How to Craft a 401(k) Crisis

Last week an article in an industry publication led with the title “401(k) experiment has failed, fueled U.S. retirement crisis, labor economist says.”

In what I am sure generated a fair number of “clicks” that turned out to be the pronouncement of none other than Professor Teresa Ghilarducci, teeing up a new book[i]—one that she says aims to review the last 10 years of research by multiple entities on something she’s labeled the “liminal” period of life—that apparently intended to refer to an “intermediate” stage of life. According to the article, she is taking aim at certain assumptions that are made with regard to retirement investing/saving between the ages of 55 and 70. Bad assumptions, apparently.

Now, considering that Professor Ghilarducci has written an entire book on this particular subject, extrapolation from a short interview about it (particularly when someone else did the interview) is a hazardous undertaking. But in that article—based on the upcoming book—she asserts that “experts and professionals and policymakers” have got it wrong; in this case “wrong” appears to be thinking that when people get to be about 62 and realize they don’t have enough resources to do so—they’re simply counseled to work longer. She also takes issue with the advice promulgated by a number of experts (and advisors) that folks should postpone taking their Social Security benefits—something she says (in the article) that “does not speak to the lives of most Americans.”

On the latter point (and I hope you’re sitting down), I completely agree.[ii] The logic in that advice is based on a solid strategy designed to maximize Social Security benefits—but increasingly is “buddied” by financial professionals/experts with the approach of using what may be inadequate retirement savings to bridge living expenses between leaving the workforce for good and age 70. That said, and as the article acknowledges, the decision to leave the workforce for good often isn’t a choice, which not only shortens the accumulation opportunity, but extends, and thus undermines the ability to stretch those savings.  Particularly when that happens late in one’s career, there’s no question it creates problems, and surely for some, financially insurmountable ones.

While that apparently isn’t the focus of the book, those type misapplications do seem to be at least a contributing factor to the crisis Ghilarducci perceives. More than that, she apparently sees an overarching theme at work here. In the interview she says that some unnamed “experts and professionals and policymakers” have embraced this notion if you find yourself later in your career short of funds, you simply have to work longer—a presumption she claims is further undermined by the debt carried by those heading into retirement. THIS she says is undermining retirement security, though in the article she lays the fault for this (“much of the loss of their security”) on the loss of defined benefit plans, before proceeding to label the 401(k) an “experiment,” and a “failure”—labels she has applied to these programs…repeatedly. 

On this, as you might imagine, we disagree. Now, I’ve got no beef with the comfort of a federally insured and well-funded defined benefit plan, particularly those in the private sector that traditionally required no involvement with[iii] or investment by individual participants. Of course, even at the height of their popularity, fewer than a third of private sector workers were ever covered by those plans, and only about 1 in 8 of those ever met the service length criteria to fully vest in those benefits. As retirement coverage “experiments” go, those are surely shortcomings.

Indeed, when you consider the coverage gaps left by the defined benefit “system,” I don’t know where we’d be without the 401(k)—or, more precisely, I do—and it wouldn’t be a good place. 

Those of us who actually work with real people know that this so-called “broken” system works amazingly well—for those who have access to it—including, most especially, those at the lower end of the income scale.[iv] Academics routinely target the well-off in their criticisms, but ignore the needs of middle-income households for whom Social Security will almost certainly not be… enough. And they routinely completely discount and/or ignore the role that the current tax preferences play in fostering the formation and maintenance of these retirement plans. With all its admitted imperfections, thanks to this “failed experiment,” tens of millions of Americans now have trillions of dollars of retirement savings set aside…and they—and their employers—have done so voluntarily, deferring, not avoiding, tax obligations. 

No, as “experiments” go, it seems to me that the real failure is that not enough Americans have the opportunity to do so. And we’re working on that.

 - Nevin E. Adams, JD

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[i] Titled “Work, Retire, Repeat: the Uncertainty of Retirement in the New Economy.”

[ii] In the interests of full disclosure, the author considered, but did NOT defer taking his Social Security benefit until age 70. 

[iii] So little involvement, in fact, that surveys routinely still find ridiculously high number of individuals think they have one. 

[iv] I have never understood the notion that the “rich” are gaming the system with the maximum (in 2024) $23,000 annual 401(k) contribution (not including the $7,500 in catch-up contributions for those over age 50), often less due to the limits of non-discrimination testing.

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A 'Cure" Worse than the Disease?

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

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

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

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

Some Assumptions

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

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

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

And Some Presumptions

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

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

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

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

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

- Nevin E. Adams, JD

 

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

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

[iii] See "Upside" Potential

‘Nothing’ Doing About Social Security?

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

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

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

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

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

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

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

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

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

- Nevin E. Adams, JD

 

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

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

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

Is It (Finally) Finally Time?

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

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

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

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

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

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

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

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

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

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

What It Will Take

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

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

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

  - Nevin E. Adams, JD

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

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

(Not-So) ‘Common’ — Wisdom

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

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

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

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

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

‘Less’ Likely

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

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

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

Advisor Attributes

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

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

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

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

- Nevin E. Adams, JD 

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

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

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

4 Fiduciary Resolutions for 2024

A brand new year awaits us – and with the New Year comes an opportunity to assess and reassess – for some when, resolutions for the cessation of bad behaviors and the beginning of better ones are in vogue. Here are some for plan fiduciaries for 2024 – that could benefit plan outcomes for years to come. 

See if your target-date options are over-weight(ed) 

 

Flows to target-date funds 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 – nearly all of which (despite marketing brochures to the contrary) appear to share very similar views as to what an appropriate glidepath is supposed to look like – and nearly all of which have embraced the notion that a target-date is little more than a speed bump along the “through” target-date glidepath. 

 

A target-date fund is, of course, a plan investment. 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). Particularly in view of recent market volatility, it’s worth (re)examining the asset allocations – and perhaps most significantly those that are applied to target dates that are near-term – and ask yourself – should an individual within five years of retirement have that much invested in those options?     

 

Look, 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 – and it’s probably (past) time you took a fresh look. 

 

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 change 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 that 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). 

 

With more than a couple of decades of experience under our belts (a third of that under the auspices of the Pension Protection Act of 2006), we know a couple of things. First, 3% isn’t “enough” (ironically, that is probably what accounts for its popularity – it’s small enough that it wasn’t thought to spur massive opt-outs by automatically enrolled participants). We also know (or should) that the auto-enrollment safe harbor of the PPA calls for a minimum starting deferral of 3%, which is a floor, not a ceiling. And finally, that – at least according to any number of industry surveys – a default contribution rate twice as high as the prevalent 3% would likely not trigger a big surge in opt-out rates. However, there is a great deal of difference in the retirement outcomes between the two. 

 

On an encouraging note, more than half of the respondents to the 66th Annual Survey of Profit-Sharing and 401(k) Plans now have an initial default contribution rate in excess of 3% - and nearly as many (27.6%) have a rate of 6% as do (29.2%). 

 

Give reenrolling a second thought 

 

There is a natural human tendency to apply change from a point in time forward, to apply a new approach in plan enrollment, like automatic enrollment only prospectively, to workers who join the company after the point in time at which it is effective, rather than retroactively. And sure, workers who have had their chance to enroll voluntarily may well, in their refusal to do so, have spoken their intent not to participate at a previous point in time. 

 

However, that was then and this is now. If they don’t want to participate, it’s easy enough to opt-out. But maybe they didn’t fill out that form the last time because they forgot to, because the investment menu was too complicated or intimidating, or maybe the valid reason(s) they had then no longer applied. 

 

Regardless, don’t you owe them the same opportunity that you are giving your new hires? 

 

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.

- 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 use those images to caution our occasionally misbehaving brood that they had best be attentive to how their (not uncommon) misbehaviors might be viewed by the 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 stumbled across an ingenious website that purported to offer a real-time assessment of their “naughty or nice” status. Indeed, nothing we said (or did, or threatened) ever had the impact of that website—if not on their behaviors (they were kids, after all), then certainly on the level of their 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, worried that he’d find nothing under the Christmas tree but the lump of coal he so surely “deserved.”[i]

In similar fashion, most of those responding to the ubiquitous surveys about their retirement confidence and preparations don’t seem to do much in the way of rational responses to the gaps they clearly see between their retirement needs and their savings behaviors. Not that they actually believe in a retirement version of Stst. Nick, but that’s essentially how they behave—or more accurately, don’t. 

I’m talking about the majorities who—asked to assess their retirement confidence—express varying degrees of doubt and concern about the consequences of their “naughty” behaviors—but like my son in that week before Christmas, they tend to only worry about it—far too late to influence the outcome.

Ultimately, the volume of presents under our Christmas tree never really had anything to do with our kids’ behavior, of course. 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 expected it to modify their behavior (though we hoped, from time to time), but because we believed that kids should have a chance to believe, if only for a little while, in those kinds of possibilities.

This is, of course, a season of giving, of coming together, of sharing with others. However, it is also a time of year when we should all be making a list and checking it twice—taking note, and making changes to what is “naughty and nice” about our lives, our relationships with others, and yes, our financial wellness.

So, yes, Virginia, there IS a Santa Claus—but he looks a lot like you, assisted by “helpers” like your workplace retirement plan, the employer match, and your retirement plan advisor.

Happy Holidays!

 - Nevin E. Adams, JD

p.s.: I am happy to report that the “naughty or nice” site is still active. I’m even happier to report that, as of this writing, yours truly was rated “super nice,” with the following notation: “Has been nice most of the year (not just near Christmas)! Makes others happy. Could share a little more, however. Politeness is sometimes very good. Can be great listener.”

 

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[i] Fortunately for him (and our parental piece of mind), the site does allow for multiple evaluations—and my son was able to keep trying until he got a more “soothing” response.

Making a Move

My wife and I are in the process of moving to a new home—and it occurs to me that the process of changing homes is a lot like changing recordkeepers. Here’s how.

Know What You’re Looking For

We’ve made about a half dozen moves during our 37-year marriage—all driven by work, anchored by commuting concerns, and—in all but the first and last—school considerations. However, this particular move (my wife swears it’s the last one) literally started with a blank sheet of paper and a “so where would you like to live” conversation. Several conversations, actually. For this move, our high-level priorities involved climate (we’re not fans of snow, hurricanes, wildfires, or earthquakes), ready access to good healthcare (we’re not getting any younger), and proximity to cultural activities/things to do (we’re not THAT old). Indeed, with no particular ties to our current residence, and no external anchoring factors like grandchildren to consider (those with four legs don’t really “count”), we had a quick “oceans or mountains” discussion—and agreed on the latter.

Having established that high-level target, we then proceeded to look for specific houses—and that’s where things got tricky, in no small part because of the current “fluidity” in the real estate market. That said, the house we bought in 2011 to accommodate us, three kids and four dogs (that’s not a typo) was way more than the two of us (and just two dogs) now require. The multiple flights of stairs in our home that were once “interesting” were now a potential concern (particularly as they required scaling every time our dogs wanted to answer nature’s call). Oh, and there was the matter of price. 

That said, we had a geographic target, some guardrails for housing considerations, and while the latter in particular certainly limited our field of consideration(s), it made it easy(er) to conduct preliminary searches online—and ultimately to provide guidance to our realtor.

Effectively—and prudently—searching for a new recordkeeper requires a similar discipline. Simply pushing out a sample RFI or RFP with no clear idea of what you’re looking for (or looking to fix) will likely only confuse, complicate, and extend the process—and in all likelihood leave you with nothing but a general frustration. That means knowing what you like (and don’t) about your current situation, and doing just a bit of blue-skying as to things you’d really like to be able to consider. Who knows, that could be possible, even with your current provider… but you might need to ask.

Don’t Rely on the Marketing Brochures (or the Flowery RFP Responses)

As our targeted area was several hundred miles away, we did a LOT online (following the aforementioned driving around part), and relied pretty heavily on Zillow, where we found lots of good information about the properties, and generally speaking dozens of photographs. That said, it was pretty obvious that the written descriptions were almost pure marketing—flowery hyperbole that, from time to time, was good for a laugh if nothing else. 

The pictures did play a role in our reviews—until we discovered that while a picture may be worth a thousand words, the chosen angle and lens can make a room (or yard) look bigger than it is—and a neighbor’s home…vanish. Indeed, our own listing—though pictures were taken on a cloudy day, were “brightened” via photoshop. A picture may be worth a thousand words—but it pays to see things with your own two eyes. 

As for recordkeeping “homes,” one can hardly blame marketing/sales for putting their offerings’ best promotional foot forward in any commercial endeavor. In fact, those materials may well make statements or performance claims that are 100% accurate, and even understated. But—as was the case with our visualizations, I wouldn’t take any at face value without some level of validation.

Consider a Site Visit

As I noted, our previous moves had all been driven by considerations such as my commute, and we often had to make decisions based on distance and economics, rather than an appreciation for the characteristics of the community. Oh, we'd driven around with a realtor, and done some research online—but we never had (or at least felt we had) enough time to really get to experience what it would be like to live there.

While we were somewhat familiar with our targeted area (eastern Tennessee), that was mostly as tourists, and we hadn’t really had a chance to experience the surrounding communities—where we would actually live. So, earlier this year we made it a point to go spend some time driving around and getting a sense of the various communities. In the process we were able to rule out some as being too remote, others as being too built up, and still others that looked considerably different in person than they did on paper. We weren’t ready to make a decision yet, but having gotten a feel for the realities “on the ground,” it allowed us to better focus our online considerations later.

Admittedly, site visits to providers aren’t always instructive.[i] Let’s face it, however linear and production-flow oriented it may be, this business doesn’t generally lend itself to an assembly line visualization—and walking past row after row of (nearly) identical cubicles might not tell you a lot, however eloquent your guide(s). There is, however, something to be said for actually seeing the place where the “sausage” is made, to see how folks get along, to see the environment in which they operate.   

Hire a Professional ‘Inspector’

Some (perhaps all?) states require an inspection of the property by a licensed inspector. That said, the inspectors we’ve hired over the years have been distressingly inconsistent in the quality and thoroughness of their review (ditto the realtors we’ve engaged, but that’s a story for a different time)—and, generally speaking, (much) less discerning (it seems) than those engaged by the individuals buying OUR house(s). 

That said, this last round our inspector did a world-class review of a property that we’d likely have purchased absent his findings. He went places we didn’t (and in some cases, couldn’t), brought to our attention things I hadn’t considered—and in that process not only documented potential issues, he also noted which were minor and those that would require significant expenditures. Now, admittedly that’s what he was SUPPOSED to do—but we’ve paid more only to have others do less (and then later paid more to remedy the issues they should have identified). It saved us time and money, and I am thrilled that he also did the inspection on the house we chose next. 

There’s a lot that goes into making a change in providers, and it requires information and expertise that most plan sponsors don’t have, and don’t really have an opportunity to become expert in. Change can be difficult, but a change that makes a bad situation worse, or that belies the promises in the marketing brochures and sales pitch—well, that can be a nightmare—albeit one that frequently doesn’t manifest itself right away. All the more so in view of the fiduciary responsibility—and personal liability—for decisions that aren’t in the best interests of plan participants and beneficiaries.

In sum, you’re not required to be an expert in such matters—but ERISA requires that, if you’re not, you engage the services of those who are. And that’s an essential element in “making a move” to a new home—or deciding not to.

- Nevin E. Adams, JD

 

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[i] Failing that, there’s something to be said for the perspective of experts who HAVE made that visit—and/or the references of current (and preferably EX) clients. 

When You Assume...

Over the years, so-called personal finance experts have provided valuable information—but also a smattering of misinformation—but I can think of none quite as egregious as some remarks recently made by Dave Ramsey.

By now I’m sure you’ve heard—or heard about—his “counsel” with regard to acceptable retirement withdrawal rates—and his disparagement of the “supernerds” who would dare to disagree with him. As for that counsel, at a high level, Ramsey maintains that an 8% withdrawal rate is not only doable, but sustainable. All you have to do is be invested 100% in equities—oh, and assume a 12% return.[i]

Of course, such machinations have always been predicated on assumptions—about inflation, about market returns and, most notably, about the length of life itself. That said, this didn’t become a specific focus—a so-called “rule of thumb”—until 1994, when financial planner William Bengen[ii] claimed[iii] that over every rolling 30-year time horizon since 1926, retirees holding a portfolio that consisted 50% of stocks and 50% of fixed-income securities could have safely withdrawn an annual amount equal to 4% of their original assets, adjusted for inflation without… running out of money.

That said, even though it was predicated on a number of assumptions that might not be true in the real world—a 30-year withdrawal period, a 50/50 portfolio mix of stocks and bonds, assumptions about inflation—oh, and a schedule of withdrawals unaltered by life’s changing circumstances—well, with the return of inflation as a reality (rather than a theoretical construct), it now seems that there’s an annual scramble to reassess that “safe” withdrawal rate. Indeed, a couple of years back a Morningstar paper challenged its conclusions in view of “current conditions”—opining that “using forward-looking estimates for investment performance and inflation,” the Morningstar authors said that the standard rule of thumb should be lowered to 3.3% from 4%.

That said, this is something of a moving target, and a few weeks ago Morningstar moved the target back to 4% (after having opined that a starting safe withdrawal rate for a 30-year horizon with a 90% probability of success was 3.3% in 2021 and 3.8% in 2022). Enter Dave Ramsey and HIS assumptions that allegedly support a much higher rate (though I don’t recall him offering a probability figure of savings lasting as long as your life[iv]).

Now, in fairness, even the Morningstar folks allow for some variance in “safe” withdrawal rates—explaining that the increase from 2022 in this “highest safest starting withdrawal percentage” for a 30-year horizon with a 90% probability of success “owes largely to higher fixed-income yields, along with a lower long-term inflation estimate.” Moreover, they assert that it’s predicated on assumed portfolios that hold “between 20% and 40% in equities and the remainder in bonds and cash”—which is, in itself, a fairly sizeable range.

There’s been plenty of evidence—both empirical and anecdotal—that retirement “spends” aren’t nice, even streams. Life’s circumstances change, of course—and our health care, and health care costs, are notoriously variable. There’s a sense that the pace of spending earlier in retirement is more like that anticipated in most retirement education brochures—travelling and such—but that pace slows down as we do.

At its core, once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, a guideline like the 4% “rule” is really just a mathematical exercise. A 4% “rule” may be simplistic, but it’s also simple—and when it comes to getting your arms around complex financial concepts and distant future events, there’s something to be said for that.

But—and as Dave Ramsey’s response should remind us—when you “assume” … (or when others assume on your behalf) make sure you understand the assumptions required to make it “work”—and perhaps more importantly, the likelihood/probability that those assumptions will be a reality. 

- Nevin E. Adams, JD

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[i] One of the more humorous—and insightful—rebuttals on all this came from SRP’s Jeanne Sutton: https://www.linkedin.com/feed/update/urn:li:activity:7130951358609838080/

[ii] https://www.forbes.com/advisor/retirement/four-percent-rule-retirement/

[iii] See www.portfolioconstruction.com.au/obj/articles_perspectives/retailinvestor.org_pdf_Bengen1.pdf

[iv] That said, Morningstar’s John Rekenthaler has—and you can read that analysis here

 

Are There Boogeymen in the New Fiduciary Proposal?

Like many of you, I have spent a fair amount of time over the past couple of weeks reading and analyzing the impact and import of the new fiduciary rule proposal—not to mention the legal pundits who seek to tell us what they think it means, or might mean, regardless of what the proposal actually says.

At a high level, it seems to me (and several well-regarded ERISA attorneys) that retirement plan advisors who are today operating under the auspices of PTE 2020-02 should have little to worry about under the new proposal. Indeed, the biggest controversies around the proposed rule seem to be extending the reach of PTE 2020-02 to organizations and entities that hadn’t previously had to adhere to those requirements. 

But if you’re already doing so—and surely if you’re a retirement plan advisor you are—there’s little of concern in the proposal. In fact, you might well draw comfort from the possibility that entities and advisors that have competed with you for rollover business would have to adhere to the same rules and disclosures that are now part of your business, painful though it may have been to adopt them at the time. Of no small consequence is that recommendations to plan sponsors regarding which investments to include in 401(k) and other employer-sponsored plans—advice that is not subject to the SEC’s Regulation Best Interest and right now is not required to be in the customer’s best interest—would be.

Make no mistake, this is a new and considerably revised proposal. One that appears to not only have acknowledged the things that led a federal district court to vacate the 2016 rule—but to actively address and remedy those missteps. 

That said, rumors abound, and some law firms (certainly those that represent the interests of those who would be newly subject to new regulations) have, to my read anyway, been inclined to see plenty of clouds in the silver linings—and to characterize the new proposal as basically being a resurrection of the old one (to that end, the Halloween unveiling made for plenty of “zombie” references)—in the process imagining things that aren’t actually “there.” 

Perhaps the most pernicious is one that they admit isn’t there—but argue it might be; the so-called “private right of action”—which means simply that individuals would be able to sue on their own for a breach of the law. The concerns harken back to comments made during the controversy concerning the 2016 rule that the fiduciary rule was not only opening a new door for litigation, but that the Labor Department was perhaps even counting on it.     

Now, on this, and other points in the new proposal, the DOL acknowledges both the issues raised in the vacating of the rule by the Fifth Circuit, and the deliberate steps they’ve taken to avoid those issues in the new proposal. “The 2016 Rulemaking was significantly different than the current rulemaking,” the DOL explains in the preamble to the proposed rule, “in that it imposed a fiduciary obligation on virtually all investment recommendations specifically directed to retirement investors, imposed demanding contract and warranty requirements in the IRA market, which gave investors a direct cause of action against firms and advisers for breach of the Impartial Conduct Standards, and represented a significant break from the then-existing regulatory baseline.”

To be sure, there is already a cause of action for fiduciary breaches under ERISA for recommendations to plans and participants—and there’s no question that while under a recent decision in a Florida district court, rollover recommendations are not considered fiduciary recommendations under current law—but will be under the proposed rule.

That said, in considering this latest proposal, one notable DC law firm says, for example that the proposal includes “strong enforcement mechanisms, including provisions that give the DOL oversight and authority over firms’ individual retirement account (IRA) business and (although DOL claims otherwise[i]) a potential private right of action.” That’s right—even though the Labor Department specifically says otherwise, this law firm has chosen to read between the lines and see the potential for something the DOL explicitly denies. 

In fact, the Labor Department clearly states in a footnote in the preamble of the proposed rule that (the underline is mine, for emphasis) “Unlike the PTEs that were a part of the 2016 Rulemaking, these PTEs do not, and the amendments would not, include required contracts or warranties that the Fifth Circuit objected to.”  

The footnote goes on to explain that “these prohibited transaction exemptions also do not exempt a party from status as a fiduciary, and therefore, the proposals do not affect the scope of the regulatory definition of an investment advice fiduciary. Rather, the exemption proposals involve an exercise of the statutory authority afforded to the Department by Congress to grant administrative relief from the strict prohibited transaction provisions in Title I and Title II of ERISA for beneficial transactions involving plans and IRAs.”

Now, the standard of care for “conflicted” recommendations to plans, participants and IRAs is the Best Interest Standard—a combination of the prudent man rule and duty of loyalty. If the “conflicted” recommendation isn’t in the best interest of a retirement investor, the protection of the prohibited transaction exemption (PTE) is lost and the advisor isn’t permitted to be legally compensated. That said, the best interest standard in the PTE isn’t actionable.

Another critical “boogeyman” that proposal critics claim to have seen there is an undermining of the ability to enforce arbitration clauses as a precursor to litigation. I say “conjured” because—unlike a controversial provision in the 2016 rule that barred the use of the Best Interest Contract Exemption (BIC) if advisory contracts included an arbitration requirement—there is no mention or reference to that in the current proposal.        

There’s plenty still to analyze and evaluate in this new proposal—and arguably not as much time to do so as we might prefer. Here’s hoping most of that time and energy is spent on the things that are actually in the proposal instead of imaginary “monsters” that aren’t. 

 - Nevin E. Adams, JD

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[i] Their exact words.