Second Thoughts About the ‘Third Rail?’

In recent days—notably at the State of the Union address—Social Security is back in the headlines.

Granted, its invocation seems largely intended as a political dividing rod, but it seems today that the vast majority (and despite the veiled insinuations, perhaps the entirety) of Congress and the President are committed to that system’s preservation, or at least rebutting its diminution. It appears that touching Social Security remains the “third rail” of American politics. That said, it’s going to take more than bold podium pontifications to fulfill that commitment.

It’s been called a Ponzi scheme by its critics—and, while not technically correct, there is a familiar element at work—the notion that money being deposited to the system now is basically going to be paid out to other beneficiaries. Indeed, in most Ponzi structures the scheme “runner” generally pays off longer-term participants with money invested by newer investors. Sooner or later, there are not enough new investors to fulfill those expectations and the whole thing blows up—though, depending on the sales skills of the Ponzi purveyor (and the expectations of the investors), it can run for years. Certainly one of the funding issues with Social Security is a result of having fewer new contributors relative to the payout to older participants,[i] if not by number, then by contribution amount(s).    

However, technically speaking, Social Security is not an investment program. Despite those individual withholding statements provided occasionally by the Social Security Administration, nobody has a Social Security “account” into which all those years of FICA withholdings (not to mention the employer contributions) are deposited. People who see those Social Security checks in retirement as a return of the money they put in (with interest) are misguided (at best), though politicians have long found it in their interest for workers to see a link between the two.

Whatever that system’s historic success, and the dependence of the nation’s retirees on its benefits, most surveys find a deep skepticism among the populace as to its long-term financial viability. However, that’s not a new sentiment. Along the way adjustments have been made over time to address those potential shortfalls—the retirement age has been lifted, the taxes withheld from current pay to fund that system have been increased, the benefits eventually paid from that system have been subjected to taxation (effectively reducing benefits)—and these days, most honest politicians will admit that those same kinds of changes will be required again to avert a future crisis.

Whatever you want to call it, to my eyes, Social Security is basically a societal retirement income insurance policy. Those FICA withholdings are premiums and, depending on our life circumstances, we may or may not collect on it. One thing is for sure, however: Whether it’s for life insurance, car insurance, or Social Security, when we make those payments, we expect that we will receive the benefit(s) for which we contracted. Older workers are, naturally, counting on receiving those benefits—because they have been told they can expect them by a reliable source, because they have spent a lifetime dutifully making those payments, and because they have seen their elders do the same.

Not only that, just try finding a retirement income needs projection that doesn’t have as a foundational baseline Social Security benefits. Or consider that an emerging strategy to compensate for retirement savings shortfalls is to use those savings to postpone Social Security claiming in order to maximize those benefits.[ii] Indeed, considering how many Americans rely on Social Security as their sole—or at least a primary—source of retirement income, you’d think addressing the looming shortfall would be a matter of high priority for policy makers. But for the most part—and the current enflamed rhetoric notwithstanding—it unfortunately still seems to be a problem that everyone agrees—someone else needs to fix.

- Nevin E. Adams, JD 

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[i] In 2022, there were an estimated 2.8 covered workers per each Social Security beneficiary. By 2035, the Trustees estimate there will be 2.3 covered workers for each beneficiary.

[ii] Some of the pushback on that argument is a concern that those future benefits will be trimmed—directly or through expanded “means” testing.

'Hidden' Figures

This week was Valentine's Day—and, as usual, there’s been the typical seasonal promotions for flowers, candy, and even pajamas. 

I’ve been pretty good over the years remembering those type events—anniversaries (wedding AND dating), birthdays and, yes—Valentine’s Day. But sometimes the time gap between my remembering the date and actually getting around to doing something to commemorate it has been problematic. With Valentine’s Day that can be particularly painful, if only because so many others are scrambling to do the same thing—and at a time when delivery services (and costs), not to mention growing season(s) can be in short supply, relative to the need.

Several years back, I was running late in my preparations—and spotted an email touting a dozen roses for $24.99 (they’re a LOT more expensive now). Of course, for that price (even then), you could only get them in red (though it was Valentine’s Day, after all), and you actually got a glass vase included in that price (with options to “upgrade,” of course). 

So, I’m feeling pretty good about my bargain-hunting, but then the “other” charges emerged; “standard” delivery was another $12.99, and—at least at that (late) date, it cost (another) $9.99 to guarantee Valentine’s Day delivery, another $14.99 if you want it there in the morning, and there’s a “care & handling charge” of $2.99, regardless of delivery date or time. In fact, by the time you add in taxes those $24.99 roses will run you… well, quite a bit more than $24.99.

Not that you’ll see that all presented in one place—well, until the very last screen, anyway.

Surprise ‘Zing’ 

I wonder sometimes if that isn’t how those who request a hardship withdrawal feel—though, disclosures notwithstanding, it’s not like they can see what it’s actually going to cost at the point they make the request.

Oh, they know the amount they need, and presumably request. But then there’s the 20% withholding that comes off the top, but then, come tax time, they’ll find out if that 20% withholding was “enough.” At the same time, they’ll likely discover the 10% penalty (for those who aren’t yet 59½). Less obvious is the retirement savings “ground” they’ve lost to the customary six-month suspension of contributions (and match). And that’s not considering the 401(k) loan they likely had to take first because, after all, we have to make really, really sure that you absolutely have no other way to get to that money. Those “surprises” are likely to be lessened with the emergency savings and withdrawal provisions of the SECURE 2.0 Act of 2022, of course.[i] 

And then there are the surprises that come WITH retirement. That’s when you “discover” the DISadvantage of pre-tax savings, as Uncle Sam (and his state and city “cousins”) line up for their postponed “cut.” It’s also when Social Security (and Medicare) look to that as fresh income against which benefits (and the cost of benefits) is now means-tested (a.k.a. reduced/taxed).   

Now, if all that seems like a particularly depressing theme for Valentine’s Day, fear not. The impact of the “hidden” costs of retirement—like the hidden costs of that floral arrangement can be muted, if not mitigated, by not waiting until the very last minute to make preparations …

- Nevin E. Adams, JD 

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[i] We’ll save for another day the potential impacts on future retirement savings.

Could Super Bowl LVII Flummox Your 401(k)?

Will your 401(k) be chipped by the Chiefs—or soar with the Eagles?

That’s what adherents of the so-called Super Bowl Indicator[1] would likely conclude, after all. It’s a “theory” that when a team from the old National Football League wins the Super Bowl, the S&P 500 will rise, and when a team from the old American Football League prevails, stock prices will fall.

It’s a “theory” that has been found to be correct nearly 80% of the time—for 41 of the 56 Super Bowls, in fact. Not that it hasn’t had its shortcomings.

One need to look back no further than last year’s victory by the Los Angeles Rams that should have been a portent of good times, only to see the S&P 500 slump more than 19% for its biggest loss since 2008.  And while the previous year’s victory by the NFC’s Tampa Bay Buccaneers bolstered the premise behind the “theory,” the year before that the win by the AFC’s (and original AFL) Kansas City Chiefs over the then-NFC Champion San Francisco 49ers undermined its track record (or did your 401(k) miss that 18.4% rise in the S&P 500?). Or how about the year before that when the AFC’s New England Patriots (who once upon a time were the AFL’s Boston Patriots) bested the NFC champion Los Angeles Rams—but the S&P 500 was up more than 30% that year (2019).

Or, looking the other way, the year before that a win by the NFC champion Philadelphia Eagles (back for this year’s contest) against the AFC Champion Patriots turned out to be a loser, marketwise, with the S&P 500 down more than 6% (though for most of the year it was quite a different story). Ditto the year before, when the epic comeback by those same AFC Champion Patriots against the then-NFC champion Atlanta Falcons failed to forestall a 2017 market surge.

Now, one might think that the real “spoiler” to this market “theory” is the New England Patriots—but the year before that, the AFC’s (and original AFL) Broncos’ 24-10 victory over the Carolina Panthers, who represented the NFC, also proved to be an “exception.”

Market Makings

You might well wonder why, in view of that consistent string of “exceptions” that we’re still talking about this “theory”—but, as it turns out, that’s an unusual (albeit consistent) break in the streak that was sustained in 2015 following Super Bowl XLIX, when the AFC’s New England Patriots (yes, they show up a lot) bested the Seattle Seahawks 28-24 to earn their fourth Super Bowl title.

It also “worked” in 2014, when the Seahawks bumped off the legacy AFL Denver Broncos, and in 2013, when a dramatic fourth-quarter comeback rescued a victory by the Baltimore Ravens—who, though representing the AFC, are technically a legacy NFL team via their Cleveland Browns roots (this is where things start to get confusing, as the Ravens, who were the Browns moved to Baltimore in 1995 (though the NFL still views them as an expansion team) filling the hole left by the then-Baltimore Colts’ 1984 “dead of night” move to Indianapolis.

Admittedly, the fact that the markets fared well in 2013 was hardly a true test of the Super Bowl Theory since, as it turned out, both teams in Super Bowl XLVII—the Ravens and the San Francisco 49ers—were, technically, NFL legacy teams.

However, consider that in 2012 a team from the old NFL (the New York Giants) took on—and took down—one from the old AFL (the New England Patriots—yes, those New England Patriots… again). And, in fact, 2012 was a pretty good year for stocks.

Steel ‘Curtains’?

On the other hand, the year before that, the Pittsburgh Steelers (representing the American Football Conference) took on the National Football Conference’s Green Bay Packers—two teams that had some of the oldest, deepest and, yes, most “storied” NFL roots, with the Steelers formed in 1933 (as the Pittsburgh Pirates) and the Packers founded in 1919. According to the Super Bowl Theory, 2011 should have been a good year for stocks (because, regardless of who won, a legacy NFL team would prevail).

But as some may recall, while the Dow gained ground for the year, the S&P 500 was, well, flat (dare we say “deflated”?).

And then there was the string of Super Bowls where the contests were all between legacy NFL teams (thus, no matter who won, the markets should have risen):

• 2006, when the Steelers bested the Seattle Seahawks;
• 2007, when the Indianapolis Colts (those old Baltimore Colts) beat the Chicago Bears 29-17;
• 2009, when the Pittsburgh Steelers took on the Arizona Cardinals (who had once been the NFL’s St. Louis Cardinals); and
• 2010, when the New Orleans Saints bested the Indianapolis Colts, who, as we’ve already remarked, had roots dating back to the NFL legacy Baltimore Colts.

Sure enough, the markets were higher in each of those years.

As for 2008? Well, that was the year that the NFC’s New York Giants upended the hopes of the AFL-legacy Patriots (yes, those Patriots) for a perfect season, but it didn’t do any favors for the stock market. In fact, that was the last time that the Super Bowl Theory didn’t “work” (well, until the year before last—oh, and the year before that—and the year before…).

Patriot Gains

Times were better for Patriots fans in 2005, when they bested the NFC’s Philadelphia Eagles 24-21 (yep, those Eagles). Indeed, according to the Super Bowl Theory, the markets should have been down that year—but the S&P 500 rose 2.55%.

Of course, Super Bowl Theory proponents would tell you that the 2002 win by the New England Patriots accurately foretold the continuation of the bear market into a third year (at the time, the first accurate result in five years). But the Patriots’ 2004 Super Bowl win against the Carolina Panthers (the one that probably nobody except Patriots fans and disappointed Panthers advocates remember because it was overshadowed by the infamous “wardrobe malfunction”) failed to anticipate a fall rally that helped push the S&P 500 to a near 9% gain that year, sacking the indicator for another loss (couldn’t resist).

Bronco ‘Busters’

Consider also that, despite victories by the AFL-legacy Denver Broncos in 1998 and 1999, the S&P 500 continued its winning ways, while victories by the NFL-legacy St. Louis (by way of Los Angeles) Rams (that have since returned to the City of Angels) and the Baltimore Ravens (those former “Browns”) did nothing to dispel the bear markets of 2000 and 2001, respectively.

In fact, the Super Bowl Theory “worked” 28 times between 1967 and 1997, then went 0-4 between 1998 and 2001, only to get back on track from 2002 on (though “purists” still dispute how to interpret Tampa Bay’s 2003 victory, since the Buccaneers spent their first NFL season in the AFC before moving to the NFC).

Indeed, the Buccaneers’ move to the NFC was part of a swap with the Seattle Seahawks, who did, in fact, enter the NFL as an NFC team in 1976 but shuttled quickly over to the AFC (where they remained through 2001) before returning to the NFC.[2] And, not having entered the league until 1976, regardless of when they began, can the Seahawks truly be considered a “legacy” NFL squad?

Bear in mind as well, that in 2006, when the Seahawks made their first Super Bowl appearance—and lost—the S&P 500 gained nearly 16%.

As noted above, the Eagles have played in three Super Bowls—but only won once—defeating Tom Brady and the New England Patriots 41-33 in Super Bowl LII in 2017 (they previously lost to the Oakland Raiders in Super Bowl XV and to the Patriots in Super Bowl XXXIX). But those outcomes haven’t really lined up with what the Super Bowl Theory suggests. 

As for the Chiefs, they’ve been there before—four times—but with long stretches in between and mixed results. They were in the very first (though back then it was called the AFL-NFL World Championship Game), losing to the Green Bay Packers, but made it back to Super Bowl IV, where they beat the Minnesota Vikings (the first of the four Super Bowls that team would lose). And then, it was a long 50-year stretch between then and 2020 when they bested the 49ers 31-20—only to come back the next year (2021)—and lose to Tom Brady and the Tampa Bay Buccaneers in Super Bowl LV. Again, a mixed contribution to the SB Theory.

The Eagles are the designated “home” team—and given that the game is taking place in an NFC Stadium, so this doesn’t come as a surprise. That said, they’re going to be wearing their home green jerseys—and the Chiefs will be wearing white—and the team wearing white jerseys in the Super Bowl has won 15 of the last 18 Super Bowls (though the last time Kansas City won they were wearing red).

One more thing to watch for those of you into such things; the winner of the coin toss has lost the Super Bowl eight straight years. In fact, the last team to win the coin toss and win the game—was the Seahawks against the Broncos in Super Bowl XLVIII. Yeah, it’s been a while.

Finally—if you’re feeling like the Super Bowl is later and later, you’re not imagining things. In fact, this year’s contest is the SECOND latest ever. The latest? Last year’s contest between the Rams and the Bengals.

All in all, and particularly in view of the exciting playoff games that have led up to it, it looks like it should be a good game.

And that—whether you are a proponent of the Super Bowl Theory or not—would be one in which regardless of which team wins, we all do!

- Nevin E. Adams, JD

 

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[1] An alternate theory linking the Super Bowl to stock market performance in reverse fashion postulates that Wall Street’s results can be used to predict the outcome of the game. According to this theory, if the Dow rises from the end of November until Super Bowl game day, the team whose full name appears later in the alphabet will win. Some people have too much time on their hands….

[2] Note: Seattle is the only team to have played in both the AFC and NFC Championship Games, having relocated from the AFC to the NFC during league realignment prior to the 2002 season. The Seahawks are the only NFL team to switch conferences twice in the post-merger era. The franchise began play in 1976 in the NFC West division but switched conferences with the Buccaneers after one season and joined the AFC West.

A Change of "Hearths"

There are few things more disruptive to the peace or clarity of a 401(k) plan than a switch in recordkeepers.

Let’s face it—change—even change for the better—is frequently disruptive to the human psyche. Most of us tend to drift into comfortable “ruts” of pattern, or perhaps habit—places where we know what to expect and, roughly anyway, when to expect it. And, at least in my experience, the more frazzled your existence, the more one pines for these oases of quiet and relative clarity.

That’s true, of course, even when the change is instigated by a regular, thoughtful, focused evaluation of the alternatives; and certainly when that change is the product of a desperate quest driven by a truly awful service relationship. But it is perhaps particularly disruptive when the change is thrust on the plan by forces outside of its control or instigation—and for the thousands of plans that have recently or are in the process of a change in recordkeepers due to industry consolidation.

Some changes are less impactful than others on the plan’s daily administration, of course. Changes that trigger a mass departure of key staff can be upsetting, and those that necessitate moving to a new processing platform even more so. Change that requires communication to participants is anathema to most plan sponsors. On the other hand, recordkeeper changes that result in additional resources, better capabilities, a clearer focus, and a stronger commitment to “the business” are not as rare as one might fear.

But—whether for good or ill—a change in recordkeepers—regardless of the motivating forces behind the move—is one of those “choices” that plan fiduciaries are expected under ERISA to evaluate as a prudent expert. And so, regardless of whether the change appears to be good, bad, or inconsequential on its face, plan fiduciaries can be expected to know:

How much your plan pays in fees. And to whom. And for what.

The essence of a recordkeeper/service evaluation is the determination that the services provided—and the fees paid for those services—are reasonable. It starts, of course, with knowing how much is being paid for those services. But you can’t know if those fees are reasonable without knowing the services they support. But this analysis also involves a determination that the services provided are appropriate.  That starts with enumerating the services you received prior to the move—and checking those against the one(s) your new arrangement provides.  

What revenue-sharing is (and where it goes).

At a high level, revenue-sharing is just the redistribution of fees paid to one provider to another. It can be a relatively straightforward matter of compensating a sub-contractor, though in retirement plans it’s generally 12(b)1 marketing/distribution fees collected by a mutual fund company and “shared” with the recordkeeper that is actually doing the “distribution” of the funds. There is a general trend away from such practices—but if they are in place, you need to know how much, to whom, and how they’re paid.

How your investment menu might change.

Changes in recordkeepers don’t always involve shifts in the investment menu offered to participants, though they can and often do. And even if they haven’t—and if you have reviewed them recently—the change in recordkeepers can be a good opportunity to reconsider/affirm your investment options to make sure not only that they are prudent, but that they (still) meet the needs of your workforce, and the objectives of your benefit program.

And you might also want to:

Document your review/decision(s)

Whatever process you are using to evaluate your plan (this doesn’t require a recordkeeper change), the goals and objectives in doing so should be written down, as should the conclusions drawn from the exercise. You might get there with a simple committee review, or perhaps something more formal—like a request for proposal (particularly if you have the time to do so ahead of the move). Indeed, odds are a formal benchmarking process or RFP will produce documentation of those conclusions/considerations as a natural outcome. But if it doesn’t, you should make the effort to make sure it does.

A change in recordkeepers is a good opportunity to reconsider your plan’s design and operations—and one that, as a prudent plan fiduciary—you’re expected to.

- Nevin E. Adams, JD

Markets Timing

As it happens, I’ll commemorate an anniversary of my birth this weekend.

It’s not a particularly significant one—it doesn’t end in a 5 or a 0, won’t trigger any new savings opportunities or impact (catch-up, RMD trigger, forbearance of withdrawal penalties, or Social Security)—but it is a birthday, and therefore a day upon which to reflect (and to wonder anew why we don’t make more fuss about our mothers, who—let’s face it—did the real work on that day).

Traditionally, on my birthday weekend (and the 4^th of July holiday), I have taken a look at my current asset allocations and, when circumstances warranted, rebalanced. There’s no magic to those points in time. It’s not the ONLY time I look (and act)—but it happens to be a time when, whatever is going on in the market, I have a calendar-driven opportunity to take a breath and take a longer view. And, let’s face it, this year has been a bumpy ride in the markets.

The mantra in times of volatile markets is, inevitably, “stay the course”—wise counsel in most situations, particularly since the impulse in such times is often action that one comes to regret in the fullness of time. However, for some, just sitting still and “taking” what the markets choose to inflict on your retirement savings can be excruciating. 

For me, anyway, this year will be a little different. Most significantly, as I near my “retirement” threshold, I’ll actually be shifting into a different pace of accumulation. And, for the first time in my working career, I will be doing it with my retirement savings accumulated into a single place (well, technically two—one for Roth, the other for the traditional pre-tax rollovers). That said, and my birthdate notwithstanding, I still have plenty of investment runway to ride.  

That said, and while my weekend should be a bit less structured than usual, here are some things I have traditionally done—that you, or those you support, may find useful—particularly with the current market uncertainties.      

Get started on rebalancing by changing the investment elections of NEW contributions, rather than transferring existing balances. It will take longer to realign the entire account, but at least you aren't realizing those as-yet-unrealized losses.

Increase current deferral rates. When you think about just how much cheaper those retirement plan investments are now, compared to a year ago, it's hard to pass up that kind of bargain. More so if you aren't yet saving at the maximum level of the match.

Consider automated rebalancing. Most providers now have in place mechanisms that will, on some preset frequency (monthly, quarterly, annually), automatically rebalance individual accounts in accordance with investment elections. It's a good way to keep things in balance without having to worry (or remember) about the best time to do so—calendared events notwithstanding.

Better yet, consider shifting to a target-date fund or managed account. You may well be wondering why I would go to the “trouble” of manually rebalancing my 401(k) when there are professionally managed solutions available like target-date funds and managed accounts. The reality is that only one of my previous 401(k)s had target-date funds available on their menu[i]—and I have taken advantage of that regular rebalancing by professionals to some advantage.

None of this has to wait for a birthday, of course. But doing so on a regular basis can be an effective way to ensure that you get that retirement wish when you blow out the candles!

Nevin E. Adams, JD 

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[i] Another had a managed account option (that I didn’t care for).

Closing the "Opportunity" Gap

There’s no one silver bullet likely to close the nation’s retirement plan coverage gap—but the target is pretty easy to spot.

As it turns out, the nation’s retirement plan access coverage gap is almost exclusively found among small businesses, and it’s not hard to imagine why. The failure rate for small businesses is daunting—and those who’ve managed to avoid that fate are doubtless focused on trying to avoid becoming a statistic. Under those circumstances one can well appreciate that offering benefits, much less RETIREMENT benefits, probably seems like a luxury for another time, if not another business.

A recent issue brief by Anqi Chen and Alicia Munnell of the Center for Retirement Research (CRR) at Boston College examined the issue, and drawing on previous research[i] cited the following three main barriers:

• uncertain revenues that make it hard for a firm to commit to a plan;
• employee preferences for wages and other benefits;[ii] and
• the cost associated with establishing and administering a plan (this latter included an assumption by some/many that employer contributions were required).

Indeed, surveys seeking to better understand this reluctance generally find two major obstacles: cost and complexity of administration. And that was before the recent economic downturn. 

Starter Up!

Enter the SECURE 2.0 Act of 2022 which, among its 90-some-odd retirement plan provisions, contains two that are squarely fixed on resolving those issues. The first of these is the so-called Starter K.  Basically, starting now—employers that have never had a plan can set up a “starter” 401(k) or 403(b) plan. There is no required employer contribution, though employees are automatically enrolled at 3% of pay (they can opt out). While this an actual 401(k)/403(b) plan, it looks more like an IRA, more specifically the type that have been established by a number of states. The limits for employee contributions start at $6,000, indexed to inflation—and there is an additional opportunity for a catch-up contribution of $1,000 for those individuals over 50. However, unlike the traditional 401(k)/403(b), there is no nondiscrimination or top-heavy testing requirements. 

All in all, it’s a straightforward, simple 401(k) design that removes the complexity (and cost) concerns that have held many small businesses back. Conservative estimates prepared for the American Retirement Association suggest that this could provide 19 million working Americans access to a workplace retirement plan that didn’t have that opportunity previously.

Credits ‘Worthy’

But perhaps the biggest incentive found in SECURE 2.0 is the greatly expanded tax credit for new plans.  Under current law, employers with less than 100 employees that adopt a new retirement plan can qualify for an annual tax credit for up to three years equal to the lesser of (1) 50% of the administrative cost of establishing the plan, or (2) $5,000. But, effective for 2023, SECURE Act 2.0 increases that percentage from 50% to 100% for employers with 50 or fewer employees (it remains at 50% for those with 51-100 employees). So, it covers 100% the cost of operating the plan, up to $5,000 (which, I’m told with some confidence is more than the cost of running those size plans). 

More than that, it also establishes a generous new tax credit for contributions made by small employers to a newly established retirement plan (other than a defined benefit plan)—a tax credit that is a set percentage of the amount contributed by the employer for employees up to a per-employee cap of $1,000 (though contributions to those that make $100,000 or more are not taken into account). Better still, that set percentage is 100% for the year the plan is established AND the following year, 75% for the third year, 50% for the fourth year, 25% for the fifth year (0% thereafter). The full amount of the new tax credit would be available to employers with 50 or fewer employees but phases out for employers with 51 to 100 employees. 

MEP ‘Step’

Oh—and for fans of multiple employer plans (MEPs), the start-up credits are available for three years to employers that join an existing MEP, regardless of how long the plan has been in existence (the MEP rule is retroactively effective for taxable years beginning after Dec. 31, 2019).

The reality is that even today more than 30% of all private-sector American workers still lack access to workplace retirement plans and thus lack an equitable opportunity to achieve a comfortable retirement.   Further, nearly 60% of workers in the lowest income classes still lack access to workplace plans. We talk about a “coverage” gap, but it’s really an opportunity gap.     

The challenges confronting small businesses are no less—and arguably even larger now—than they’ve ever been. But, amidst all the economic uncertainty—and with the importance of worker attraction and retention more critical than ever—SECURE 2.0 offers opportunity—not only to strengthen and solidify those workplace bonds—but in the process to help give American workers the opportunity to better prepare for a secure retirement.

- Nevin E. Adams, JD 

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[i] Specifically by the Employee Benefit Research Institute (EBRI), the Pew Charitable Trusts, and the Transamerica Institute.

[ii] Incredibly, the EBRI research, which admittedly went back to 2003, cited as a primary rationale that employees hadn’t REQUESTED the benefit.

Withdrawal Symptoms?

 There’s nothing like a global pandemic to fuel interest in, if not the need for, emergency savings. Indeed, there are a half dozen provisions[i] in the new SECURE 2.0 designed to make it easier for workers to tap into their retirement savings—two aimed specifically at emergency savings.

Though the financial impact of the pandemic (not to mention a series of natural disasters) has arguably been uneven, a report from Vanguard[ii] highlighted the longer-term impacts of the economic slowdown and inflation’s growing bite of the household budget. It's also widely acknowledged that concerns about the inability to fund an unexpected financial emergency is a source of stress for workers, undermining financial wellness.   

All that said, well before COVID-19, there have been concerns about Americans’ lack of emergency savings[iii] and, perhaps more broadly, that they were using their retirement savings accounts as that resource. Behavioral finance-types have counseled that a mental, if not physical, segregation of money by purpose is helpful, and at least one of the new SECURE 2.0 provisions seems designed to make that structure a reality by creating an emergency savings “sidecar” alongside regular retirement savings accounts. 

The first of these is found in Section 115 and, beginning in 2024 it says a participant may generally make a withdrawal of up to $1,000 per year from their retirement account for certain emergencies. The withdrawal may be taxable (unless drawn from Roth) and MAY be repaid within three years, but it will not be subject to the 10% penalty for early withdrawals. Only one withdrawal is permitted per the three-year repayment period—if the first withdrawal has not been repaid.

The other emergency savings provision (Section 127)—and the one that seems to be garnering most of the media attention is the (confusingly labeled) “Pension Linked Emergency Savings Accounts.” Beginning in 2024, it will ALLOW (not require) employers to create an Emergency Savings Account (ESA) as part of a defined contribution plan (401(k) or 403(b)). Only non-highly compensated employees may contribute to the account, though employers MAY auto-enroll such individuals in an EAS up to 3% of their compensation, and the EAS value cannot exceed $2,500[iv] (indexed for inflation). All employee contributions to this emergency savings account MUST be made on an after-tax basis—and each month participants may take withdrawals from the account (just to further complicate administration, the first four withdrawals for a year cannot be subject to distribution fees). 

Oh—and speaking of complications, those employee contributions must be treated as elective deferrals for purposes of any matching contributions. The matching contributions are treated by a plan no differently than matching contributions made on account of elective deferrals.   

Now this provision likely makes the behavioral science-types happy—it provides a separate mental (and notational) accounting—and one that doesn’t force the individual to choose between saving for retirement or saving for that “rainy day” emergency, at least in terms of foregoing a company match. 

But, aside from the obvious administrative complexities of this option (certainly for the plan sponsor/recordkeeper), it’s by no means clear that this kind of set up won’t create a kind of “Christmas club” account, with individuals withdrawing these contributions for just about any reason every year (just) long enough to get the match—and then the next year they could do it all over again. And again. The Treasury is authorized to issue regulations to prevent abuse, but there’s no telling if or when (or  what) those rules would be.  

It might be good mental “accounting”—but I’m not sure that it will be good for retirement. 

- Nevin E. Adams, JD 

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[i] While I’m focusing on only two of those provisions here, the others are Section 314 (allows for up to $10,000 of withdrawals from plans and IRAs in cases of domestic abuse, effective 2024), Section 326 (exempts from the 10% excise tax withdrawals from plans and IRAs in cases of terminal illness, effective now), Section 331 (allows for withdrawals from plans and IRAs of up to $22,000 in federally declared disasters, effective retroactively to Jan. 26, 2021), and Section 334 (allows for up to $2,500 a year of withdrawals from workplace plans to pay for long-term care, effective three years after enactment (so generally not until 2026)).

[ii] In fact, that report, published last October, and amidst growing concerns about the above factors and volatile investment markets, noted that the share of workers taking cash from their employer retirement plans through new loans, non-hardship withdrawals, and hardship withdrawals were on the rise in 2022.  Called out for special note was the rise in hardship withdrawals, which Vanguard said had reached an all-time high—though that was only 0.5% of workers tracked by Vanguard (5 million participants in 1,700 employer-sponsored retirement plans administered by the firm).

[iii] The most widely repeated likely being the Federal Reserve survey asking Americans if/how they’d handle a $400 emergency (approximately 1 in 9 said they couldn’t, and while that’s a minority, the headlines have tended to highlight the impact)—but see https://www.minneapolisfed.org/article/2021/what-a-400-dollar-emergency-expense-tells-us-about-the-economy.

[iv] Though there’s been some question as to whether $2,500 is “enough” (there’s language in the bill calling for a study to see if it needs to be higher).

5 New Year’s Resolutions for 401(k) Plan Fiduciaries

This is the time of year when resolutions for the cessation of bad behaviors and the beginning of better ones are in vogue. Here are three for plan fiduciaries for 2023.

Develop a plan budget.

Most financially-focused New Year’s Resolutions focus on spending (less) or saving (more)—and the really thoughtful ones do both—all tied around the development of a budget that aligns what we have to spend with what we actually spend. 

Most (many?) plans have a budget when it comes to the expenditures that require corporate funding.  Less clear is how many establish some kind of budget when it comes to what participants have to spend.  Now, granted, what they pay will vary based on any number of …variables—but an essential part of ensuring that the fees paid by the plan (for the services provided to the plan) is knowing how much—and for what. 

At some level that means not only keeping an eye on things like expense ratios, the options with revenue-sharing, and the availability of alternative share classes (or options like CITs)—but it also means having an awareness not only of the plan features, but the usage rates of those plan features.

Because when it comes to retirement plans, there often IS a direct link between spending less and saving more.

Put your fund menu on a diet.

Though it is a point often made with studies (well, one frequently cited study, actually) dealing with jellies and ice cream, a long-standing behavioral finance tenet is that more choice doesn’t lead to better decisions. So, what’s with those (still) burgeoning 401(k) investment menus? The 65^th annual Plan Sponsor Council of America’s Survey of Profit-Sharing and 401(k) Plans found that more than a quarter of plan sponsors offer 26 OR MORE options, while another 18% offered 21-25, and 27% offered 16-20.

Odds are that there are funds on the current menu that either aren’t being used or aren’t being used widely—options that contribute little other than clutter to your investment review and to the decisions of your participants.

Take a look—your retirement plan menu shouldn’t be a kitchen sink “solution.”

Check-up—on your target-date fund(s).

Flows to target-date funds (TDF) have continued to be strong—and little wonder, what with their positioning as the qualified default investment alternative (QDIA) of choice for most 401(k)s. That said, the vast majority of those assets are still under the purview of an incredibly small number of firms—with glidepaths that are not as dissimilar as their marketing materials might suggest. 

A TDF is, of course, a plan investment, and like any plan investment, if it fails to pass muster, a plan fiduciary would certainly want to remedy that situation, including removing the fund if necessary (don’t take my word for it—that’s coming straight from the Labor Department).  

That said, TDFs are frequently, if not always, pitched (and likely bought) as a package. While each fund in the family is reviewed separately, and certainly should be, breaking up the set certainly carries with it a series of complicated consequences, not the least of which are participant communication issues and glide path compatibility. Not that those can’t be overcome—and not that those complications would be deemed sufficient to retain an inappropriate investment on the plan menu—but it doesn’t take much imagination to think about the heartburn that might cause.

The reasons cited behind TDF selection run a predictable gamut; price/fees, performance (past, of course, despite those disclaimers), platform (as in, it happens either to be their recordkeepers, or compatible with their program)—and doubtless some are actually doing so based on an objective evaluation of the TDF’s suitability for their plan and employee demographics. 

Whatever your rationale, it’s likely that things have changed—with the TDF’s designs, the markets, your plan, your workforce, or all of the above. 

Pump up the default rate in your auto-enrollment plan.

While a growing number of employers are auto-enrolling workers in their 401(k) plan, one is inclined to assume that, a decade and a half after the passage of the Pension Protection Act, if a plan hasn’t done so by now, they likely have some very specific reasons.

But for those who have already embraced automatic enrollment, those are plans who have (apparently) overcome the range of objections; concerns about paternalism, administrative issues, cost—some may even have heard that fixing problems with automatic enrollment can be—well, problematic (though things have gotten a little easier on that front).

There has been movement here over the years—indeed the most recent PSCA survey found that two-thirds (65%) of plans with automatic enrollment set the default deferral rate high enough so that participants receive the full possible company matching contribution, up from 57.1% as recently as 2020. In fact, the most common default rate for automatic enrollment plans is now more than 6%. 

Set goals for your plan designs.

The mantra about retirement benefits has always been that they exist to help attract and retain good workers. More recently, a reimagined emphasis on financial wellness has offered some nuance to that—to provide better levels of engagement while they are working, to forestall the “distractions” (and potential malfeasance) that financial stress can engender, and ultimately to help workers retire “on time.” These goals are not inherently incompatible, but at any given point in time they require differences in communication, education, emphasis, and potentially program design.  

There is, by the way, a sense of a shift in such things. While the primary goal of participant education has historically been to increase participation rates, the Plan Sponsor Council of America’s 65^th Annual Survey of Profit-Sharing and 401(k) plans notes that in 2020 that shifted to increasing financial literacy of employees in 2020—a shift that held in the most recent survey with 77.4% of organizations now stating that as their primary educational goal. The secondary goal was increasing appreciation for the plan (likely as a retention method) followed by providing retirement planning to employees. The percent of organizations offering financial wellness programs increased to 27%, including more than half of large employers.

If you haven’t revisited those objectives in a while—or, heaven forbid, have never done so—there’s no time like the present for a reset. After all, as Yogi Berra once commented, “If you don’t know where you’re going, you might wind up someplace else.” 

- Nevin E. Adams, JD

The 'Best' of 2022

I’ve been writing a weekly column (and then some) for more than two decades now. Some are easier to write (and read)—and some hold up better (and longer) than others. These are some of my (and perhaps your) favorites from 2022.

Let me know what you think in the comments below… particularly if I have missed one of your favorites…  

7 Things to Know About the New ESG Regulation

There’s a lot to unpack in that regulation (and the rest of the 236-pages that help explain its process and rationale), but here’s a few things that seem particularly important to note at the outset. https://www.napa-net.org/news-info/daily-news/7-things-know-about-new-esg-regulation

‘Damned’ (Even) If You Do

The flurry of lawsuits unleashed on holders of the BlackRock LifePath target-date funds is not without precedent—but it’s surely a head scratcher. https://www.napa-net.org/news-info/daily-news/damned-even-if-you-do

Things to Ponder

In the course of my day, I talk to (and email with) people, read a lot, and every so often jot down a random thought or insight that gives me pause and makes me think. See what you think. https://www.napa-net.org/news-info/daily-news/things-ponder

6 Obstacles to Retirement Income Adoption

It’s ironic that programs designed to provide retirement income pay so little attention to the realization of that objective. https://www.napa-net.org/news-info/daily-news/6-obstacles-retirement-income-adoption

The Sure Not-So-Sure Thing

Perhaps the only “sure” things are death and taxes after all—but the lesson for those of us still drawing a paycheck and planning for retirement is the importance of preparing for that third “sure” thing when it comes to retirement planning. https://www.napa-net.org/news-info/daily-news/sure-not-so-sure-thing

7 Assumptions That Can Derail Your Retirement Reality

The future is an uncertain thing, and planning for uncertainty inevitably involves making some assumptions. Here are seven that, done improperly, can—yes, derail your retirement realities. https://www.napa-net.org/news-info/daily-news/7-assumptions-can-derail-your-retirement-reality

5 Dangerous Fiduciary Assumptions

There’s an old saying that when you assume… well, here are some assumptions that can create real headaches for retirement plan fiduciaries. https://www.napa-net.org/news-info/daily-news/5-dangerous-fiduciary-assumptions

9 Things You May Not Know About the Saver’s Credit 

As I was pulling together tax information this weekend, I was reminded that, in addition to the benefits of pre-tax savings and deferred taxes on retirement savings, there’s another tax benefit—but one of which many aren’t aware. https://www.napa-net.org/news-info/daily-news/9-things-you-may-not-know-about-savers-credit

Not-So-Unforeseen Outcomes

Thanks to their mother, my kids have grown up with a variety of pets in our house—but none more bizarre than our experience with… a chicken. https://www.napa-net.org/news-info/daily-news/not-so-unforeseen-outcomes

- Nevin E. Adams, JD

You Better Watch Out…

"You better watch out, you better not cry, you better not pout…”

Those are, of course, the opening lyrics to that holiday classic, “Santa Claus is Coming to Town.” And while the tune is jaunty enough, the message—that there’s some kind of elfin “eye in the sky” keeping tabs on us has always struck me as just a little bit… creepy.

That said, once upon a time, as Christmas neared, it was not uncommon for my wife and I to caution our occasionally misbehaving brood that they had best be attentive to how their (not uncommon) misbehaviors might be viewed by that big guy at the North Pole.

In support of that notion, a few years back—well, now it’s quite a few years back—when my kids still believed in the (SPOILER ALERT) reality of Santa Claus, we discovered an ingenious website[i] that purported to offer a real-time assessment of their “naughty or nice” status.

Indeed, no amount of parental threats or admonishments—in fact, nothing we ever said or did—ever managed to have the impact of that website—if not on their behaviors (they were kids, after all), then certainly on the their level of concern about the consequences. 

In fact, in one of his final years as a “believer,” my son (who, it must be acknowledged, had been particularly “naughty” that year) was on the verge of tears, panic-stricken—following a particularly worrisome “reading[ii]”—concerned not so much that he’d misbehaved, and certainly not that he’d disappointed his parents with his misbehaviors—but that as a result, he'd find nothing under our Christmas tree but the lumps of coal[iii] he so surely “deserved.”

Making a List?

Every year about this time we read survey after survey recounting the “bad” savings behaviors of American workers. And, despite the regularity of these findings, must of those responding to the ubiquitous surveys about their (lack of) retirement confidence and their (lack of) preparations don’t offer much, if anything, in the way of rational responses to those shortcomings (even) though they (apparently) see a connection between their retirement needs and their savings (mis)behaviors. 

Now, arguably with inflation fears looming ever larger, those pressures have been magnified—but this is not a new concern. Indeed, the reality has long been that a significant number will, when asked to assess their retirement confidence, generally acknowledge that there are things they could—and know they should have—done differently. Retirees routinely bemoan and regret their lack of attention to such things. Sadly, if there’s anything as predictable as the end of year regrets, it’s the perennial list of new year’s resolutions to (finally) do something about it. 

So if they know they’ve been “naughty”—why don’t they do something about it? 

Well, some certainly can’t—or can’t for a time—but most who respond to these surveys seem to fall in another category. It’s not that they actually believe in a retirement version of St. Nick, though that’s essentially how they seem to (mis)behave. They carry on as though, somehow, these “naughty” savings behaviors throughout the year(s) notwithstanding, they'll be able to pull the wool over the eyes of that myopic, portly old gentleman in a red snowsuit—and that at their retirement date, despite their lack of attentiveness during the year(s), that benevolent elf will descend their retirement chimneys with a bag full of cold, hard cash from the North Pole. Unfortunately, like my son in that week before Christmas, many worry too late to meaningfully influence the outcome.

A World of Possibilities

Now, the volume of presents under our Christmas tree never really had anything to do with our kids’ behavior. As parents, we nurtured their belief in Santa Claus as long as we thought we could (without subjecting them to the ridicule of their classmates), not because we truly expected it to modify their behavior (though we hoped, from time to time), but because we believed that children should have a chance to believe, if only for a little while, in those kinds of possibilities.

We all live in a world of possibilities, of course. But as adults we realize—or should—that those possibilities are frequently bounded in by the reality of our behaviors, as well as our circumstances. And while this is a season of giving, of coming together, of sharing with others, it is also a time of year when we should all be making our own retirement list and checking it twice—taking note, and making changes to what is “naughty and nice” about our personal behaviors—including our savings behaviors. To “be good,” not for “goodness” sake, but for what we all hope is the “goodness” of financial “freedom” in our lives.

Yes, Virginia,[iv] as it turns out, there is a retirement savings Santa Claus—but he looks a lot like you, assisted by “helpers” like your workplace retirement plan, your employer’s matching contributions—and your trusted retirement plan advisors and providers.

Happy Holidays!

- Nevin E. Adams, JD

 

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[i] And it’s still online at http://www.claus.com/naughtyornice/index.php.htm.

[ii] And yes, though this was before smartphones, there was a tendency to constantly check in. That said, there do appear to be a number of apps online now that purport to fulfill a similar function. 

[iii] For those unfamiliar with that reference: https://abc7chicago.com/st-nicholas-day-saint-lumps-of-coal/4846172/

[iv] In case you’re curious as to that reference… https://www.newseum.org/exhibits/online/yes-virginia-there-is-a-santa-claus/

6 Obstacles to Retirement Income Adoption

It’s ironic that programs designed to provide retirement income pay so little attention to the realization of that objective. Still, some have said that this could be the year for retirement income—a combination of new offerings, volatile markets, and rising interest rates—and yet, it still seems that there are obstacles to overcome. 

Here are six:

1. There is no legal requirement to provide a lifetime income option.

Let’s face it, it’s a full-time job just keeping up with the plan provisions, standards, participant notices and nondiscrimination tests that are required by law. The notion that a plan sponsor would, in the absence of a compelling motivation take on extra work, and work that carries with it additional financial and fiduciary responsibility as well, doesn’t seem very realistic.

Indeed, with no legal obligation to provide this offering, and an underlying concern that providing the option does involve taking on additional liability…

2. The safe harbor for selecting an annuity provider doesn’t feel very “safe.”

I’ve never met a plan sponsor who felt that the guidance on offering in-plan retirement income options was “enough.”

I’m not saying they’re not out there—clearly there are in-plan options available in the marketplace now, and thus, logically, there are plan sponsors who have either derived the requisite assurances (or don’t find them necessary). Or who feel that the benefits and/or participant need for such options makes it worth the additional considerations. That said, industry surveys (still) indicate that only about half of defined contribution plans provide an option for participants to establish a systematic series of periodic payments, much less an annuity or other in-plan retirement income option. 

Now, over the years the Labor Department has tried to ameliorate those concerns, as recently as Field Assistance Bulletin (FAB) 2015-02. Perhaps more significantly, among the key elements of the SECURE Act that sought to expand retirement income awareness/availability was a new safe harbor. Essentially it says that when a plan fiduciary of a defined contribution plan selects a “guaranteed lifetime income contract” to be offered under its plan, the fiduciary will be deemed to have acted prudently if it follows the steps outlined in the law. In other words, it provides a specific road map to follow[i], and if it’s followed, the new safe harbor means that the fiduciary will not be liable if the insurance company later defaults on its obligation to participants who invest in the contract. Basically, the fiduciary must obtain specified representations from insurance companies about their financial soundness (and not have any information that contradicts those representations).

Of course, that safe harbor emerged in the waning days of 2019—just ahead of COVID, the CARES Act, and a fair amount of workplace/workforce disruption. It seems fair to say that the implications of its guidance have yet to be absorbed by most plan sponsors. Will it finally be “enough?” Time will tell.

3. Operational and cost concerns linger.

While several industry providers have offered what seem to be workable, effective solutions to the “portability problem,” plan sponsors remain concerned that the cost and complexity of transitioning these offerings—either by individual plan participants, or the plan itself—would be daunting, at best.  And that doesn’t take into account the educational challenges. 

Granted, there are a host of new and newly-branded solutions in and coming to market (check out our recent Retirement Income Buyer’s Guide for some insights)—but there remains a “learning” curve, and, at least in some cases, an UN-learning curve—for plan fiduciaries, and those who advise them.   

4. Participants aren’t asking for it.

Once you’ve walked through all the objections[ii] to in-plan retirement income options, it all seems to come down to this. Despite industry surveys that suggest worker interest in the concept (if not the reality) of retirement income solutions, it never seems to get to the level of expressing that interest to those who actually make retirement plan design decisions.

Sure, most plan sponsors acknowledge that participants (certainly older, longer-tenured participants) could use the kind of help that a retirement income structure could provide, and yes, plan sponsors are (still) looking for a more secure safe harbor, and they’d certainly welcome a PPA-ish “nudge” (along the lines of QDIAs) in that direction. At the same time large employers, anyway, have expressed interest in helping workers retire “on time,” and there is apparently increasing interest in retaining participant accounts in their plans. All in all, it seems that those interests would be well-served by a prudent, well-executed solution to provide a reliable retirement income alternative. 

That said, until it becomes an articulated concern for the workers they hope to attract, retain and eventually retire from their workforce, it’s likely that the adoption rate—by plans and plan participants—will be slower than might be hoped.

5. Participants don’t take advantage of the option when offered.

The so-called “take up” rates among participants can be sliced in different ways—by provider (the options are varied, after all), by participant age, even by the involvement of the employer in positioning in the option—but however you parse it, the word I’ve generally heard to describe participant adoption rates is… “disappointing.”

Not that those dynamics can’t be influenced by plan design or advisor input, but justifiable concerns remain about fees, portability and provider sustainability. Moreover, there are significant behavioral finance impediments—be it the overweighting of small probabilities, mental accounting, the fear of losing control of finances, a desire to leave something to heirs, or simple risk aversion. It’s often not just one thing. It’s… complicated.

To its credit, the retirement income industry has pretty consistently tried to overcome the objections raised with a series of product innovations. Unfortunately, that process has tended to make the offerings more complex AND more expensive. One thing for sure—if it’s not TDF-easy/simple to use, participants won’t.

6. (Most) advisors (still) aren’t promoting it.

Plan design can surely help steer participants toward these options, but most advisors I’ve spoken with say that, for a variety of reasons (mainly cost and complexity) these retirement income options are still sold, and not bought. Beyond that, the current advisory focus seems more targeted on wealth management—a perfectly logical emphasis for those with enough wealth to warrant it, but arguably beyond the needs of many retirement plan accounts.     

As an industry, we bemoan worker inattentiveness to the sufficiency of their retirement savings accumulations—and that’s with the aid and assistance of workplace retirement savings education, defaults for decisions like contribution amount and investments, and increasingly the availability of a retirement plan advisor. 

But let’s face it: When it comes to making a decision about a lifetime income option, or even evaluating the option, most workers are—still—literally on their own.

- Nevin E. Adams, JD

 

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[i] See Guaranteed Income: The Impact of the SECURE Act

[ii] See 7 Reasons Retirement Income Solutions Stall

7 Things to Know About the New ESG Regulation

A little more than a week ago, the U.S. Department of Labor unveiled its much-anticipated final ESG rule.  There’s a lot to unpack in that regulation (and the rest of the 236-pages that help explain its process and rationale), but here’s a few things that seem particularly important to note at the outset.

There are some (important) things that did NOT change.

First, and to my mind, foremost, the Labor Department noted that “The duties of prudence and loyalty require ERISA plan fiduciaries to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries (such as by sacrificing investment returns or taking on additional investment risk) to objectives unrelated to the provision of benefits under the plan.

But it also included an important clarification:

“…the final rule amends the current regulation to make it clear that a fiduciary’s determination with respect to an investment or investment course of action must be based on factors that the fiduciary reasonably determines are relevant to a risk and return analysis and that such factors may (emphasis mine) include the economic effects of climate change and other environmental, social, or governance factors on the particular investment or investment course of action.”

It does away with “pecuniary” as a standard (or at least as a word claiming to be the standard).

The Trump Administration’s version defined pecuniary (a term “introduced” to the ERISA lexicon by the United States Supreme Court in the Fifth Third v. Dudenhoefer decision[i]) as “a factor that a fiduciary prudently determines is expected to have a material effect on the risk and/or return of an investment based on appropriate investment horizons consistent with the plan’s investment objectives and the funding policy established pursuant to section 402(b)(1) of ERISA.” 

However, that word choice was determined by the Labor Department to be causing “confusion” and to have a “chilling effect” — “deterring fiduciaries from taking steps that other marketplace investors would take in enhancing investment value and performance, or improving investment portfolio resilience against the potential financial risks and impacts associated with climate change and other ESG factors.”

However, and despite what some saw as an implication in the proposed regulation, the final regulation does NOT mandate consideration of ESG factors.

Quite the contrary—quoting from the Labor Department:

“The final rule makes unambiguous that it is not establishing a mandate that ESG factors are relevant under every circumstance, nor is it creating an incentive for a fiduciary to put a thumb on the scale in favor of ESG factors.” 

“Outside the ERISA context, investors may choose to invest in funds that promote collateral objectives, and even choose to sacrifice return or increase risk to achieve those objectives. Such conduct, however, would be impermissible for ERISA plan fiduciaries, who cannot sacrifice return or increase risk for the purpose of promoting collateral goals unrelated to the economic interests of plan participants in their benefits.”

It treats QDIAs just like any other investment option in the plan.

The Trump Administration in its preliminary regulation had barred funds with an ESG focus from qualifying as a qualified default investment alternative (QDIA), and then—following criticism on that front—in its final regulation modified the provision in the proposal on QDIAs to prohibit plans from adding or retaining any investment fund, product, or model portfolio as a QDIA or as a component of such a default investment alternative, if its objectives, goals or principal investment strategies include the use of non-pecuniary factors.

The new regulation removes that distinction, noting that “QDIAs would continue to be subject to the same legal standards under the final rule as all other investments, including the prohibition against subordinating the interests of participants and beneficiaries in their retirement income to other objectives. QDIAs also would continue to be subject to the separate protections of the QDIA regulation.”

That said, the Labor Department says it expects to see an increase in the number of QDIAs that are ESG funds—though, considering the number currently in the market (and there are some), that hardly seems a controversial call.

Eliminated additional disclosure/labeling requirements associated with alternative investments with collateral benefits.

The Trump era regulation imposed a requirement that competing investments be indistinguishable based solely on pecuniary factors before you could turn to collateral factors to break a tie—oh, and even then, you would have had to comply with a special documentation requirement on the use of such factors.

The final rule, on the other hand, replaces that with a standard that instead requires the fiduciary to conclude prudently that competing investments, or competing investment courses of action, equally serve the financial interests of the plan over the appropriate time horizon—and, having determined that they equally serve those goals, is not prohibited from selecting the investment, or investment course of action (like an ESG focus), based on collateral benefits other than investment returns. 

And they no longer have to document that evaluation (which, interestingly enough, turns out to be one of the cost benefits[ii] associated with the new rule). 

Participant preferences can (still) play a role in menu design.

Now, in my experience, plan sponsors (and advisors) have long considered participant preferences in menu design. Not to the subordination of prudent fiduciary standards, of course—though there have been concerns that some might not see it that way. 

Well, the new regulation contains a new and interesting provision that “clarifies” that fiduciaries “do not violate their duty of loyalty solely because they take participants’ preferences into account when constructing a menu of prudent investment options for participant-directed individual account plans. If accommodating participants’ preferences will lead to greater participation and higher deferral rates, as suggested by commenters, then it could lead to greater retirement security."

Now, notice that while such considerations don’t necessarily violate the duty of loyalty—but there is no setting aside of the standards of prudence in evaluating and monitoring those investments noted above.  More specifically, those decisions need to be evaluated “taking into consideration the risk of loss and the opportunity for gain” compared to the opportunity for gain “with reasonably available alternatives with similar risks.”   

As noted above, there’s a lot to unpack here—and we’ll continue to do so right up to the Jan. 30, 2023 effective date—and beyond.

- Nevin E. Adams, JD

 

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[i] In that case, the nation’s highest court concluded that the responsibilities of an ESOP fiduciary must be directed toward the duty to provide benefits and defray expenses—and that any non-pecuniary interests, such as Congress' strong encouragement of employee stock ownership, did not warrant an alteration of the fiduciary standard.  

[ii] Noting that in view of the “large scale of investments held by covered plans, approximately $12.0 trillion, changes in investment decisions and/or plan performance may result in changes in returns in excess of $100 million in a given year,” the Labor Department estimates that 20% of defined contribution and defined benefit plans (149,300 plans with some 28.5 million participants) will be affected by the regulation “because their fiduciaries consider or will begin considering climate change or other ESG factors when selecting investments.” In the Labor Department’s estimation, for each plan, a “legal professional will need to review paragraphs (b)-(c) of the final rule, evaluate how these provisions might affect their investment practices and assess whether the plan will need to make changes to investment practices. The Department estimates that this review will take a legal professional approximately four hours to complete, resulting in an aggregate cost burden of approximately $91.5 million or a per-plan cost burden of approximately $613.[ii]”

That said, the Labor Department noted that plan fiduciaries “generally already undertake deliberative evaluations as part of their investment selection decision-making process and this final rule does not add burden to those deliberations; but rather, the final rule clarifies that the scope of those deliberations may include climate change and other ESG factors within the confines of paragraphs (b)(4) and (c)(1) of the final rule. The Department does not intend to increase fiduciaries’ burden of care attendant to such consideration; therefore, no incremental costs are estimated for these requirements.”

Advisor Value ‘Adds’

Most of the attempts to affix a value to having an advisor tend to focus on investment returns or cost savings. Both are valid, objective measures that can have a real, substantive impact on retirement security—but, at least with the best advisors—there’s usually more.

Indeed, years ago as a fiduciary of another firm’s 401(k) plan, and while I had always felt comfortable with the decisions the plan committee had made, as our little company grew to be less little, I was increasingly aware of the personal liability associated with my role, and the small amount of time I was able to dedicate to the task alongside my “day job.” 

That advisor delivered in all the ways I had hoped he would—but there was value well beyond that in terms of the structure he brought not only to our discussions, but to our process. Things like:

The Discipline to Meet

Internally driven committee meetings are frequently a casualty of whatever crisis emerges on any particular day. As human beings we are wont either to assume that nothing will happen unless we are present, or that because others will be there, our voice isn’t required.

Having a committee and not having committee meetings is potentially worse than not having a committee at all. In the latter case, at least ostensibly you know who is supposed to be making the decisions. But if there is a group charged with overseeing the activities of the plan, and that group doesn’t meet, then one might well assume that the plan is not being properly managed, or that the plan’s activities and providers are not prudently managed and monitored, as the law requires.

However, the presence of an outside advisor helps bring a seriousness both to the gathering itself and the agenda.

The Discipline to Educate

Individuals are chosen to be on these committees for a variety of reasons, some better (and some much better) than others. But the first thing our advisor did at that first committee meeting was to acquaint the members with what was expected of them. That included the requirement to act solely in the interests of plan participants and beneficiaries, the importance of process (and documenting that process), and the implications of the prudent expert rule.

It also included reminders that by being on this committee they were a fiduciary under ERISA, that that brought with it personal liability (and, in our case, how the company had chosen to insure them), and that each of us was responsible for the actions of other plan fiduciaries. 

Sure, I could have delivered all those messages—but it meant a lot more coming from that external, expert resource.

The Discipline to Establish an Investment Policy Statement

While I have known attorneys who have counseled against having a written investment policy statement (IPS), I can’t recall a plan advisor of my acquaintance who wouldn’t insist on it (I may now hear from some, of course). ERISA doesn’t require one—and some lawyers see it as a smoking gun (if you don’t follow its terms, it certainly can be). But in its best form it establishes investment guidelines for the plan—and plan fiduciaries, and plan advisors in particular, will generally find it easier to conduct the plan’s investment business in accordance with a set of established, prudent standards if those standards are in writing. And in writing crafted in the objective, cold, clear light of day, rather than in the throes of tumultuous market (or plan) conditions.

In sum, you want an IPS in place before you need an IPS in place—and in my experience any advisor worth their salt will demand that as a starting point.

The Discipline to Remove Funds

As human beings we are largely predisposed to leaving things the way they are, rather than making abrupt and dramatic change. Whether this “inertia” comes from a fear of the unknown, a certain laziness about the extra work that might be required, or a sense that advocating change suggests an admission that there was something “wrong” before, it seems fair to say that plan fiduciaries are, in the absence of a compelling reason for change, inclined to rationalize staying put.

As a consequence, you routinely see new fund options added, while old and unsatisfactory funds linger on the plan menu, a general reluctance to undertake an evaluation of long-standing providers in the absence of severe service issues, and an overall inertia when it comes to adopting potentially disruptive plan features like automatic enrollment or deferral acceleration.

Whether or not the plan has an official IPS, plan fiduciaries are expected to conduct a review of the plan’s investment options as though they do. Sooner or later, that review will turn up a fund (or two) that no longer meets the criteria established for the plan. Oh, and make no mistake—there will be someone with money in that fund, maybe even a senior executive.

Rational thought reminds us that leaving an inappropriate fund on the plan menu—and allowing participants to invest in it—is a bad thing. But human beings, including those who serve on plan committees, have a hard time walking away from a “bad” investment.

The Discipline to Document

I’ve heard it said that when it comes to ERISA, “prudence is process—but only if you can prove it.” To that end, a written record of the activities of the plan committee(s) is an essential ingredient in validating not only the results, but also the thought process behind those deliberations.

But as anyone who has ever participated in a group meeting of any kind knows, it’s hard to fully participate while taking notes. And sometimes those notes don’t make sense by the time you get around to writing them up. An advisor can help with that—and that matters because those minutes can provide committee members (both past and future) with a sense of the environment at the time decisions were made, the alternatives presented, and the rationale offered for each, as well as what those decisions were. They also can be an invaluable tool in reassessing those decisions at the appropriate time.

The current emphasis on fees and plan costs, while important, brings to mind a quote by Oscar Wilde, who once famously described a cynic as someone “who knows the price of everything and the value of nothing.”

As an advisor, what are YOU bringing to the table?  As a plan sponsor, what are you getting from your advisor?

- Nevin E. Adams, JD