for participants to make informed investment decisions—or at least that requiring more would “require judicial expansion of the detailed disclosure regime crafted by Congress and the Department of Labor pursuant to its statutory authority.”

While he acknowledged that some of the issues raised were undergoing reconsideration (1), when all was said and done, he found no merit in the claims, concluding in effect that it appeared “beyond a reasonable doubt that the plaintiffs can prove no set of facts in support of the claim which would entitle the plaintiffs to relief.”

One should be cautious in drawing too many conclusions from this result, of course. In the same way that lawsuits contain only one side of the situation, dismissals all too often shuttle aside potentially triable issues, not because the issues aren’t there, but because plaintiff’s counsel didn’t make an effective presentation. Still, on the issue of revenue-sharing disclosures, I think Shabaz got it right.

When the cases were first filed I, perhaps like many of you, was no doubt surprised that these kinds of allegations were applied to some of the largest 401(k) plans in the nation—plans that, by any reasonable assessment, probably had the staff and plan-size “clout” to get such matters “right.” Of course, they also had the size that makes for “deep pockets” and public brand(s) that typically eschew the kind of publicity that accompanies a lawsuit and facilitates a quiet settlement.

This time, however, it seems that they have a willingness to fight back.

- Nevin E. Adams, JD

(1) “A review of the report confirms that the revenue sharing issue raised by plaintiffs’ complaint is a matter of policy concern within the Department of Labor. It also unequivocally confirms that present regulations do not require disclosure of the information.”

Caveat Emptor

A couple of weeks ago my better half told me that she thought it was time that we traded in two of our aging vehicles – one a car that is too small for our family, the other a van that now seems too big for all but cross-country trips – for something in the middle. I was amenable to the idea – until she mentioned that she didn’t think we needed to buy a new vehicle as a replacement.

If you have ever in your life purchased a “pre-owned” anything, you’ll appreciate the dangers inherent in the principle of caveat emptor, literally “let the buyer beware.” That’s why, to this day, the notion of purchasing a used car practically causes me to break out in cold sweats. Not that lemons don’t roll off the new car lots every day – but there, at least, it seems that your odds are better – if not in terms of product, at least of obtaining satisfaction if something doesn’t work out.

Buying a used car is, of course, as much art as science – particularly if you aren’t mechanically inclined. That’s why it has become fairly common to enlist the support of a trusted mechanic to assess the reliability of a potential vehicle purchase. Of course that works only if you actually HAVE a trusted mechanic to rely on. In my experience, the only way – outside of a personal relationship - for a mechanic to have earned that trust is for you to have spent a lot of time at the garage (which, of course, may be why you are looking for a different vehicle in the first place).

Plan sponsors are increasingly looking for guidance on what constitutes reasonable, and – spurred by the flurry of recent 401(k) plan lawsuits, and the increasing level of scrutiny applied by regulators and lawmakers – have, logically, tended to be dominated by a focus on fees.

It’s hard to argue with the “clarity” of that focus, but what do you think would be the result if my used car purchase used cost as the only criteria? All things being equal, cost may be a perfectly adequate point of differentiation, but all things are seldom “equal”. When it comes to used cars, common sense dictates that a vehicle in better condition could well be worth more than an identical make and model that has been handled roughly. And we all know of “cheap” car purchases that have more than made up for that initial price differential in terms of subsequent trips to the repair shop.

Things are even more complicated with retirement plans, where plan design flaws are often obscured, and where subtle restrictions and operational limitations don’t appear until well after that finals presentation. Fortunately, ERISA doesn’t require “cheapest.” However, it does call for plan fiduciaries to make decisions that are solely in the best interests of plan participants and beneficiaries, to ensure that those decisions culminate in the selection of services (and fees for those services) that are “reasonable” – and to do so with the insights and perspective of an expert in such matters, or to enlist the support of those who are.

Failing that – “caveat emptor’.

Nevin E. Adams, JD

Moving Targets

In nearly 30 years working with employer-sponsored retirement plans, I am hard-pressed to call to mind a product innovation that has been adopted with as much vigor as the current generation of target-date funds. In PLANSPONSOR’s 2006 Defined Contribution Survey, more than three in four of the nearly 5,000 responding plans had a risk- or target-date-based option on their menu – compared with “just” 54% in the prior year’s survey.

There’s being on the menu, of course, and there’s being chosen from that menu. Still, in the 2006 survey, roughly 25% of participant balances, on average, were already invested in such options – and, on the median, 15% - and this well ahead of the Department of Labor’s tacit enhancement of these vehicles as the default investment vehicle of choice. All in all, it would appear that participants have more access to such choices and are beginning to wake to the simplicity of an investment choice that requires referencing little more than a birth certificate (many still make the case that a single investment allocation approach cannot possibly be suitable for each and every participant who plans to retire in the year 2040).

Moreover, the investment management industry has responded to the opportunity with enthusiasm. One need consider only the number of new offerings introduced in 2007 alone to appreciate just how much more choice is available than was the case the last time I penned a column on the topic (see “Style Conscious,” PLANSPONSOR, September 2005). That’s a very positive development for the most part – after all, a lack of choice was, in the very recent past, a cautionary note of consideration for plan fiduciaries. Additionally, as the choices have expanded, competition (not to mention a renewed emphasis on fee transparency) seems certain to provide a pricing discipline that surely must be applied by fiduciaries, certainly in a “just pick one” fund alternative.

Philosophical Differences

Our free market also has served to bring to the fore a dazzling array of differences in basic asset allocation philosophy. There are compelling arguments being made for allocations that are heavily laden with equities at retirement, while others embrace a more “traditional” fixed-income bent, and still others seek to mirror the allocations in evidence among large defined benefit programs (which themselves are undergoing some fairly radical shifts). These competing notions – and seemingly everything in between – are still often “cloaked,” certainly in the case of target-date offerings, behind names that are frustratingly similar. All claim to be focused on helping the investor achieve retirement security, while minimizing risk – that of running out of money too soon, or of not having enough to run out of in the first place. They can’t ALL be right, surely.

On the other hand, in the midst of all this burgeoning interest, it also has been interesting to watch some of the industry’s more revered asset allocation fund pioneers reinvent and/or rejigger their strategies, their glide paths, the logic that underpins their asset allocation philosophy.

It’s impossible at this point to say who is “right,” of course (perhaps even harder to say that a single investment allocation approach is suitable for each and every participant who plans to retire in the year 2040). Still, IMHO, the industry’s willingness to continue to contemplate and embrace change in these glide paths bodes well, I think, for the intellectual rigor that surely must attend their emergence as a ubiquitous presence on defined contribution plan menus.

What that also means, of course, is that plan fiduciaries will be similarly challenged to keep pace.

- Nevin A. Adams, JD

Life Lines

A couple of weeks ago, I stumbled across a paper published by the National Bureau of Economic Research titled “New Estimates of the Future Path of 401(K) Assets.” In this particular case, “new” appeared to relate to the paper, not the future path of 401(k) assets. Bottom line: 401(k) assets are going to keep growing, and at a better rate over the next couple of decades than they have the past 20 years (there was also a brief article on this paper in the New York Times last week, which you also may have seen syndicated locally). In fact, the paper notes enthusiastically, “We conclude that the increase in the pension assets of future retirees will be much greater than the assets of current retirees.”

This is good news, of course, since such programs seem destined to represent the primary retirement savings in the decades to come. We need them to grow, and we need them to grow faster than they have heretofore, certainly based on the average and, more significantly, median account balances reported from various sources.

Projections of the future are, inevitably, based on understandings and extrapolations of the past, and this paper is no exception. The paper’s authors remind us that 401(k)s are a relatively recent “invention,” with contributions to them beginning only in 1982. Thus, the argument goes, the balances in today’s retiree accounts have not had as long to accumulate as will those who retire 40 years hence. Moreover, they compare data from 1984 with that in 2003 that illustrates a large increase both in the number of workers eligible for a 401(k), and in those actually choosing to participate. In essence, today’s retiree balances have suffered from both a late, and a slow, start relative to the retirees of the future. And, since the retirees of 40 years hence will have had “full” access to the benefits of saving (and investing) via a 401(k) for their entire working lives, they will wind up with more—significantly more—In the way of savings accumulations than their parents.

None of this is particularly controversial logic, though it seems to me that it ignores another reality—that defined contribution savings programs existed well before the advent of 401(k)s. As a mid-range Boomer, I was saving in my employer’s “thrift incentive plan” for the “free money” from a match just as soon as they would let me (waiting a year to be eligible was normal in those days). My savings weren’t pre-tax then, of course (1979)—but the earnings and company match were.

Now, it is entirely possible that the advantages of pre-tax savings drew the attention of workers in the 1980s who had not previously taken advantage of various “thrift” plan alternatives—programs that were (including stock bonus and profit-sharing), in large part, subsumed (in name, anyway) into the newer 401(k). It is equally possible that the nation’s economic resurgence in the 1980s led employers to offer 401(k)s that had not previously offered a defined contribution plan, or that the tightening labor market of the 1990s compelled employers to offer new programs as a competitive advantage. Furthermore, there seems little doubt that the decline in coverage and availability of traditional pensions, and the widespread media coverage of same, has more recently led some to contribute to their own retirement security in amounts they might not otherwise.

Still, while we certainly have more ways to save today, ways that are generally “better” and more “convenient” (don’t even have to fill out an enrollment form these days) than they were 20 years ago, the savings rates I hear reported for younger workers today strike me as remarkably consistent with those of the past. IMHO, choosing to save for retirement, or for any purpose, is—and always has been—about balancing current economic realities with long-term goals. Generally speaking, the former looms larger the younger—and poorer—you are.

There’s little question that the 401(k) has attained a certain ubiquity (though it’s worth remembering that most American workers aren’t covered by a workplace retirement plan). But we shouldn’t assume that just because more workers have an earlier ability to participate in a 401(k) plan—and for their entire working lives—that they will do so. We—and they—can’t afford to.

- Nevin E. Adams, J.D.

The research paper is online at http://papers.nber.org/papers/w13083.pdf

Starting Blocks

There’s little question that automatic enrollment “works,” at least in terms of turning employees into participants—just as there is little doubt that, left to their own devices, too many employees remain on the retirement-savings sidelines.

However, as I talk to advisers, third-party administrators, and plan sponsors around the country, I’m increasingly aware that the Pension Protection Act’s automatic enrollment safe harbor is more unpalatable than one might have imagined on first blush. Sure, automatic enrollment is an effective way to get people into the plan—but that 50% matching requirement on an escalated contribution (Congress apparently thought that a 50% match up to 6% of pay deferral was “normal,” rather than merely common among larger plans), particularly on participation levels escalated by automatic enrollment, is simply too expensive for many. And many, already taking advantage of the current safe harbor designs, simply don’t need the discrimination testing shield that the PPA’s version offers as a carrot to offset the match’s “stick.”

As that realization sinks in, I am increasingly asked about other ways to turn more workers into participants. Here’s a quick list:

(1) Start Sooner. The typical plan still makes people wait to join, generally as a matter of administrative practicality—Why go through the paperwork of setting someone up who is going to leave in three weeks, after all? Still, I wonder how many people we lose to the “take the package home, discuss it with your spouse, and turn it in 90 days hence” message that is part-and-parcel of today’s enrollment mentality.

(2) Start Simpler. A growing number of providers now make available something they call “ez-enrollment,” or something to that effect. Workers only have to pick a deferral amount in some cases, while others ask them to pick a deferral amount and perhaps one target-date fund.

(3) Return “Engagement.” Even if there are good reasons for making people wait to join, there’s no reason to let them off the hook. Certainly, these are voluntary programs, but there’s no reason you can’t make workers return the enrollment form, even if it is just to say “thanks, but I’m not interested in participating now.” You can make them turn the forms in at the same time all the other employment-related forms are turned in (even if you don’t start withholding contributions for a period of time), or you can simply build a reminder system of some sort to ensure that they turn the forms in. You might be surprised how many, forced to do so, actually become participants (see also Participant Directives - I
).

(4) Meetings Matter. Admittedly, mandatory enrollment/education meetings bring with them certain “complications”—but it’s hard to persuade the unconvinced to join the plan if you only preach to the choir (the ones who come voluntarily are generally already committed to the process).

(5) Management Matters. Make sure that the boss is in the room for the enrollment meeting, and give them a speaking role. First, if the boss is there, voluntary meetings quickly become mandatory (see above). Second, if the person who signs their paychecks tells them how important this is, that message is almost certainly more impactful than the perspective of an “outsider” (see also Meeting Minders).

(6) Make Missionaries. One of the most effective encouragements to workplace savings is the workplace leaders. These can be supervisors, of course, but sometimes the hierarchies are less formal than that. These are the folks that everybody else listens to—respected individuals in the workplace who, once they are committed to the program, can talk up the plan, the benefits, etc. during the regular work day on the shop floor—long after you’ve packed up the presentation and gone home. These folks can (and do) preach the gospel of savings—and those who don’t save feel pretty stupid for not doing it. An additional benefit? They can help reach across barriers of language, race, etc. They literally speak the language.

Finally, it may be worth reminding employers who have a problem with the “strings” attached to the safe harbor automatic enrollment design that they can still do automatic enrollment outside of the PPA’s auspices. They’ll miss out on some of the PPA’s protections, of course, but, ultimately, they’ll likely get what they most care about—better participation rates.

- Nevin Adams

A Prospective Perspective

Plan sponsors (and advisers) who think the Pension Protection Act’s automatic enrollment safe harbor represents an easy solution to disappointing participation rates may have another “think” coming, according to the findings of recent industry data—Including PLANSPONSOR’s own 2006 Defined Contribution Survey.

The 10th annual version of PLANSPONSOR’s assessment of the activities of nearly 5,000 plan sponsors found that the median participation rate for plans that had implemented automatic enrollment was 80%. Now, that’s certainly nothing to sneeze at, but it’s not very much ahead of the 75% median rate for the plans in the same survey that had not taken the step toward automatic enrollment—and it’s well short of the outcome that one normally sees touted alongside that option (generally in the 90-95% participation range).

Our survey was based on the experience of plans that had adopted automatic enrollment prior to last summer’s passage of the Pension Protection Act of 2006 (PPA), along with its new automatic enrollment safe harbor (which kicks in next year). Still, since most of those programs have been in place now for more than two years, one might well expect a “better” result.

Traditionally, caution has ruled the day in adopting automatic enrollment. That caution has generally meant that relatively modest deferral rates were chosen, that contributions were invested in relatively conservative options, and that the program was implemented on a prospective basis—only for workers hired after the implementation date. Indeed, for many plan sponsors, the still-active assumption is that workers who had previously “chosen” not to participate (generally by not returning the enrollment form) have effectively already made their decision—to let “sleeping dogs lie.” Nor is this common presumption likely to change of its own volition even with the passage of the PPA, whose automatic enrollment safe harbor does not require a retroactive application.

In fact, IMHO, it seems quite likely that this decision to implement these programs on a “prospective only” basis likely accounts for the negligible uptick in participation rates in automatic plans reporting in PLANSPONSOR’s DC Survey.

What it does mean is that plan sponsors looking for a silver-bullet solution to their participation problem (not to mention the advisers touting such programs as same) may wonder why their prospective solution isn’t turning out to be quite the panacea for those ills they had been led to expect.

While plan sponsors are understandably reluctant to rouse those “sleeping dogs,” it’s hard to imagine that they aren’t just as concerned about their retirement well-being as those that have just been brought on board. The ultimate solution, of course, lies in understanding that the reasons some newly eligible workers chose not to participate—or more likely made no choice at all —are the same reasons the not-so-newly eligible are still on the sidelines.

That, and being willing to do something about it.

- Nevin Adams

Attention Deficit Disorder

We have long been concerned about the attention deficit of participants when it comes to their 401(k) plans. There’s the problem of getting them to pay attention to the importance of saving in the first place, and of choosing an appropriate level of savings, the challenge of helping them make sound investment decisions—and the biggest challenge of all, getting them to reconsider those choices over time. Our continued inability as an industry (I realize there are pockets of exception to this rule) to fully engage participants on the issue has, ultimately, led to the adoption of automatic plan designs that don’t require the participant to “do” anything other than write the check.

I have a more radical solution to the problem: Let’s make people sign up for their 401(k)—every year.

Before you spit up your morning beverage (apologies if it’s too late for that), hear me out. I will concede that signing up for a 401(k) plan can be a daunting task for a participant, and that it is already logistically challenging for employers (and advisers) to accommodate annual meetings for new workers. But consider this: Is it any more onerous than the annual decision(s) attendant with health-care plan enrollment?

Starting Blocks?

In many ways, the “automatic” solutions are a band-aid, at best. The Pension Protection Act’s automatic enrollment safe harbor requires only a 3% contribution from workers who don’t contribute actively, and steps that up by only 1% a year, and then only until it reaches 6%. That’s where many participants start contributing today, of course—and don’t tell me that an automatic enrollment program won’t turn some (perhaps many?) who today take the time to fill out the forms into defaulted savers in the future. Ironically, the PPA could actually serve to reduce some deferral rates, left unattended (see “Starting Blocks”).

Think those target-date fund defaults will fix poor asset allocation decisions? Perhaps for those that adopt them—but many (most?) plan sponsors seem only to be interested in adopting the change prospectively, doing nothing for those who are already enrolled in the plan. And the PPA’s safe harbor only requires prospective adoption for the automatic enrollment provisions.

Still, even if the PPA’s automatic solutions aren’t a perfect solution, even if they require some implementation oversight, why would I suggest that we make participants (and employers) undertake the painful process of enrollment every year?

I have long thought that the concept of saving for an ambiguous goal like “retirement” was just beyond the short-term comprehension of most people. Just about everything else we focus on has a much shorter term—we have annual budgets, monthly expenses, weekly meetings. Additionally, saving for retirement has largely been presented as something you need to do - - - someday. Most plans don’t allow for immediate eligibility (I appreciate the administrative rationale for some high-turnover workforces), and the vast majority of programs don’t even require that the 401(k) enrollment form be returned, much less completed (see “Participant Directives”). Contrast that with your workplace health-care program—the one you have to choose every year, and return the form—or have a program chosen for you.

Decision Points

Still, to say that an annual 401(k) enrollment is no more painful than health-care enrollment is not to say that it wouldn’t be painful. However, IMHO, an annual enrollment process could well lead to better decisions with these programs. Vanguard published a study on Roth 401(k) enrollment this week—and they found that the strongest correlating factor with participants choosing the Roth was being a new employee (see “Early Roth Adopters Are Active Retirement Savers”). This single attribute increased the probability of adoption by 3.2 percentage points on top of the normal 5% adoption rate—an increase of about 65%. Are these new workers smarter? I doubt it. Younger (and thus more likely to be enamored of the tax benefits of the Roth)? Perhaps, but age, while a factor, wasn’t the determinative factor—tenure was. Moreover, this result corresponded with the findings of another survey (also done by Vanguard) a couple of years ago that found some significant differences in asset-allocation choices—depending on when you joined the plan. These studies—and any number of others—suggest that, once most workers are “in,” they’re “done” making informed decisions about their retirement savings; the amount, the investment, the type. But they also suggest that, at the point of enrollment, participants are paying attention and are, in the aggregate at least, making decisions that seem reasonably informed.

Ironically, IMHO, the current solutions touted for engaging participants more seem mostly to rely on involving them less. That may be what they want—but I’m not convinced it’s what they need.

- Nevin Adams

The Deification of DB-ification

Last week, I stumbled across another of those “DC plans are becoming like DB plans” articles—you know, the “DB-ification” of 401(k)s?

This is all supposed to be a good thing, of course, because we know that defined benefit plans do a better job of providing adequate income in retirement than defined contribution plans (well, properly funded, and when workers accumulate adequate service credits, anyway). Moreover, the new Pension Protection Act-engendered trends toward auto-enrollment (nobody asks people to fill out a form to be covered by their DB plan) and asset allocation fund defaults (nobody asks participants to make the investments in the DB plan) are also widely touted as DB innovations that we have finally had the good sense to bring to the DC side of the world.

Don’t get me wrong—anything that turns employees into participants (and automatic enrollment surely does that) and helps them make better investment decisions (and, generally speaking, asset allocation solutions fulfill that need) has to be a good thing. But to suggest that these trends are essentially helping our DC programs mature into their more “responsible” DB counterparts represents, IMHO, a gross misinterpretation of what is going on.

The most obvious difference, of course, is that DB plans not only don’t ask employees to sign up or make investment decisions—they generally don’t ask participants to FUND them, either. In a DB plan, all the participant has to do is—well, they don’t have to do anything (other than continue to meet the eligibility requirements for the plan, and that’s generally been a natural outgrowth of keeping your job). Some might argue that that lack of involvement contributes to what continues to be a widely evidenced lack of appreciation for the benefit.

Another Difference

There is another big difference, of course, and it also has to do with how these plans are funded. Defined benefit plans are funded—at least, they are supposed to be—with an eye toward the benefit that will be paid out. As the name suggests, the benefit is defined—and the decisions that are made about how much to contribute to the plan and how those contributions will be invested are also done with that in mind.

Defined contribution plans, on the other hand—even the “new,” “automatic,” DB-ificated ones—have an entirely different focus. They are (still) about how much you can afford to put into them, not how much you need to get out of them. Oh, sure, the PPA’s safe harbor automatic enrollment includes a provision to increase those contributions on an annual basis—but starting at just 3%, and rising only to 6% of pay. That may well be all that many can afford to contribute—but is it any replacement for the kind of funding discipline that a true defined benefit focus represents? More importantly, will it be enough to provide the same kind of retirement security that the DB system promised?

Still, this notion of DB-ification keeps popping up. As though, through the graces of the PPA, we have managed to magically replace that missing leg on the three-legged stool of retirement security—when all we have really done is stick a piece of cardboard under one of the two remaining.

IMHO, we won’t really have a “DB-ification” of our defined contribution designs until we shift the focus—not just the funding.

- Nevin Adams

A Different Kind of "Investment"

As the parent of a daughter away at college for the first time, the events in Blacksburg, Virginia, last week had a particularly horrific effect.

No, she’s not going to school at Virginia Tech, but what happened there could happen anywhere. Parents often worry that, despite years of raising them carefully, our kids will, nonetheless, wind up in the wrong place at the wrong time. Yet, so far as we know now, all those poor kids did was be in the right place – where they were supposed to be - at a very wrong time. In a matter of minutes, bright and promising futures were brought to a premature close for no better reason than their proximity to a madman.

Many will try to get back to “normal” this week – while for some, normal will never again seem possible. I’ve tried several times to pick up some other theme or idea to speak to in this week’s column – some normal topic, if you will – but all I can think of is those students that won’t be coming home to families. Families that, like mine, were anxiously waiting to have their family once again be complete.

People die unexpectedly every day, of course – and children much younger than the students at Virginia Tech unfortunately have their lives snuffed out in much less dramatic fashion. Still, those tragedies that grab our collective attention for a brief time can serve as a vital wake-up call to things that our busy lives all too frequently set aside for “another time.”

The admonitions that are part of our industry’s DNA – start early, do as much as you can, keep an eye on things – apply to many areas of life. As we make investments in our 401(k)s, we also invest in our friends and family – investments that generally produce a yield that would put to shame the most giddy hedge fund investor.

This week, if you don’t already, I’d encourage you to tell those you care for how you feel – tell them as often as you can; and keep an eye – or an ear - on them, particularly the ones you don’t see every day.

You never know how long you’ll have to do so, after all. And the only thing worse than losing a loved one – would be losing them without having told them how you feel.

“Self-Fulfilling” Prophecies

The Employee Benefit Research Institute (EBRI) and Matthew Greenwald & Associates published the 17th Annual Retirement Confidence Index last week – and, for the very most part, it’s probably safe to say it didn’t tell us much we didn’t already know.

More than half (52%) expect to be comfortable, another third categorize their post-retirement income status as “adequate,” and 6% are looking forward to being “well-off” – at least in the first five years after retirement. Just 10% say they will be “struggling.”

While they are apparently less confident than they once were in terms of a traditional pension benefit, they remain largely complacent about their overall prospects for a comfortable retirement – more than a quarter are VERY confident, and another 43% are somewhat confident, in fact. Still, only 18% are much less confident about receiving that traditional pension. (Oddly, and perhaps proving that confidence is a relative term, “only” 29% of those who do not expect to receive a pension are less confident. Can one truly be less confident of receiving something that you don’t expect to receive?) And while 62% say that they expect to see that traditional pension someday, only 41% say they are currently covered by such a program.

The survey, well-regarded for its breadth and depth of analysis, also revealed that almost half of the workers who are saving for retirement (bear in mind that only about 60% are at present) have accumulated…less than $25,000. Seven in 10 of these workers have less than $10,000 saved (including more than a quarter of those older than 55). They also continue to misjudge the age at which they will be eligible for full Social Security benefits (it’s no longer 65, by the way), appear to overestimate the existence of long-term health coverage (they think they have it, though only 10% of the population does), and – at least based on current trends – seem to be more optimistic about the availability of employer-provided health care in retirement.

“Agree” Mien?

But what I found most intriguing about the RCS results from the perspective of advisers – was how survey participants responded to the notion of advice. There have been any number of surveys done in recent months about participants and the need for help in making investment decisions, and they consistently indicate a strong desire on the part of participants for help. Setting aside for a minute the fact that many of those surveys are underwritten by firms interested in providing that help, I’ve heard that exact message from both plan sponsors and advisers in the field (although, more recently, the call hasn’t been for help in making the decision, it has been an interest in having someone just take care of it).

However, in the RCS, fewer than two in 10 workers said they would be very likely to take advantage of investment advice at a modest cost (“modest cost” was not defined for them), and only about a third (35%) said they would be somewhat likely to do so (the rest broke nearly evenly between would not likely, and would definitely not take advantage). However, advisers might take some comfort in knowing that those who had used an adviser previously, those who were under the age of 55, and those with higher household incomes were more favorably disposed toward the service.

But even among those interested in investment advice, only about one in five (21%) said they would implement all of the recommendations – if they trusted the adviser. A full 11% said they wouldn’t implement any of the recommendations, and two-thirds said they would implement only the recommendations that were in line with their own thinking.

All of this would, unfortunately, seem to portend a rough road ahead for advisers who are trying to get across the importance of retirement savings. After all, if people are feeling this “confident” about their prospects, no wonder the nation’s savings rate continues to languish. And if participants are only interested in recommendations that match their own thinking – and their thinking is grounded in these feelings of relative optimism – how are they going to be able to ready themselves for what may be a very rough future reality? Ultimately, of course, it will take more than confidence to ensure retirement security: It will take awareness, planning, and action. The RCS should, IMHO, be a wake-up call for us all.

- Nevin Adams

Note: The good news in the RCS is that workers who are saving for retirement, who have taken the time to do a retirement needs calculation (and who have higher incomes) – tend to be more confident than others about their prospects.

For more about the Retirement Confidence Survey, see Workers’ Confidence in Traditional Benefits Slip

The 80/20 Rule

Sooner or later in your career, you are exposed to the 80/20 rule or, as purists term it, the Pareto principle. Simply stated, it suggests that 80% of the consequences stem from 20% of the causes. You frequently hear how you get 80% of your revenues from 20% of your clients (and sometimes that 80% of your aggravation comes from that same minority).


Similarly, with all the furor of late focused on cost sensitivity, revenue-sharing, and the call for greater transparency, it’s easy to overlook the fact that most of that scrutiny and regulatory angst is being applied to 20% of the “problem” of retirement plan fees.

"Out of" Proportions

Traditional logic held that the fees on your “typical” retirement account ran like this: 70% for investment management, 20% for recordkeeping, and 10% for miscellaneous things like trust/custody, audit, etc. That apportionment wasn’t perfect, of course, but it was a rule of thumb that has been applied fairly liberally over the years. Investment fees were typically drawn from plan assets and, thus, participants have been bearing more than two-thirds of the costs of these programs for a very long time now.

Of course, over the past 20 years, we have seen a gradual shift where more and more of the remaining third is also paid from plan assets—and then redistributed to the same parties that used to get a check from the plan sponsor. Despite the occasional “study” from the Investment Company Institute to the contrary, 20 years ago, my sense is that mutual fund expenses were pretty much what they are now for the average 401(k) plan, at least for institutional class shares*.

So, while there is a growing sense that the participant is picking up a greater share of the plan costs, I’m reasonably sure that most are paying about what they used to, at least on a percentage basis. What’s different is those shareholder servicing fees that once upon a time simply rolled back into the pockets of the mutual fund complexes - now go to reimburse entities that actually perform those services for a retirement plan.

But while we agonize over how that 25-basis-point shareholder-servicing fee is parsed out between recordkeepers and advisers, the current debate barely acknowledges the fact that 70% or more of retirement plan fees paid by participants are the 50 to 100 basis points that come out of every participant dollar for “investment management.”

I’m not suggesting that investment management isn’t a skill to be highly prized and reasonably compensated. Nor am I suggesting that current investment management fees are disproportionate in every case to the value received. There may even be legitimate reasons why these funds grow from millions – to billions – of dollars in assets with no reduction in the expense ratios.

The 80/20 rule notwithstanding, IMHO, you won’t solve 100% of the problem by probing just 20% of the fees being taken from those participant accounts.

- Nevin Adams

* The misuse of retail class shares, and the liberal application of “R” shares, is a topic for another column.

Another One Bites the Dust?

When Fidelity announced this last week that it was dropping its pension plan, it drew my attention.

Not so much because it was taking that step. By now, there have been enough pension fund freezes—or enough reports about how many pension fund freezes there will be—that the occasional announcement barely fazes me anymore. That Fidelity chose to do so while “riching up” their 401(k) plan (see “Fidelity Investments to End DB Plan”) was also pretty much standard fare for such moves.

But there was a significant difference in this particular announcement—a focus on concerns about paying for health care in retirement. In a Boston Globe report, a Fidelity spokesperson cited data that 71% of Fidelity workers didn’t know how they would pay for health-care expenses in retirement (kind of makes one wonder about the other 29%); and as part of this shift in strategy, Fidelity will be putting $3,000 into health-care reimbursement accounts for each worker—monies that won’t be taxable when withdrawn (ostensibly if used to pay health-care-related expenses).

There’s little question that health care looms large as a concern for most Americans. People routinely make job choices based on the availability and quality of an employer’s health-care program, and there is at least anecdotal evidence that, as workers have been asked to shoulder a larger share of the costs of those programs, they have paid for at least some of that with cutbacks in retirement savings. It’s now seen (or at least reported) as a “good” year when health-care costs increase at only twice the rate of inflation.

A Growing Concern

Moreover, there is a growing sense that the seemingly relentless upward trend in the costs of health care could well jeopardize an already financially precarious retirement lifestyle. A recent study by none other than Fidelity itself projects that an average 65-year-old couple will need $215,000 to cover retirement health-care costs (see “Fidelity Says Retirees Need $215,000 to Cover Health-Care Costs”). Workers have reason to worry; Medicare, the primary medical safety net for many retired Americans, is in more tenuous financial shape than Social Security—and corporate America has been shedding its retiree medical programs for longer and with more “vigor” than their more recent focus on setting aside those traditional pension plans.

It remains to be seen how Fidelity workers will respond to the change. With an average employee age of 35, it’s doubtful that they were emotionally much invested in the pension plan, IMHO. Moreover, a richer 401(k) match and the ability to roll their accumulated pension balances into a more “tangible” (as in one being capable of being touched) profit-sharing account will likely be appealing.

All in all, Fidelity has probably managed to transform a vague, uncertain, future benefit into something that can be appreciated in the here and now—and by putting an emphasis on retiree health-care costs front and center with their own workers, they also may have helped bring visibility to a critical retirement savings need—while there’s still time to do something about it.

- Nevin Adams

When You Assume...

We live in an uncertain world, and when it comes to retirement planning, we are forced to make assumptions about an uncertain world some uncertain number of years in the future.

However, a recent white paper by JPMorgan Asset Management (JPMAM) calls to mind that old adage about what happens when one assumes (see Participant Behavior Matters in Target Fund Strategy).

First, retirement projection tools tend to overlook the reality that many, perhaps most, participants dip into their retirement savings from time to time: some for only awhile—JPMAM’s research found that 20% of participants borrow, on average, 15% of their account balance—and some forever. JPMAM’s data noted that a full 15% of those over the age of 59 ½ (the age when one avoids the 10% premature distribution penalty) withdraw, on average, a quarter of their account balance. The research, which looked at the behaviors of 1.3 million participants in some 350 plans recordkept by JPMorgan Retirement Plan Services, also found that the average participant withdraws over 20% of their account balance per year at, or soon after, retirement—not the even 4-5% drawdown implicit in most projections.

Additionally, most projections also tend to be optimistic about the rate of participant deferral. JPMAM found that, on average, participant deferral rates start at 6%—and stay there for a sustained period—increasing to 8% only by age 40, and not attaining 10% until age 55. More significantly, while most projections still contemplate annual pay increases, JPMAM found that, on average, people only get raises only every two of three years (and I’ll wager that, filtering out the occasionally distortive impact of averages, many aren’t seeing increases that often). Even more troubling—but a reality in an era of soaring health-care costs, rising fuel costs, and the economic squeeze being placed on the “Sandwich Generation”—is that, on average, 10% of participants lowered their rate of deferral—or stopped contributing altogether—each year!

Finally—though the JPMAM paper doesn’t touch on this—in this space, I have previously cast a doubtful eye on the rate-of-return assumptions often applied to participant investment patterns.

Optimistic Undercurrents

Now, there is an undercurrent of optimism associated with the Pension Protection Act—a confidence that its automatic enrollment safe harbor will usher more participants into the discipline of retirement saving; that the associated provisions on deferral acceleration will, over time, transform current savings rates to the requisite levels; that the application of professionally managed asset allocation funds as a default choice will impart a rational investment result to participant savings. Certainly these tools have the ability to modify some of the most egregious savings behaviors, and doubtless they will encourage some—perhaps a significant number—to come off the sidelines and begin a responsible preparation for retirement.

They’re not likely, however, to stem the premature drawdown of retirement savings, or to accelerate the pace or regularity of salary increases. In fact, it’s not beyond the realm of believability to envision how the adoption of these tools could, certainly in the short run, serve to reduce the rate of deferrals (participants auto-enrolled at the 3%, rather than the 6% rate they might have enrolled at if they had completed the form), and perhaps even decrease the rate of return (a more balanced portfolio might experience losses in the short-run that a stable-value-only portfolio might not).

What’s attendant upon us all in this emerging age of “automatic” solutions, IMHO, is to realize that they aren’t.

- Nevin Adams

Mirror Image

For now we see through a glass, darkly. 1 Corinthians 13:12

When St. Paul wrote those words, he was trying to explain to the early Christians that we may not understand why things are the way they are today, because our perspective is clouded. That phrase, to see through a glass—a mirror—darkly, conveys a similar sense in today’s usage: a sense of an obscured or otherwise imperfect vision of reality.

For the very most part, those of us in the business of retirement plans look at the landscape and fret about things like the dismal rate of participation, tepid deferral rates, and inert asset allocations (see “IMHO: ‘Never, Ever’ Land” ). Heck, these days, you don’t have to be in the retirement plan business to wring your hands over the sorry state of retirement savings.

Equally discomfiting to me are the incessant recitations regarding how apparently oblivious retirement savers are about the looming financial disaster. And while “the industry” often comforts itself by noting that those who have taken the time to consider their situation are more confident than those who haven’t, I don’t get that either. Perhaps it is a veiled attempt to encourage participants to do some retirement/financial planning (“You’ll feel better if you do”), but from every objective statistic, it would seem to me that most, perhaps the vast majority of, participants should feel more concerned, not less, after contemplating their situation (one would hope concerned enough to do something about it).

Then we get reports like last week’s from the Fidelity Research Institute that suggest that a “typical” worker is on track to replace 58% of their pre-retirement income in retirement (see “Replacement Rate Assumptions Could Be Wishful Thinking”). From what I can discern, 58% is pretty good for typical (to their credit, Fidelity positioned it as a shortfall, not good news). I don’t know that the traditional replacement ratio bogey of 70% is valid (see “IMHO: An Inconvenient Truth”), but Fidelity’s findings would suggest that most aren’t so far off the mark that the gap couldn’t be closed with just a bit more effort/focus. That’s the good news.

The Fine Print

The “fine print” is where it all falls apart. Fidelity’s numbers aren’t drawn from actually looking at people’s balances/savings and comparing them with current compensation levels. Rather, for the most part, they are drawn from what participants report to them as expectations. Among those expectations of a typical household was an $18,000/year pension—from a traditional defined benefit plan. Now, traditional pensions are no longer typical, though they are more prevalent than one might glean from the news. Moreover, $18,000 pensions aren’t typical, either—certainly not outside the public sector (see “Saving While You Still Work”).

Basically, then, not only is 58% likely “short” of what will be required to provide a financially comfortable retirement, the “real” number is likely somewhat short—perhaps significantly short—of the reported 58%. In fact, much of the data in this and other surveys is drawn not from reality, but from participant perceptions of their reality. That may explain why we have expressions of participant “confidence” that seem misaligned with reality.

Ultimately, the concept of retirement security is so individualistic as to defy ready generalization. Our individual expectations are shaped by our past, our health, our careers, our families, our income, and certainly by our preparations for retirement—and the reality, when it comes, will likely be just as individualized. Still, we shouldn’t focus on the status of a typical saver, for there is no such thing. Nor should we rely on the sensibilities of a saver who may be saving what he or she can (or thinks they can), not what they should.

For now, we all see through a glass, darkly. But the time will come when what we’ll see—is all we’ll get.

- Nevin E. Adams

Price "Check"

The good news is, Congress is beginning to take a hard look at 401(k) fees.

Unfortunately, that also happens to be the bad news.

They have a lot of company, of course. The Department of Labor has several initiatives currently under way, the Government Accountability Office (GAO) has called for more transparency, and a number of lawsuits have been filed alleging all sorts of fiduciary malfeasance on the subject (a complaint filed against Cigna last week seemed to suggest that having investment management fees netted against the returns in a mutual fund was some kind of conspiracy - see CIGNA Latest Target of 401(k) Fee Suit). In view of all that activity, last week’s hearing before the House Education and Labor Committee was relatively sanguine (see Congressional Committee Hears 401(k) Fee Disclosure Testimony).

Not that there weren’t points of contention (but not as many as one might have thought)—and even a couple of moments of tension between those offering testimony. All in all, those seemed to be rare, however—after all, we appear to be at a period where everyone agrees that we need to provide participants and plan sponsors with better information about the fees assessed against their retirement plan balances.

Comparison Points

Speaking on behalf of the American Benefits Council last week, Robert Chambers presented an intriguing analogy, noting that an automaker like Toyota no longer made cars—they assembled them, outsourcing the preparation of the various components. He made the point that consumers don’t know—or particularly care—what Toyota paid the individual subcontractors, they’re buying the total product. While it was a compelling image of how today’s 401(k) is put together, the analogy falls apart in two key aspects, IMHO. First, most of us buy our own vehicles, and not from a menu selected by our employer. Second, when I go to buy a car, I may not know (or care) how much the manufacturer paid its subcontractors—but I surely know how much I am expected to pay for that car.

Over the past thirty years, participants, and to a lesser extent, plan sponsors, have been lulled into a false sense of security about the fees they pay for these accounts. I don’t know how many actually believe these accounts are free, but I would imagine that a significant number of participants would be amazed at how much they are paying each year (that doesn’t mean those fees are necessarily unreasonable, by the way).

"Under" Currents

You can hear that same concern just below the surface of comments made by the defenders of the status quo—in between phrases about how “fragile” our current system is, and expressions of concern that participants might be so put-off by those revelations that they will eschew participation altogether. It’s not that I don’t understand what they are trying to say, but I wonder sometimes if they have any idea how that line of reasoning sounds. The implication is clear, even to those who aren’t yet convinced there is a problem: If people actually knew how much they were being charged….

The devil, of course, lies in the details—and concerns about how that information will be constructed and shared (and, trust me, it will be shared) were also just below the surface during the hearing last week. The concerns are twofold; that the mandated structure will be prohibitively difficult or costly to produce, or that the complexity of the information and/or the mandate will render a meaningful disclosure impossible (think prospectus). Indeed, IMHO, the scariest aspect of last week’s hearing was that Congress might feel compelled to roll up its sleeves and “help.”

I’m not altogether sure that the industry can be trusted to heal itself, but I do believe that a growing number are confident enough in the value provided—and their ability to explain it—to do the right thing, to place a visible price tag on those services. After all, if you don’t know how much you’re paying—it’s hard to appreciate how much it’s worth!

- Nevin E. Adams

Option 'Null"

Not too long after my first daughter was born, my wife decided that we needed to have a vehicle with four doors. All other decisions about the car were mine—color, options, make, model, etc.—so long as it had four doors (anyone who has ever wrestled with a car seat, or with getting a child into and out of a car seat, will appreciate why).

In this particular case, even though I hate car shopping, I had done my homework—the service record of the make made it a cinch, the dealership was close, my wife and I saw eye-to-eye on color, and, for my money, there was only one model (in that make) whose four-door version looked sporty enough to satisfy my sense of a car I wouldn’t mind being seen driving. There was just one problem. This particular manufacturer had its model options arranged in three very specific packages. The model that had the features I wanted—for the price I wanted to pay—was the middle option. The one option I really wanted (and I REALLY wanted it) that wasn’t included in that middle option was a sun roof.

Model "Behaviors"

The dealer was able to give me the model I wanted with a sun roof—I would just have to wait some extraordinary period of time to take possession (this at a time when this car manufacturer was, in many cases, commanding a premium above sticker price due to limited availability) and pay more, of course. Oddly, it would wind up costing me almost as much for that modified mid-range model as if I just bought the higher-end version. As it turned out, that was more than I wanted to spend on that car. I didn’t want to wait that long for the modifications, nor did I want some of the “extras” on the higher-end model. Ultimately, I decided that, while I surely wanted the sun roof, I wasn’t willing to be “snookered” into buying the model the dealer surely wanted me to buy.

I’m sure that the manufacturer’s position on such matters was carefully developed, and I’m just as sure now as I was at the time that the desire for a sun roofed vehicle that could be driven off the lot had driven many a buyer to simply “upsize” their purchase. And while I was never really “happy” with that decision (the car worked out fine—the daughter who used to ride in that car seat now drives it), ultimately, I gained the satisfaction of having stood by my principles.

A Growing Concern

Much of the talk at the 401(k) Summit this past week was about fees: transparency, mandatory disclosures, lawsuits. In relatively short order, plan sponsors are going to be able to see how much they are paying for the services their plans receive. For some, that’s going to be a mere formality, of course; but for others—well, I suspect they’re going to feel that they are paying for things they don’t want, and perhaps aren’t getting.

It shouldn’t be all about how much you’re paying, of course. ERISA requires that the fees be reasonable, not dirt-cheap—and the determination of reasonable surely requires not only an awareness of what is being paid, but also an appreciation of the services provided relative to that remuneration. Bundled pricing has, in many respects, made it easier for many to buy (and sell) a retirement plan “package” without delving into those details. However, IMHO, it also has had a tendency to obscure the costs associated with individual components of the package. Like that sun roof, it isn’t that they think it is, or should be, free—but presented with the detailed invoice, they may not think the price is “reasonable.”

It’s not altogether sure to me that plan sponsors will relish the ability to probe those depths—but I don’t think it’s going to be an “option” in the near term, if it ever was.

- Nevin E. Adams

"Never, Ever" Land

It’s an undisputed fact that the vast majority of retirement plan participants never rebalance their accounts. It’s one of the reasons that that initial investment decision, particularly in a default situation, is so crucial. And most of us would guess that those participants who do make changes probably make a mess of it.

However, new research from the Vanguard Center for Retirement Research tells a different story. Their report indicates that “traders” outperformed nontraders by 0.55% on an annualized basis.

Not that we should draw much comfort from that result. First, only 17% of the one million or so participants in the Vanguard sampling were “active” traders (averaging just a bit under three trades each, but most did only one)—and, according to the Vanguard researcher, on a risk-adjusted basis, these same traders fared no better than nontrading participants. In effect, the extra risk they took on—during the relatively mild investing climate of 2003 and 2004—wiped out the benefit of their trading (though, at the end of the day, I’m not sure participants are willing to undertake the statistical analysis to appreciate that impact).

Realign Mien?

The more interesting conclusions, IMHO, dealt not with trading, but with rebalancing; the realignment of the investment portfolios within a reasonably tight percentage of a target allocation—10 percentage points, in the Vanguard evaluation. This group Vanguard termed “active” rebalancers” because they took action to maintain an asset allocation. Another group, which Vanguard termed passive rebalancers, never traded on their own and invested their entire balance in a balanced fund or a lifestyle fund during the period. Their accounts were presumably rebalanced, but without their involvement or intervention.

Compared with nontraders, on a risk-adjusted basis, these passive rebalancers realized excess annual returns of 84 basis points. The active rebalancers didn’t fare quite as well—but still earned 26 basis points in excess risk-adjusted returns. So, at least on a risk-adjusted basis, rebalancers did better than nontraders—but only 6% of the research sampling were passive rebalancers, and only 3% were active rebalancers. In total, these rebalancers were just half the so-called “active” trader total of 17%. The remaining 72%, of course, were nontraders.

Not So Fast

The research results, while intriguing, must be considered with care. A lucky asset allocation, left unattended, could prove to be quite profitable in the long run. Meanwhile, a more balanced portfolio, rebalanced on a systematic basis, could well experience losses in the short-term that an undiversified portfolio during that same period might avoid. Still, the research would seem to support the notion that a well-diversified portfolio, regularly and professionally managed, can be prudent and profitable.

Moreover, these days, an “active” rebalancing program can frequently be put in place with the click of a button—a passive rebalancing program with the mere selection of an appropriate target-date offering. The challenge is to help move the remaining majority of participants—who never, ever touch their accounts—to a rebalancing model that can make a real difference in their retirement security.

- Nevin Adams


Note: Foregoing the scientific “risk-adjusted” statistical analysis for one participants are more likely to rely on — their side-by-side comparison of participant statements with their neighbor's —it was better to be active than passive, and better to be a nontrader than a passive rebalancer.

Active rebalancers enjoyed an annualized return of 18.86% during the period of study, outpacing the 16.90% of active traders, and the 16.77% of nontraders. Passive rebalancers were at the bottom, gaining just 15.25%. Now, that's not on a "risk-adjusted" basis - but it's real money.

An Inconvenient Truth

There appear to be two great debates of our time—Is global warming (oops, I mean global climate change) real? and How much do people need to save for retirement?

The former is beyond the scope of this column, of course (watching the public debate, I’m not certain but that it is beyond the scope of many so-called experts on the subject). As for the latter point, every so often, some academic emerges with proof that people don’t need to save as much as “common wisdom” suggests they should.

The issue was most recently addressed in a column in the New York Times titled “Are Americans Saving Too Much for Retirement?”—a column that was quickly picked up in syndication across the country. Of course, what are usually taken to task are the assumptions imbedded in those ubiquitous retirement calculators, the notion that one must accumulate a sum able to replace 70% of one’s preretirement income in retirement, and the ministrations of retirement plan providers and advisers who, ostensibly, stand to profit from encouraging a life of hyperactive thrift.

Let me concede a couple of points: Many retirement planning calculators still make assumptions about inflation and market returns that no longer seem founded in reality. They still assume that we’re benefiting from annual cost-of-living increases in our pay, for example. Even applied to costs, does anyone believe that the standard projections are able to keep pace with the escalating costs of health care that we are likely to confront in retirement? As for investment returns, it isn’t that the default investment return is a fiction—it’s just that it is a fiction in view of the way most participants actually allocate their balances (this, IMHO, stands to change with the growing embrace of asset allocation offerings).

As for that replacement ratio of 70%, well, I’ve always wondered if it was high enough, what with soaring health-care costs, the Boomer generation’s notoriously less-than-parsimonious lifestyles, and those refinanced mortgages. But, as averages go, it seems a reasonable place to start.

"Average" Bearing

Therein lies the rub, of course. For the most part, the assumptions on both sides are based on averages of a sort. The “average” 401(k) balance in an individual plan, much less a national average balance, tells you almost nothing about the adequacy of that balance to provide a decent retirement income. To do that, you’d have to know something about that individual’s age, their health, where they live, where they plan to live after they retire, their marital status, their other sources of income, their expectations for spending in retirement….In sum, you have to know something about the individual’s specific situation to have a prayer of estimating how adequate their savings truly are. Besides, averages on things like lifespan tend to gloss over the reality that as many people live beyond that point as not.

Ultimately, like the gas gauge on your vehicle of choice, these calculators can only tell you so much; a full tank in a hummer may not carry you as far as one on that hybrid, a journey up into the mountains may take more than a cruise across the prairie, a car full of family members may need more than that solo trip….In point of fact, a half-tank may do just fine for driving around town, but not for a cross-country vacation. What is “enough” depends largely on where you’re going, and how you’re getting there.

Headlines that claim we may be saving too much belie the reality we see every day, IMHO—and they provide people with a flawed rationalization for their poor savings habits. Let’s face it—the “inconvenient” truth is that most aren’t coming close to saving what those calculators call for. In that sense, claiming that the calculators provide an exaggerated result misses the point entirely. Most people are saving based on what they think they can afford to save or, in many cases, what will allow them to maximize the employer match. In the end, that may be enough—or not.

But, given a choice between a gauge that potentially exaggerates the problem, and one that obscures a harsh reality, seems to me that most would rather be safe than sorry.

- Nevin E. Adams

See “Are Americans Saving Too Much for Retirement?”

See also

“The Lure of Averages”

“Bad Assumptions”

A Little 'Free' Advice

On Friday, the Department of Labor issued a Field Assistance Bulletin on the “Statutory Exemption for Investment Advice.” These FABs, which essentially are designed to give DOL personnel in “the field” guidance on the interpretation of the law, provide incredibly valuable information for anyone who works with qualified retirement programs—and this one is no exception.



Three Issues

This particular FAB dealt with three issues:

• Did the investment advice provisions of the Pension Protection Act “invalidate or otherwise affect” prior DOL guidance on the subject?
• To what extent are the standards for selecting and monitoring a fiduciary adviser (as defined by the PPA) different from the standards applied to those who offer advice outside those provisions?
• For purposes of an “eligible investment advice arrangement” under the PPA, is an affiliate of a fiduciary adviser subject to the level-fee requirement?

The answers to the first two were relatively straightforward. The FAB plainly states that the DOL sees nothing in the PPA’s investment advice provisions that invalidates, or in any way alters, prior guidance—including Interpretive Bulletin 96-1 (which set out the line between investment advice and education), Advisory Opinions 97-15A, 2001-09A (SunAmerica Advisory Opinion that said it was OK for money managers to offer advice on their funds, so long as the asset allocation was determined by an independent firm), and 2005-10A. These “continue to represent the views of the department, and may continue to be relied upon by the employee benefits community,” according to the DOL.

Same Duties

Similarly, the DOL stated that “the same fiduciary duties and responsibilities apply to the selection and monitoring of an investment adviser for participants and beneficiaries in a participant-directed individual account plan,” irrespective of whether the advice is provided by a fiduciary adviser under the PPA or not. That, by the way, apparently not only means that the plan sponsor is expected to be just as diligent in selecting and monitoring the advice provider, but also that the plan sponsor is not liable for the advice delivered to the individual, either under the PPA’s new provisions or existing guidance—a point that might be a surprise to some plan sponsors, who have worried about just that level of liability.

The last issue—fees, and how the restrictions of the PPA might be applied—will draw the interest of most advisers, certainly those who are affiliated with a firm that manages money. Here, it seems to me, the DOL also drew what attorneys are fond of calling a “bright line.” The FAB says that “Congress did not intend for the requirement that fees not vary depending on the basis of any investment options selected to extend to affiliates of the fiduciary adviser, unless, of course, the affiliate is also a provider of investment advice to a plan.” On the other hand, the FAB also noted that “when an individual acts as an employee, agent, or registered representative on behalf of an entity engaged to provide investment advice to a plan, that individual, as well as the entity, must be treated as the fiduciary adviser” under the PPA’s provisions.

Ultimately, IMHO, the DOL has provided some very timely and important information on advice. It reinforces the reality that the PPA’s advice provisions represent an addition to current guidance, rather than a refutation or replacement. Significantly, it should assure plan sponsors that, regardless of their approach on offering advice, they are responsible for the adviser, not the advice. It should also put them on notice that they are fully accountable for the prudent selection and monitoring of the adviser—and it provides a sense of the applicable considerations for doing so.

What may remain problematic for some is how (and more significantly, if) the fee structures will work with their individual business models, and those of the organizations with which they are affiliated.

Still, it seems to me that things are clearer today than they were a week ago—and clarity is nearly always preferable to the alternative.

- Nevin E. Adams

Field Assistance Bulletin 2007-1 is online HERE

'Over' Blown?

Looks like the pension crisis is finally over.

Well, the funding part of the crisis, anyway. No fewer than three separate studies* were published this past week that essentially said that the pension plans of larger employers are either fully or nearly fully funded again.

For several years now, we’ve been struggling with the impact of the so-called “perfect storm” on pension plans. The catchy nomenclature was borrowed from the 2000 film by the same name (which, in turn, was pulled from the 1997 book on which it was based)—a reference to the 1991 Halloween Nor’easter that resulted from the unusual combination of several forces of nature to create an exceptionally powerful storm across a very large area. A storm—nearly a hurricane—that caught many off-guard.

The so-called perfect storm for pension plans also resulted from an unusual confluence of factors—a slumping investment market, the “vacation” from funding that many plans took during a period when soaring investment returns made such actions unnecessary, and, significantly, an unprecedented decline in the interest rate of the 30-year Treasury bond after the Clinton Administration decided to quit issuing new ones.

Back in the Black

In the intervening years, plan sponsors have benefited from investment returns that exceeded projections—as they frequently do over the long term. Also adding to the value of the assets in these programs, plan sponsors have returned to the process of making regular—and in some cases, extraordinary—contributions to the programs. Finally—and this has had a significant impact on the calculation of the liabilities owed by these plans—the return to something like a “normal” interest rate environment coupled with the use of a blended rate, rather than an artificially distorted 30-year Treasury. It hasn’t been easy, it hasn’t been painless, and it surely hasn’t been “perfect”—but many, perhaps most, large pension plans seem to be back in the “black.”

Not that the funding shortfalls for most were ever as bad as they were portrayed. While there were clearly some villains—and some unsustainable promises dumped on the Pension Benefit Guaranty Corporation—being 85% funded on a pension obligation isn’t all that different from having 85% of your mortgage paid off with 20 years to go (it’s actually better than that).

You’d never have gotten a sense of that from the headlines, or the angst of the legislators. It may be worth remembering that the last time these funds were flush with cash (we’re a long way from that), pensioners were up in arms that the pension surplus should be given to them in the form of higher benefits, analysts were critical of the “gloss” that pension returns lent to financial reporting, and, frankly, plan sponsors were disinclined to make regular contributions in excess of the required amounts.

It’s worth noting that since this last storm “broke,” many plan sponsors have chosen to freeze or terminate their traditional pension plans. The reasons are varied, of course. The confluence of factors cited above may have made the program untenable financially; workplace demographics may have cried out for a different retirement plan design; or they may simply have looked ahead to the future and made a different choice.

Still, it’s hard not to wonder how many were set on that path for no reason more substantive than the relentless pillorying of the funding “crisis” in the media. It was certainly more than a tempest in a teapot—but IMHO, the concerns expressed were always overblown.

- Nevin Adams, JD


* Editor’s note: the studies include reports from:

Towers Perrin (see DB Funding Landscape Starts to Shine in 2006),
UBS (see UBS New Tracker Finds 2006 Pension Improvement), and
Watson Wyatt (see A Return to Better Funding for Pensions in 2006)

"Exit" Strategy

This past week, we passed the “anniversary” of the commencement of bombing strikes in Operation Desert Storm (1991). Now, I was too old—and my kids too young—to have been directly impacted by that action. But I’ll always remember that night.

I was living in North Carolina at the time, and had been invited by a co-worker to my first NCAA basketball game at the “Dean Dome” at the University of North Carolina. Tickets had been hard to come by, and Chapel Hill was a nearly three-hour drive from where I lived (and on a “school” night, to boot)—but I was excited at the prospect. My friend and I got there early—grabbed some refreshments, found our seats, and sat down to watch the warm-ups. We were only about 10 minutes to tip-off when they made the announcement about Desert Storm—and the resulting decision to cancel the game.

Now, unless it is a playoff game, or a remarkably close contest, people have a tendency to exit such events early to “beat the rush.” In this case—and I don’t know how many people can actually fit in the Dean Dome—nobody saw the cancellation coming, so everybody tried to hit the exits at the same time. My buddy and I actually thought we were in a distant enough parking lot that we could beat some of it, but spent the next hour basically one car length from the parking place we started in—and another hour just getting to the exit of the parking lot.

For years, we’ve been worried about the Boomers heading into retirement. We’ve worried what would happen on that day when they would quit working (and cause our economy to come to a halt), worried that they would pull out all of their retirement savings from the stock market and invest it in bonds, and, most of all perhaps, worried that they would simply get to retirement without enough money to live through retirement. And while, on an individual level, those concerns are certainly real, we’ve also rightly worried about what would happen when they all tried to “exit” the working arena for the “home” of retirement at the same time.

Different Paths

A new study by Vanguard affirms what most of us know, at least anecdotally--people’s approach to retirement is about as variable as, well, people. The report highlights six different paths (see “Workers Plan To ‘Downshift’ Into Retirement” at ) but, of course, it’s more complicated than that. The bottom line is this: Working full time until you reach age 65 and then “retiring” appears to be the exception, not the rule. Apparently, people begin gradually cutting back in their fifties (by their late fifties, the rate of full-time workers falls to 62%)—and even by the time you get to the second half of the sixties, 17% are still working.

The good news could be that people are working, and saving, longer—and perhaps deferring tapping into their retirement savings beyond the date(s) that many retirement projections now assume. The bad news, of course, is that workers could be cutting back on work (and compensation) earlier than those same projections contemplate—and not always at the choice of the worker. Note that, among those who returned to work in the Vanguard sampling, more than half did so to meet basic expenses, and a quarter needed to pay for health insurance.

We’ve tended to think of retirement as a cessation of compensated employment and, perhaps simplistically, crafted certain financial assumptions around the notion that that occurs at a specific point in time. IMHO, the Vanguard study reminds us that the individual decisions around employment generally, and retirement specifically, are just that—individual decisions.

Accordingly, I’d like to propose an alternative definition for retirement in the workplace—an “exit” strategy, if you will—“to fall back or retreat in an orderly fashion, and according to plan.”

It’s an exit strategy in which advisers can clearly play an integral role.

- Nevin Adams

Forth "Right"

A couple of weeks ago, we got a panicked call from daughter No. 1, who had, on her way home from work, gotten her first flat tire. Now, flat tires are never fun, but she was clearly unnerved. It was after dark, at the end of a full day of work for her, and even though she was less than two miles from home, and we have motor club coverage, her mother and I piled into a car to change the tire.

Whilst I was attending to the changing of the tire, my wife turned her attention to gaining a better understanding of the events that had led up to the event. I thought that was odd at the time—after all, tires run over objects and go flat all the time. But gradually, and painfully, my wife—who has a mother’s knack for discerning when the kids are being less than forthcoming—wrested the truth. It turns out that daughter No. 1, in her 10-minute drive home, had been adjusting the car radio—took her eyes off the road—and struck a curb at just the right angle. Sure, the tire going flat had been upsetting, but the real problem for her that night was that her actions created the situation. And the real problem for her after that disclosure—as she soon found out—was that she hadn’t been straight with us in the first place.

Now, it could have been so much worse—a pedestrian could have been involved, or another car. Frankly, we retraced her steps later, and it was something of a miracle that she didn’t hit a fire hydrant or tree. Still, as one might expect, we took full advantage of the “opportunity” to explain to her the potential consequences of her actions—and fuller advantage of the opportunity to deal with the real consequences of her reluctance to be immediately “forthcoming” with her parents (not to mention making her dad change a tire in the dark in the middle of the street in the middle of winter).

Less Than Forthcoming

“Less than forthcoming” seems to be at the heart of this recent wave of revenue-sharing lawsuits—those filed by that St. Louis law firm on behalf of plan participants, challenges by the New York Attorney General, and more recently, pushbacks and lawsuits from plan sponsors themselves. Granted, the language in the lawsuits is generally more provocative than that. A lawsuit filed just this past week against ING says that "Those amounts bear no relationship whatsoever to the cost of providing the services or a reasonable fair market value for the services”—language echoed in a separate plan sponsor suit against Principal that claimed that the revenue-sharing practices "bear no relationship to Principal's costs of providing services to plans or participants," and that the firm effectively used “plan assets to generate revenue-sharing kickbacks for Principal's own interest and for its own account."

Now, it’s not at all certain that any of these actions will go to court, much less trial—and one surely can’t assume that the allegations made by plaintiff’s counsel represent a comprehensive, balanced recitation of fact. There are a lot of disparate issues under scrutiny here, even if they do all have a common linkage in the issue of fees. We can’t know now how all this will work itself out. Perhaps some of these arrangements truly are illegal; some may well be violative of the letter or spirit of trust essential to such programs. Some, no doubt, represent nothing more than an opportunistic plaintiff’s bar.

What surprises us most, IMHO, is not that these lawsuits have emerged, but that it has taken so long for some of these “less than forthcoming” practices to draw this level of attention. However, providers and advisers who have, up till now, been “less than forthcoming” would be well-advised to reconsider that approach.

- Nevin E. Adams

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See also Paying the Price

Plan Sponsor Sues Principal over 401(k) Fund Revenue Sharing

AIG VALIC Relents on Revenue Sharing Disclosure

FL Pension Plan Accuses ING of Revenue Sharing Fraud
FL Sheriff Sues Nationwide Over Fees
St. Louis Law Firm Files Another 401(k) Fee Suit

The Best Test

I’ve been in this business since before I graduated college (and that’s now been a while) – but my first interaction with a financial adviser didn’t happen until I got to PLANSPONSOR magazine.

Well, sort of. It would be more accurate to say that it was my first opportunity to have an interaction. Like too many plan sponsors out there, we had years earlier been sold the 401(k) by an adviser who, at some point not too long after the sale, went “missing.”

In the real world, employers – even employers that cover the retirement plan industry – have a business to run. Running the retirement plan, as important as it is, generally isn’t part of that business. That’s why, particularly for smaller employers – but increasingly for employers of all sizes – a financial adviser can be such an important addition to the “team.”

That realization has been a growing component of our focus here the past several years. It was part of our decision to launch AdvisorDash in 2003, an integral aspect of the launch of the PLANSPONSOR Institute and the PLANSPONSOR Retirement Professional (PRP) designation in 2005, and an essential factor in our decision to introduce PLANADVISER and PLANADVISER.com in 2006.

It was also, in 2004, the reason we decided to create an award that would acknowledge the best efforts of the best retirement plan advisers in the country. It was a daunting task to contemplate that first year – I wasn’t even sure that we would be able to FIND the best advisers, much less establish the kind of benchmark standards that could truly speak to retirement plan servicing excellence.

I need not have worried – the advisers committed to this space knew us, even when we didn’t (yet) know them. We were blessed with judges who not only knew the space, but the profession. And we received the eager support of plan sponsors who were willing – and in many cases, eager – to share their adviser experiences. Still, every year it gets harder to choose “the best” simply because there are so many good advisers to choose from.

The finalist groups recognized below are indicative of that trend. Over the next several weeks, our judges will be tasked with the challenge of picking one Retirement Plan Adviser of the Year and, in a new category, a Retirement Plan Adviser Team of the Year. It’s not likely to be an easy decision – but how can it not be a good one?

- Nevin E. Adams

You can meet the finalists online at http://www.plansponsor.com/pdfs/RPAYfinalists2006.pdf

Note: We will be announcing the Retirement Plan Adviser of the Year and Retirement Plan Adviser Team of the Year at the 401(k) Summit in San Diego on February 25. Additionally, the Retirement Plan Adviser finalists will join me for an interactive “Best Practices” roundtable at the 401(k) Summit. You won’t want to miss this – find out more about the 401(k) Summit at http://www.asppa.org/archive/conf/2007/2007summit.html