6 Questions For Your Next 401(k) RFP

RFPs, or requests for proposals, come in all shapes and sizes. Mostly they are long, drawn out affairs, frequently copied from templates drawn up to capture a broad sense of capabilities. The problem is, for most plan sponsors it’s akin to going shopping for a car armed with Chilton’s auto repair manual (that said, if you need one, a quick Google search on “401k RFP” will turn up plenty).

So, aside from all the general information that you’ll want to get from every provider during the RFP process – the size of their business, the quality, tenure and turnover of their key staff, their capabilities, service structure, years and investment in “the business,” fees, services offered and references, there are some questions that aren’t in every RFP — but to which the answers can be enlightening.

1. What plan design changes would you recommend, and why?

This question has two payoffs. First, in order to recommend changes, they have to know what your current plan looks like. Secondly, it gives you a chance to evaluate the quality of their recommendations. As an extra bonus, if the changes recommended indicate they don’t know what your current plan looks like, that tells you something as well.

2. How many other clients like me do you have?

There are many ways to answer the “like me” question — comparable size, similar workforce demographics, geographic proximity, etc. Hone in on the ones that have similar plan provisions (particularly match, eligibility, and withdrawal) and employee population sizes. Then get their contact information.

3. Are there any restrictions on fund choices?

Many providers place boundaries on the funds available on their platform. Some of this is in the interests of efficiency in education and processing, some of it doubtless ease their evaluation of suitability and review, and some of it may simply facilitate revenue-sharing structures. Regardless, if there are restrictions as to which fund(s), particularly proprietary offerings, must be on your menu, or in what proportion, you need to understand that upfront. And understand why.

4. What’s your preferred QDIA?

Admittedly, everybody doesn’t have a “preferred” qualified default investment option (at least not labeled as such). That said, industry surveys suggest that target-date funds are the most common default fund option today, though managed accounts are making inroads. Knowing what’s available (both what type, and which specific one(s) — and what’s “preferred” — can give you insights not only as to the breadth of offerings, but the perspective of your potential partner on what may well be the primary investment selection of participants in your plan.

5. How — and how much — do you and your other partners get paid?

Sure, fees will be part of any self-respecting RFP response, though since such things are often variable, you’re more likely to get a fee schedule than a fee quote — particularly during the “getting to know you” phase that accompanies most RFPs. Still, it will be worth your time to find out what variables need to be quantified to provide a precise calculation, and then provide them. Because there’s nothing like a bottom line number to help you focus on the bottom line.

As for the “how” — revenue-sharing arrangements, and the potential conflicts of interest that can be obscured by some arrangements — are a current and growing litigation concern. Knowing not only how much, but how, can shed light on potential issues before they become real ones.

6. Please provide the contact information for three clients that have left you in the last 18 months.

It’s normal, and natural, to ask for references — and you should. But references are one thing; ex-clients are another. It’s an awkward question to ask, particularly at the outset of a potential relationship. But we’ve all lost clients for reasons good and bad, and there’s value in talking to someone who, for whatever reason, has opted to go elsewhere, if only to find out how the provider handled the transition out.

Odds are you’ll get the names of clients who left via merger or acquisition, not those who have actually fired them. But you never know. And you’ll never know until you ask.

Got some other suggestions? Post them in the comments section below. Or email me at nevin.adams@usaretirement.org.

- Nevin E. Adams, JD

5 Things Plan Sponsors Don’t (Always) Do — But Should

There is frequently a difference between doing all that the law requires of a plan sponsor and doing everything that could be done.

Here are five things that plan sponsors don’t always do — but should.

1. Have a Plan/Plan Investment Committee.

ERISA only requires that the named fiduciary (and there must be one of those) make decisions regarding the plan that are in the best interests of plan participants and beneficiaries, and that are the types of decisions that a prudent expert would make about such matters. ERISA does not require that you make those decisions by yourself — and, in fact, requires that, if you lack the requisite expertise, you enlist the support of those who do have it.

However, having a committee for having a committee’s sake can not only hinder your decisions — it can result in bad decisions. Make sure your committee members add value to the process. (Hint: Once they discover that ERISA has a personal liability clause, casual participants generally drop out quickly.)

2. Keep Minutes of Committee Meetings.

There is an old ERISA adage that says “prudence is process.” However, an updated version of that adage might be “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.

More significantly, 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 and making adjustments as warranted — properly documented, of course.

3. Have an Investment Policy Statement.

While plan advisers and consultants routinely counsel on the need for, and importance of, an investment policy statement, the reality is that the law does not require one, and thus, many plan sponsors — sometimes at the direction of legal counsel — choose not to put one in place. Of course, if the law does not specifically require a written investment policy statement (IPS) — think of it as investment guidelines for the plan — ERISA nonetheless basically anticipates that plan fiduciaries will conduct themselves as though they had one in place. And, generally speaking, plan sponsors (and the advisors they work with) will 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 not crafted at a point in time when you are desperately trying to make sense of the markets. In sum, you want an IPS in place before you need an IPS in place.

It is worth noting that, though it is not legally required, Labor Department auditors routinely ask for a copy of the plan’s IPS as one of their first requests. And therein lies the rationale behind the counsel of some in the legal profession to forego having a formal IPS; because if there is one thing worse than not having an investment policy statement, it is having an investment policy statement — in writing — that is not followed.

4. Remove ‘Bad’ Funds from the Plan Menu.

Whether or not the plan has an official investment policy statement (IPS), plan sponsors 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. That’s when you will find the true “mettle” of the investment policy; will the plan sponsor/committee have the discipline to do the right thing and drop the fund(s), or will they succumb to the very human temptation to leave it on the menu (though perhaps discouraging or even preventing future investment)? Oh, and make no mistake — there will be someone with money in that fund. Maybe even a senior executive. Still, how can leaving an inappropriate fund on your menu — and allowing participants to invest in it — be a good thing?

5. Monitor Providers on a Regular Basis.

In some sense, we all “monitor” the performance of our plan provider all the time. Is the website available when people try to access it? Do checks and statements arrive on time? Are the balances displayed accurate? The reality is that, for most of us, no news is seen as “good” news. After all, if the answer to any of the foregoing questions was “no,” we’d not only know about it, we’d be complaining about it (after fending off our own set of complaining phone calls). Plan sponsors have a very full-time job dealing with a myriad of things that are “broken” — why go looking for trouble?

At least once a year — no matter how well things are going — it’s worth determining if your plan has access to the new services that have come online since you converted; that you are getting the advantages of the most current thinking about costs and fees; and how your plan’s participation, deferral, and asset diversification stack up. And yes, even with a reliable provider, you may have to ask.

Beyond that, every three to five years (sooner if there are problems, of course), plan sponsors should go through a formal request for information (RFI) or request for proposal (RFP) process—on your own, or with the help of an adviser (who undoubtedly has more experience with such things).

Two other things to keep in mind: First, if you are a fiduciary, and you feel that you lack the expertise to make those decisions, you will of course want — and, in fact, are expected — to hire someone with that professional knowledge to help.

Secondly, while fiduciaries are often reminded of the things they shouldn’t do, recent litigation trends suggest that they’re just as likely to get sued (if not more so) for failing to do something they should be.

- Nevin E. Adams, JD

10 Ways the Class of 2019’s 401(k) Will Be Different

Time marches on, and each generation comes to the workplace with its own unique set of experiences and expectations.

Each August since 1998, Beloit University has published the Beloit College Mindset List, providing a look at the cultural touchstones that shape the lives of students entering college in the fall. For example, the class of 2019, who were for the most part were born in 1997, have never licked a postage stamp, never known a world without Google or Splenda, and have grown up in a world where wi-fi is an entitlement.

Despite those differences, the class of 2019 will one day soon be faced with the same challenges of preparing for retirement as the rest of us. They’ll have to work through how much to save, how to invest those savings, what role (if any) Social Security will play, and — eventually — how and how fast to draw down those savings in retirement — whatever, and whenever, that turns out to be.

Here are 10 things I think we’ll be able to say about most of the Class of 2019 when it enters the workforce:

• They’ve never had to wait to be eligible to start saving in their 401(k) (their parents generally had to wait a year).
• They’ve never had to sign up for their 401(k) plan (their 401(k) automatically enrolls new hires).
  They’ve never had to make an investment choice in their 401(k) plan (their 401(k) has long had a QDIA default option).
• They’ve never had to rebalance their 401(k) account (their 401(k) default option was an asset allocation fund or managed account, automatically rebalanced by professionals).
• They’ve always had fee information available to them on their 401(k) statement (it remains to be seen if they’ll understand it any better than their parents).
• They’ve always known what their 401(k) balance would equal in monthly installment payments.
• They’ve always been able to figure out how much they need to save for a financially secure retirement (though they may not be any more inclined to do so than their parents).
• They’ve always been able to transfer their balances online and on a daily basis (and so, of course, they mostly don’t).
• They’ve always had an advisor available to answer their questions.

And perhaps most importantly, they’ll have the advantage of time, a full career to save and build, to save at better rates, to invest more efficiently and effectively.

- Nevin E. Adams, JD

Never Forget

Early on a bright Tuesday morning in 2001, I was in the middle of a cross-country flight, literally running from one terminal to another in Dallas, Texas, when my cell phone rang.

It was my wife. I had been on an American Airlines flight heading for L.A., after all - and at that time, not much else was known about the first plane that struck the World Trade Center. I thought she had to be misunderstanding what she had seen on TV. Would that she had….

That day, when family and friends were so dear and precious to us all, I spent in a hotel room in Dallas. It was perhaps the longest day - loneliest night - of my life. In fact, I was to spend the next several days in Dallas – there were no planes flying, no rental cars to be had – separated from home and family by hundreds of insurmountable miles for three interminably long days. As that week drew to a close, I finally was able to get a rental car and begin a long two day journey home.  While it was a long, lonely drive, it gave me a lot of time to think, though most of that drive was a blur, just mile after endless mile of open road.

There was, however, one incident I will never forget. Somewhere in the middle of Arkansas, a group of Hell's Angels bikers was coming up around me. A particularly scruffy looking guy with a long beard led the pack on a big bike - rough looking. But unfurled out behind him on the bike was an enormous American flag. At that moment, for the first time in 72 hours, I felt a sense of peace - the comfort you feel inside when you know you are going - home.

All these years hence, I can still feel that ache of being separated from those I love – and yet still remember the warmth I felt when I saw that biker gang drive by me flying our nation’s flag. On not a few mornings since that awful day, I think how many went to work, how many boarded a plane, not realizing that they would not get to come home again. How many sacrificed their lives so that others could go home. How many still put their lives on the line every day – here and abroad - to help keep us and our loved ones safe.

We take a lot for granted in this life, nothing more cavalierly than that there will be a tomorrow to set the record straight, to right wrongs inflicted, to tell our loved ones just how precious they are. As we remember that most awful of days, and the loss of those no longer with us, let’s all take a moment to treasure what we have – and those we have to share it with still.

Peace.

-          Nevin E. Adams, JD

5 Things You CAN Do After a Market Correction

By now, you’ve heard — and perhaps dispensed — what appears to be the “common wisdom” about the recent market tumult: “stay the course,” “ride it out,” and my personal favorite, “don’t just do something, stand there.”

For all our industry’s long-standing concern about participant inertia, in times like these the inclination to “do nothing” is undoubtedly to the benefit of most participants. That said, one can well imagine that those who are turning to their advisors for help and guidance (wonder what the robo-advisors are saying?) might be a little frustrated with the admonition that the best thing for them to do right now is… nothing.

Early indications are that most retirement plan participants will — again — ride this one out (though there are some exceptions. But, hey — while the markets have your attention, here are five things participants can, and should, do:

Check your account balance. While a lot of experts will tell you to avoid looking at your account right after a big drop in the markets, if you’re making individual fund choices, it’s probably worth checking out how your account is currently invested. If you haven’t checked in a while, you might find that it’s gotten “out of balance” from your original investment selections.

Get started on rebalancing. While this may not be a great time to rebalance your entire account, you can start 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 your current deferral rate. This is the biggie. When you think about just how much cheaper those retirement plan investments are compared with a few days 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.

Look into automated rebalancing. If you still make and maintain individual investment fund choices in your retirement account, it can be hard to pick the best time to make a change. (Hint: a period of extreme market volatility is almost never the best time.) However, the vast majority of providers now have in place mechanisms that will, at some preset frequency (e.g., monthly, quarterly, or annual), automatically rebalance those accounts in accordance with your established investment elections. It’s a good way to keep things in balance without having to worry (or remember) about it.

Think about getting some professional help. Odds are, even if you like keeping up with the markets, it’s not your day job. A good, trusted advisor is always a great option, but you might find it useful to look into a solution that is professionally managed all the time — such as a balanced fund, target-date fund or managed account option.

So, yes, there are some things you can do after a market correction, or even on a regular basis. And one more thing: There’s no time like the present.

- Nevin E. Adams, JD

‘Tipping’ Points: 4 Ways to Tell a Fad from a Trend

One of the most valuable skills in my profession — and perhaps in any profession — is an ability to discern trends early. Just as valuable is the ability to discern the sometimes fine line of distinction between what may be a trend, and what may, in fact, be nothing more than a fad. Most plan sponsors have a functional aversion to the latter, and the vast majority have no real passion for being too early in the adoption of the former. After all, nowhere in the fiduciary directive to do only things that are in the best interests of participants and beneficiaries will you find an admonition to be “first.”

One must be careful in making generalizations about such things, of course. The difference between a fad and a trend is often no more than one of time and acceptance, after all, and each plan sponsor situation is based on hugely independent factors. Still, in working with plan sponsors over the years, I have found that a new idea/product can quickly evolve to become a trend if it:

• is cheap (free is better);
• is easy (the less effort, the better);
• solves a problem (the bigger, and more immediate, the better); and
• has regulatory/legislative sanction (the more official, the better).

As a corollary, things that cost money, seem complicated to adopt/incorporate, or that don’t address a current perceived problem will naturally be a harder sell. (I have never found that the removal of a potential threat — such as a lawsuit — is a compelling sales proposition.) But even if all the factors listed seem to apply, that new product/idea trend can be “trumped” by one simple factor — does it mean (or appear to mean) taking on additional risk (or costs) for the plan, or the plan sponsor? If so, all the other factors don’t really matter. Those are the “trends” that “the industry” says everyone should/will be embracing… and then nobody (much) does.

Little wonder then that things like daily valuation (which, certainly at the outset, seemed to be both cheap AND easy), burgeoning fund menus (which were easy to add, if not communicate/navigate) and, more recently, target-date funds (easy, solved a problem and, post-PPA, with regulatory and legislative backing) seem to become the “norm” almost overnight. Little wonder, too, that things like automatic enrollment (certainly prior to PPA, less so these days), and in-plan lifetime income options are harder sells. It also helps explain why things like offering advice or automatic enrollment can, over time, be seen in a new light, courtesy of developments in regulations and/or technology that serve to reweight the scales.

One More Thing

There is, however, one additional factor that influences plan sponsors in their decision-making process, and as odd as it may seem, it is a factor that influences most of us from a very young age. For as surely as plan sponsors are understandably reluctant to be first to embrace a new concept, as human beings we also have a tendency to go with the flow, to follow the crowd. Fads become trends sometimes for no reason other than the rationale offered by teenagers everywhere for occasionally aberrant behavior — because “everybody (else) is doing it.”

Plan sponsors rely on advisors not only to keep them abreast of current trends, but to help them cut through the clutter and “spin” of the latest hot product pitches. To help them fulfill their fiduciary obligations to act in the best interests of participants by providing access to services (and services at fees) that are reasonable for their needs.

Indeed, the best advisors stay aware and alert to new developments and opportunities — but resist the siren call of the crowd, helping plan sponsors understand both the pros and cons of new concepts, be they fads, trends or something in between.

- Nevin E. Adams, JD

7 Things Every ERISA Fiduciary Should Know

When it comes to workplace retirement plans, there are three kinds of people: people who are ERISA fiduciaries and know it, people who aren’t ERISA fiduciaries and know it, and people who are ERISA fiduciaries and don’t know it.

If you’re in the first or last category — well, here are seven things that every ERISA plan fiduciary should know.

If you’re a plan sponsor, you’re an ERISA fiduciary.

Fiduciary status is based on your responsibilities with the plan, not your title. If you have discretion in administering and managing the plan, or if you control the plan’s assets (such as choosing the investment options or choosing the firm that chooses those options), you are a fiduciary to the extent of that discretion or control. If you’re not sure, there’s a good chance you are.

For the very most part, you can’t offload or outsource your ERISA fiduciary responsibility.

ERISA has a couple of very specific exceptions through which you can limit — but not eliminate — your fiduciary obligations. One has to do with the specific decisions made by a qualified investment manager — and, even then, you remain responsible for the prudent selection and monitoring of that investment manager’s activities on behalf of the plan.

The second exception has to do with specific investment decisions made by properly informed and empowered individual participants in accordance with ERISA Section 404(c). Here also, even if your plan meets the 404(c) criteria (and it is by no means certain it will), you remain responsible for the prudent selection and monitoring of the options on the investment menu (and, as the Tibble case reminds us, that obligation is ongoing).

Outside of these two exceptions, you’re essentially responsible for the quality of the investments of the plan — including those that participants make. Oh, and hiring a 3(16) fiduciary? You’re still on the hook as a fiduciary for selecting that provider.

If you’re responsible for selecting those who are on the committee(s) that administer the ERISA plan, you’re an ERISA fiduciary. If you are able to hire a fiduciary, you’re (probably) an ERISA fiduciary.

The power to put others in a position of power regarding plan assets is as critical — and as responsible — as the ability to make decisions regarding those investments directly.

Hiring a co-fiduciary doesn’t keep you from being an ERISA fiduciary.

All fiduciaries have potential liability for the actions of their co-fiduciaries. If a fiduciary knowingly participates in another fiduciary’s breach of responsibility, conceals that breach, or does not take steps to correct it, both are liable.

Your liability as an ERISA fiduciary is personal.

That’s right, the legal liability is personal (you can, however, buy insurance to protect against that personal liability — but that’s likely not the fiduciary liability insurance you may already have in place).

An ERISA fiduciary can’t just quit and walk away.

The Department of Labor cautions that “fiduciaries who no longer want to serve in that role cannot simply walk away from their responsibilities, even if the plan has other fiduciaries. They need to follow plan procedures and make sure that another fiduciary is carrying out the responsibilities left behind. It is critical that a plan has fiduciaries in place so that it can continue operations and participants have a way to interact with the plan.”

As an ERISA fiduciary, you’re expected to be an expert — or to hire help that is.

ERISA’s “Prudent Man” rule is a standard of care, and when fiduciaries act for the exclusive purpose of providing benefits, they must act at the level of a hypothetical knowledgeable person and must reach informed and reasoned decisions consistent with that standard. The Department of Labor notes that “[l]acking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions.”

As an ERISA plan fiduciary, it’s never too late to start doing the right things the right way. But doing the right things means understanding what is expected of you — and appreciating the implications.

- Nevin E. Adams, JD

Why the ‘Ideal’ Plan Isn’t Always

Advisors and providers often talk about the “ideal” plan — but ideal for what?

That’s a rhetorical question of sorts — generally it means “ideal” in terms of providing a better retirement savings outcome. Indeed, I routinely see articles and commentaries (and panel presentations) that self-righteously take employers to task for not “caring” enough about their workers (or their retirement outcomes) to do the “right” things.

While I think our industry views such observations as a challenge, a call to action, all too often I think policymakers and regulators — and certainly the 401(k) “haters” — hear a different message. While I suspect that one-on-one, most advisors allow for a more nuanced perspective on such things, at the risk of stirring up a little controversy, let me offer a different perspective on that “ideal” plan.

Extending Automatic Enrollment to All

Following the passage of the Pension Protection Act of 2006, with its automatic enrollment safe harbor, many likely assumed that plans which adopted the provision would do so for all eligible workers. And yet, nine years on, most industry surveys indicate that the majority (on the order of two-thirds) of automatic enrollment plans have extended that feature only to new hires.

This is a subject that I have broached with plan sponsors and advisors numerous times over the years. Most frequently I am told that there is a great reluctance to “second guess” the participation decisions of workers who have had multiple opportunities over the years to enroll and yet, for a variety of reasons, haven’t done so. And so, whether it’s attributed to “not wanting to insult their intelligence” or a simply willingness to “let sleeping dogs lie,” most plan sponsors I have spoken with simply find it easier (or less painful) to implement new things with “new” people.

One concern that is not generally articulated, but is surely a concern for some, is that automatic enrollment’s very success may be a financial impediment. Doubtless you’ve proudly promoted the surge in participation that embracing automatic enrollment produces. But have you considered what a 20% increase in participation by older, more tenured, and likely higher paid individuals would add to your typical benefits budget?

Automatic Enrollment — at 6%

By just about any measure — and in what has to be the vast majority of situations — starting participants off by deferring 3% of their pay won’t be enough to fund their retirement. It is a start, however, and a better start than many younger and lower-income workers would have in the absence of automatic enrollment (despite the periodic news items and research reports that suggest that automatic enrollment results in diminished savings rates).

There’s a flip side to that level, of course. While a 3% starting rate has the legislative imprimatur of the PPA, long before 2006 it had been widely accepted as a “standard” default rate precisely because it was deemed to be so small that workers wouldn’t take steps to stop their contributions. The experience of the past 30 years supports that premise.

As noted above, 3% is probably not enough — but in looking at the trends in automatic enrollment, 3% remains the “norm.” Moreover, participants tend not to modify that starting default. And since the adoption of automatic escalation noticeably lags the adoption of automatic enrollment, we run the risk of creating a new generation of sub-optimal savers.

Recognizing that disconnect, a growing number of people are calling for a higher starting default rate, generally 6%. Moreover, there many surveys have suggested that inertia is a strong enough force that participants aren’t much more inclined to opt out from a 6% default than they are from a 3% default.
And while a growing number of providers and advisors are touting it — and there are plan sponsors embracing that higher default rate — the vast majority aren’t.

So what’s behind the reluctance to raise the bar to 6%?

Honestly, I don’t think it’s hard to figure out. The reasons cited by plan sponsors vary, and while some still express concerns about employee pushback (see above), it seems fair to think that the typical 20% increase in plan participation rates, coupled with a commensurate increase in match costs, would give any rational plan sponsor pause, particularly to a level that would, in many circumstances, require the maximum employer matching dollars.

Stretch ‘Math’

For sponsors that have pushed back on the match cost associated with automatic enrollment, it’s gotten very trendy to push a “stretch” match. The logic goes like this: An employer that might be reluctant to expand participation (and its employer match) with a match of 50 cents on the dollar up to 6% of pay could instead offer a match of 25 cents on the dollar up to 12% of pay. The match structure is supposed to encourage participants (certainly those motivated by the employer match) to increase their contributions, but the cost of the match to the employer will be the same as under the prior formula.

Well, the math certainly works out. But we’re dealing with people, so let’s just admit that some number of those who contributed 6% to get the match won’t (and in some cases won’t be able to) contribute at the higher level.

But the larger problem — and one that is almost never acknowledged by proponents of the stretch match — is that once you’ve actually had a match program in place, “stretching” out the match is almost certain to be an employee relations disaster for the plan sponsor. The goal may be to keep the cost the same, but workers will almost certainly see the move as a reduction in benefits.

The Cost of Bad Retirement Outcomes

Ultimately the plan design alternatives outlined above don’t require employer involvement to be undertaken by employees, who can enroll on their own, and at levels higher than the standard “auto” defaults provide.

There is, of course, a cost associated with “bad” retirement outcomes: Workers who don’t have (or don’t think they have) enough retirement savings may seek to extend their tenure beyond that considered optimal for the employer. That can impact the employer’s health care costs and impede its ability to hire, retain and promote. And workers worried about their finances and retirement security may well be less productive.

So, yes, Virginia, that “ideal” plan has a price tag. And helping plan sponsors make “better” plan design decisions requires not only an acknowledgement of that fiscal reality, but creative solutions that take those considerations into account.

- Nevin E. Adams, JD

3 Things Plan Sponsors Should Know About Changing Providers

By most industry estimates, approximately 10% of plans change providers every year.  Of course, far more consider making a change (without actually acting on it), and many changes are thrust upon plan sponsors, a consequence of poor service, or provider consolidation.

Regardless of the motivation for undertaking the change, here are three things that in my experience every advisor (and provider) wishes plan sponsors understood about recordkeeping conversions — before setting them in motion.

Your provider search will take longer than you think.

Human beings are, generally speaking, poor judges of time requirements, particularly with things with which they don’t have a lot experience (like provider searches) and that require the involvement/input of committees (like provider searches).

We tend to assume that we’ll have more time available for such things than actually winds up being the case, and we tend to assume that such things will take less time than they actually do. We also tend to make those types of assumptions about the participation of other members of the team. It’s not just that those assumptions tend to be optimistic, it’s that, all too frequently, they are wildly optimistic.

Your provider and/or advisor will likely make a good faith effort to provide a timetable of events, and will likely take pains to emphasize to you the amount of time it will take to actually conduct this process. Doubtless they will remind you — and remind you more than once — just how important it is that you make the time commitment, and deadlines, noted in that timetable.

My advice: Take whatever timetable they give you — and double it.

A big part of the reason your provider search will take longer than you think…is you.

A change of providers inevitably brings with it additional work, greater time commitments, and what sometimes feels like an incessant series of questions about things to which you never previously gave much thought. Moreover, you’ll have to think about how to communicate this change to your participants — and deal with the inevitable flurry of questions from them about how to do things to which they never previously gave much thought.

However, these realities are generally not top of mind when we enter into discussions about making a provider change. So, while the search is generally set forth on a wave of optimism and hope, it can, before long, find itself bogged down in the inevitable administrative minutia that consumes so much of a plan sponsor’s time. And the longer it takes, the worse it can become.

The bottom line is, at the outset you probably didn’t have 25% of your day just sitting there waiting for some big project to fill it. Even the most committed will, at some point (and likely at several some points) be tempted to push off that update call, to set aside responding to some integral data definition, to dither on making a determination that will hold up the entire project.  A good project plan will account for some of these. But not an indefinite number.

(Almost) Everybody wants to change providers on January 1. Everybody can’t.

If your plan year-end is Dec. 31 (and it is, for the vast majority of plans), there are some real benefits to making a provider change at that point in time. Plan reporting — both participant and regulatory (Form 5500) — is quite simply neater when you finish the reporting year at the same time you conclude your arrangements with a provider. Anything else is going to require someone somewhere to “splice” together reports at some point. Doing so doesn’t have to be a big deal — but it can be “awkward.”

There are some reasons not to make those kinds of changes at year-end, of course. First off, there’s generally quite a queue wanting to do so. You may well be able to get in that queue, but your new provider will likely have their hands full with a lot of plans just like yours. More significantly, your soon-to-be-ex provider likely will as well — and guess who is likely to get the most/best attention?

Bear in mind also that a 1/1 change means that a lot of the preparation, review, and/or testing— not to mention participant communications — will happen during a time of the year when people are generally more inclined to be worrying about other things.

What’s Next?

So, considering those issues, what should a plan sponsor thinking about making a provider change do?

Well, I would suggest you start early, allow plenty of time for slippage in schedule, and be open to the possibility of making a mid-year change instead.

- Nevin E. Adams, JD

Are You Exploiting Naïve Myopic Workers With That Employer Match?

Over the years, I’ve seen some convoluted ways to rationalize undermining the tax preferences of workplace retirement plans and substituting government tax credits — but a new one just may take the cake.

“A Behavioral Contract Theory Perspective on Retirement Savings,” authored by Ryan Bubb and Patrick Corrigan from the New York University School of Law and Patrick L. Warren from Clemson University’s John E. Walker Department of Economics, starts off by assuming that workers are rational, though perhaps not rational in the way you or I might consider to be rational. However, I’ll accept as logical their assertion that rational workers will prefer saving through an employer-provided plan, rather than accepting a job that does not provide such a plan.

They also claim to provide an analysis that “provides novel explanations for the use of low default contribution rates in automatic enrollment plans, the shift away from defined benefit annuities toward lump sum distributions in defined contribution plans, and the offering of investment options with excessive fees.” Well, it’s certainly novel. More on that in a minute.

Exploit ‘Actions’

The authors claim that employers that provide qualified retirement plans provide more after-tax compensation (in the form of employer contributions not subject to FICA) to employees than employers that do not, and that if workers are rational (there’s that “rational” reference again), then competition for workers in the labor market should therefore provide incentives for employers to offer such plans. So, all other things being equal, workers would prefer to work for an employer that offers a plan than one that doesn’t. So far, so good.

Now we all know that some workers don’t save, and some don’t save enough. But the paper maintains that “if workers undersave (or make other retirement savings mistakes) due to behavioral biases,” then the labor market will give employers incentives to design plans that “cater to and exploit, rather than resolve, those behavioral biases.”

They claim that some workers undersave due to myopia — and that also results in employer plan designs that “exploit the myopic,” and that they do so specifically by — wait for it — offering matching contributions, which the study’s authors claim “naïve myopic workers overvalue.”

Moreover, they claim that this matching results in what they term “cross-subsidization” of rational workers, which, in turn, lowers myopic workers’ total compensation. Said another way, matching contributions mean that the naïve, myopic part of the workforce is not only undersaving (because they overvalue the contributions), but actually receiving less compensation (since the employer is paying them less to offset the cost of the contributions). Are you following this?

And while you may be under the impression that employers offer matching contributions either to increase NHCEs’ contribution rates or to meet one of the safe harbors so that they can provide greater tax-advantaged compensation to HCEs, according to the researchers, you would be wrong. They claim that employers offer those matches precisely because myopic workers overvalue them. Sound like a devious plot to you? Now you’re getting it…

Not only that, they also claim that matching contributions crowd out what they consider to be the superior — and non-redistributive — “commitment device” of non-elective contributions. That’s right, contributions that do not require any particular action on the part of the worker other than to exist and be eligible. Apparently it’s the reward for specific behaviors that is distorting things.

‘Over’ Matched?

Indeed, these researchers believe that the mere existence of the match means that workers will overestimate how much they will, in fact, save for retirement — and, since they think they will accumulate more than they actually will, they will save less — and employers save money, not only because they pay less (the offset for the matching contributions), the workers will choose to save less — and get less of a match.

Put simply, the paper claims that the labor market gives employers incentives to craft plan designs that cater to what biased workers perceive to be of value, and that the same behavioral biases that produce worker mistakes in saving for retirement will also typically lead workers to prefer plans that fail to correct their mistakes (apparently by encouraging them to save for retirement, but not as much as they need) and that can even exacerbate them. The result, they say, is an equilibrium set of choice architectures (plan design) that fails to effectively address the basic retirement savings policy problem of people not saving enough for retirement. Choice architecture that, in their estimation, is making things worse, not better. Because employers offer workplace retirement plans — and have the temerity to match the contributions of workers who take advantage of these programs. The horror!

Employer ‘Incentives’

The authors’ main message is that when workers undersave due to those behavioral biases, then “employers have incentives to design employer contributions in a way that fails to address the undersaving problem and indeed that can even actively exploit the undersavers.”

They not only claim that matching contributions are harmful to rational workers, but maintain that they are “unambiguously so.” How? Well, they claim that matching contributions distort the worker’s incentive to save by encouraging too much savings (which is apparently different than enough savings), and the worker would receive more “utility” from being paid this money as wages.

Oh, and as another example of employer bad behavior in plan design (and ostensibly another reason employers can’t be relied upon in this role), the authors note that most employers choose an automatic enrollment default deferral rate of 3%. The authors concede that the use of automatic enrollment can result in retirement savings by employees who would otherwise have initially contributed nothing to the plan. However, they caveat this admission by noting that some who would have saved more than that default rate if they had had to fill out an enrollment form only save at the default rate.

The solution for this? Substituting for the current system of employer-provided pension plans a new federal defined contribution plan, designed by a federal agency and not linked to any particular job, of course. Oh, and not only do they claim that this could improve savings outcomes, but that it would do so “at little to no fiscal cost to the government.”

Except, presumably, for the part where the government trades the temporary deferral of tax revenues for the permanent forgiveness of a government tax subsidy.

FWIW, I find it hard to believe that this kind of analysis would survive serious scrutiny outside of the rarefied air of academia. But stranger notions have.

- Nevin E. Adams, JD

5 Things You Should Know About Target-Date Funds

In a remarkably short period of time, target-date funds have become an integral component of the typical 401(k) menu, and a growing share of 401(k) plan assets — particularly those of newly hired 401(k) plan participants — are being directed to TDFs.

Whether you are a plan fiduciary evaluating the TDF option(s) on your plan menu — or a 401(k) plan participant being defaulted into a TDF option — here are five questions to which you should know the answers about your TDF investment.

1. What is the ‘appropriate’ asset allocation?

This is the million-dollar question for target-date funds. At a high level, this is no more complicated than deciding what is the right mix of stocks and bonds, international and domestic, alternative investments and/or cash for investors at every stage of their investing life — or than picking the firm(s) that you trust to know what that right mix is.

2. How much of what is on your glide path?

The “glide path” sounds like a complicated concept, but it is actually nothing more than how the shifts in asset allocation take place over time. It is the path that these investments take your money on throughout your investing life. Still, for some funds — particularly newer, smaller funds — the asset-allocation strategies outlined in the fund prospectus or fact sheet may still be “aspirational,” may not yet incorporate all the specific strategies that the fund manager has in mind for that time in the future when the funds achieve a certain critical mass. You need to know what the targets are — and know if those targets are part of the current strategy.

3. Are the funds composed of proprietary offerings, or are they ‘open architecture’?

The “debate” over the relative advantages of open architecture versus proprietary offerings has long been part of retirement plan administration choices, and it is part of the target-date decision as well.

Those advocating the benefits of open architecture generally tout the ability to pick “best of breed” investment solutions (while readily being able to dump those that fall short), backed by the notion that no one firm can possibly be that best choice across every asset class. Those pushing proprietary choices take issue with that latter point, while pointing to the benefits of their intimate knowledge of their own product set — not to mention the relative cost efficiencies of a proprietary product. There is no one single right answer, but the determination should be part of your evaluation.

4. How much does it cost?

Target-date funds are often constructed as a fund comprised of other funds, and — particularly when a provider incorporates other funds in their offerings, they frequently charge some kind of fee for their expertise in putting together those other funds. This is a fee generally applied as some kind of basis-point charge in addition to the other, regular fees charged by the underlying funds. You will want to know what this charge is, if any, and consider it as part of the total cost of your selection. This fee is generally smaller (sometimes there is no extra charge) for proprietary-only offerings.

Beyond the aforementioned “wrapper” fee, TDFs — particularly mutual fund TDFs — will generally have all the same kinds of fees typically associated with retirement plan investments. Bear in mind that some of the fund allocations may include some relatively exotic asset classes — and those may carry higher expenses than you are accustomed to seeing. Additionally, you may find some retail share class funds included, even in institutional share class offerings. The bottom line: Keep an eye on the bottom line.

5. How should I measure ‘success’?

It wasn’t all that long ago that there were no benchmarks to speak of in this space (other than those constructed by the firms managing those funds). These days the passage of time, and the expansion of the market, have produced several credible benchmarks against which the performance of the funds can be evaluated.

But take note: The benchmarks can be as varied in their underlying philosophy and construction as are the funds themselves. That’s why it is important to first know what you believe about the approach, glide paths, and/or asset allocation before you pick the benchmark.

- Nevin E. Adams, JD

You may also want to check out the Employee Benefits Security Administration’s (EBSA) “Target Date Retirement Funds — Tips for ERISA Plan Fiduciaries” at http://www.dol.gov/ebsa/newsroom/fsTDF.html.

The Course of Human Events

It is easy, looking back, to gloss over just how remarkable was the sequence of events that made this nation’s independence a reality. The bickering and machinations of the Continental Congress in 1776 were every bit as unpleasant, and unproductive, as the worst of today’s elected officials — even though, and perhaps in some measure because, hostilities with Great Britain had officially been underway since the so-called “shot heard ‘round the world” the preceding spring.

The men who gathered in Philadelphia that summer to bring together what was not yet a “new nation” came from all walks of life. Still, it seems fair to say that most had something to lose, both financially and in terms of the personal liberty they advocated as an “unalienable” right. True, many were merchants (some wealthy, including President of Congress John Hancock) already chafing under the tax burdens imposed by British rule, and perhaps they could see a day when their actions would accrue to their economic benefit. But they could hardly have undertaken that declaration of independence without a very real concern that they might well have signed their death warrants.

Ironically, despite the celebrations on the 4th, the resolution that declared that “these United Colonies are, and of right, ought to be, Free and Independent States” was approved by the Continental Congress on July 2. In fact, only President of Congress John Hancock and Charles Thomson, secretary, signed it on the 4th (the former famously in a hand “large enough for King George to read without his spectacles”). Most of the 56 delegates didn’t sign it for another month. One didn’t sign until 1781.

Of course, that “declaration” didn’t magically make it so. The winter at Valley Forge and many other disappointments still lay ahead. The surrender of Cornwallis at Yorktown was still more than five years off, and an official end to the hostilities would not come until two years after that, in 1783.

This week most will commemorate the declaration of this nation’s independence as a unifying experience. And yet, just “four score and seven years” later, as the nation approached another Independence Day celebration, President Abraham Lincoln would find himself in the middle of an enormously unpopular war fought to keep the nation together, even as two massive armies converged at a crossroads community called Gettysburg.

Even in 1776, historians have suggested that only about a third of the colonial citizenry actually favored independence, while a third remained loyal to Britain — and the remainder apparently just wanted to be left alone.

It seems only right then that today, as part of this “course of human events” and perhaps particularly at this time when our nation seems so deeply divided on a number of issues, that we remember not only the differences, but the sacrifices, large and small, that have made this great nation possible.

- Nevin E. Adams, JD

You can read more about the Declaration of Independence here.

4 Steps Toward Financial Independence

While retirement and retirement savings may not be high on your Independence Day weekend agenda, it can be a good time to focus on things that have been pushed aside for more pressing priorities.

Here are four steps you can take this weekend that can help put you on the road to achieve financial independence.

1. Figure Out How Much You Need

Yogi Berra once famously noted that if you don’t know where you’re going, you might not get there.
Effective savings strategies start with a goal, something to aim for. For many, retirement savings goals seem impossible to set. After all, there’s no “blue book” on the cost or quality of retirement — no single answer to the question, “How much do I need?” As a result, many people fear that their estimates “aren’t even in the ballpark” of what will be required. The 2015 Retirement Confidence Survey affirmed a long-standing trend — that most haven’t made even a single attempt to figure out what they might need for retirement.

There are, however, tools that can help you set a reasonable target. If your workplace retirement plan doesn’t currently provide that option, the Ballpark E$timate at www.choosetosave.org is free, thorough, and won’t require much of your weekend to come up with a target based on your individual circumstances.

2. Rebalance Your Account

While a growing number of individuals take advantage of strategies like managed accounts and target-date funds — options that are regularly rebalanced by investment professionals — to invest their 401(k) balances, many workers (especially older ones) still make individual fund selections, either on their own or with the help of an advisor. The problem is, we’re often too busy to go back and review those decisions. Unfortunately, left unattended too long, market movements can leave even the best investment choices out of balance and produce results that are unintended.

If you haven’t rebalanced your account in a while (or can’t remember when you did), take advantage of the long weekend to do so.

Note: if you are using a strategy like a target-date fund, balanced fund or managed account with your workplace plan, you shouldn’t need to rebalance. And if you’re not using one of those options, this might be a good opportunity to consider making a change.

3. Bump Up That Contribution Rate

Like those investment choices, most of us make a decision about how much to save once, frequently when we first join the plan. At that time you may have chosen that rate based on the employer match, or the rate that the plan automatically enrolled you, or perhaps even just the amount that you thought you could afford at the time. Odds are you haven’t changed that rate since that very first time, however — and if you didn’t make that decision based on an assessment of how much you needed to provide a financially secure retirement (see #1 above), it may not be enough.

So, take that rate and consider increasing it — by at least 1%, or more if you can.
And make a point of increasing that savings rate annually.

4. Give Your Plan an Annual Check Up

It may seem obvious, but once you have figured out how much you’ll need to live on in retirement, you need to see if you are on track to achieve that goal. So pull out those retirement plan statements, take a look at your current rate of savings, how you’re invested, the amount of the employer match, and your remaining years of saving/investing, and see how far that takes you in achieving the goal you set above.

If your current approach leaves you short of that goal, consider alternatives — saving more, for instance, or in a way that allows you to maximize your employer match. The tool you used to forecast your needs should also be able to help you see the impact that changes in your current savings strategy can make.

Then remember that things change. Whether it’s your health, your family, your income, or your place of residence, your plan needs to keep up with your needs and expectations.

While you don’t need to constantly reassess, even if there aren’t major changes it’s a good idea to check it out at least once a year — and why not on a long weekend?

Regardless, always consider seeking the help of a qualified expert advisor to help you make the decisions that will allow you to celebrate your own financial independence!

- Nevin E. Adams, JD

6 Questions to Ask at Your Next Investment Committee Meeting

Every plan, and every investment committee, is unique — and yet, conducted properly, there are inevitably areas of commonality.

As the quarter draws to a close and preparations for these meetings get underway, here are some questions that could enhance the discussion, if not the outcome, of your next meeting.

1. Do we really need to have all these funds on the menu?

We know that participants tend to hold four or five funds on average, regardless of how many choices are on the menu. And for years we’ve known that the more choices participants have, the more difficult it is for them to make choices. (Remember the famous study about jam choices?) Sure, it can be hard to let go of a fund, especially if some participants have invested money in that option. But what tends to happen over time is a kind of fund menu inflation, where new funds get added but old ones never leave.

The funds on your menu should have a purpose. If they don’t — even if they once did — you aren’t doing anyone a favor by cluttering up the menu. And you could be leaving in place a non-performing ticking time bomb that could lead to problems later on.

2. Are there less expensive share classes available for the funds on our investment menu?

Arguably, this is the question that the defendants in Tibble v. Edison should have asked, and spared themselves a lot of time and litigation. The bottom line is, if there’s no difference in a fund choice (particularly when it’s just a different share class of the same fund) other than price, why is the more expensive one on your menu?

3. How much are our participants paying for this plan?

Odds are that most of the fees paid by the plan are investment-related, and with all the additional fee disclosures floating around, you’d like to believe that the committee already knows the answer to this question.

In my experience, however, it’s one thing to invoke a sterile “x basis points” assessment and another thing altogether to stop and do the math to put a gross dollar figure on the total cost to the plan. Or maybe even how much the average participant in the plan is paying in dollars and cents.

4. What services are we buying with those fees?

There’s been a lot of focus on fees lately — but fiduciaries are charged with ensuring that the fees and services rendered are reasonable. And I’ve never understood how you can figure out if fees are “reasonable” if you don’t know what you are paying them for.

5. Do we all need to be on this committee?

Over time, committees have a tendency to expand, sometimes based more on factors like internal organizational politics than on valuable perspectives or expertise. But human dynamics are such that the larger the group, the more diffused (and sometimes deferred) the decision-making.

As for how to trim the “fat” from the committee, sometimes all you have to do is remind committee members that plan fiduciaries have personal liability (see “5 Things Plan Sponsors Should Know”).

6. Who’s taking notes?

Finally, if you’re having a committee meeting, you’ll want to document all decisions that are made and the rationale behind each one. Prudence is process, after all — and it often starts with asking the right questions.

- Nevin E. Adams, JD

A Preference on ‘Preferences’?

A research paper finds that introducing a Roth 401(k) option doesn’t have much impact on current plan savings rates — but what does that have to do with their preference for tax preferences?

Well, according to “Does Front-Loading Taxation Increase Savings? Evidence from Roth 401(k) Introductions,” governments could actually increase private savings by taxing savings up front, rather than in retirement. This conclusion basically suggests that taking away the current 401(k) pre-tax contribution and replacing it with a Roth assumption would not only not decrease, but it might actually increase, retirement savings, and with no additional cost to the government.

For years a key education element touted about 401(k) plan participation has been the ability of the individual to put off paying taxes on their contributions and on the earnings attributable to those contributions (and those of their employer, if any) until retirement, at which point they would ostensibly find themselves in a lower income tax bracket. Moreover, by saving on a tax-deferred basis, the theory went that you could get more bang for your buck in leveraging the taxes deferred.

A Preference for Roths

The researchers look at that scenario a little differently — gauging that paying taxes upfront on the contributions and foregoing paying taxes on the accumulated earnings amounts to a better deal. They then anticipate that participants would shift their 401(k) contributions to Roths.

To test their hypothesis, the researchers drew on administrative 401(k) plan data from 11 companies that introduced a Roth 401(k) option between 2006 and 2010 to analyze the impact of a Roth option on savings plan contributions. They found no evidence of a change in total contribution rates between employees hired after a Roth option is introduced and employees hired before. In fact, they note that if anything, contributions rise slightly when a Roth option is available.

Having found no evidence of the anticipated shift to Roths, they seek to explain it.

To do so, they turn from actual data to a survey of participants who are asked to provide a savings recommendation to a couple of fictional participants — basically to come up with a recommended savings rate for a pre-tax 401(k) option versus one that allows for both a pre-tax 401(k) deferral and a Roth 401(k) contribution. Despite what the researchers see as obvious advantages with the Roth, the contribution recommendations (in terms of a total contribution) are almost identical.

No ‘Wonder’

While considering several possible explanations for why this occurs, they settle on one that seems fairly obvious: “ignorance and/or neglect of the 401(k) tax rules.” But since the introduction of the Roth 401(k) option didn’t lead to any major shift in contribution rates, the researchers conclude that this suggests that governments may be able to increase after-tax private savings (because participants will have more savings accumulated with the Roth) while holding the present value of taxes collected roughly constant (the government gets less money, but gets it upfront, rather than waiting for the individual to retire) by making savings non-deductible up front but tax exempt in retirement, rather than vice versa.

In other words, since the addition of the Roth option didn’t lead to any significant changes in contribution behaviors, policymakers could consider shifting those current tax preferences to a post-tax savings assumption without being worried that individuals would react negatively, and perhaps save less, in response.

What If?

While acknowledging that a Roth-focused savings design could be advantageous to some, perhaps many workers (especially younger workers who may currently be paying the lowest tax rates of their working lives), I’d like to posit an alternative perspective.

What if those workers didn’t shift to Roth just because they liked the notion of putting off paying taxes — that they appreciated the logic of getting a dollar’s worth of savings for 85 cents worth of paycheck (that might, however, even account for the small uptick in contributions for the Roth — trying to make up for that “gap”)? Or that, having contributed on a pre-tax basis for some period of time, they were simply disinclined to make a change. After all, if plan sponsors simply added a Roth contribution type to the play, without changing default assumptions or matching formulas, simply presenting it as an additional option, I think it’s fair to say that, under those circumstances, most participants wouldn’t have any reaction or response to the new option. Indeed, considering normal behavioral inertia, it would be surprising if they did.

Let’s face it — they didn’t save more, they didn’t save less. They pretty much held the status quo.

So, what does this non-response of participants to the addition of a Roth option tell us about their likely response to the elimination the ability to defer paying taxes on income they haven’t received?

Well, Newton’s First Law of Motion is that objects at rest tend to stay at rest unless acted on by an external force. If you wanted to really test the reaction of participants to losing their pre-tax deferral choice — their “preference” for tax “preferences” — it seems to me that you’d need to actually take that option away from them. And then perhaps consider Newton’s Third Law of Motion: that for every action there is an equal — and opposite — reaction.

There is, it seems to me, a big difference between participants ignoring an additional choice and having an existing choice taken away. And policymakers who ignore that distinction in effecting tax law changes for retirement plans do so at their peril.

- Nevin E. Adams, JD

5 Things You Need to Know About Retirement Readiness

Recently the Government Accountability Office (GAO) released a report titled with its conclusion: “Most Households Approaching Retirement Have Low Savings.”

The title was no surprise — though the definitions of “most” and “low” bear further understanding.

The GAO Analysis
The GAO based most of its conclusions on findings from the 2013 Survey of Consumer Finance (SCF), conducted by the Federal Reserve every three years. It is a reputable and well-regarded source of consumer information, drawn from a sampling of about 6,000 households (different ones every cycle). That said, the information contained is “self-reported,” which is to say that it tells you what the individual thinks they have (or perhaps wishes they had), but not necessarily what they actually have. More on that in a minute.

The rationale for the “most” in the headline appears to come from its focus on households age 55 and older, where the GAO noted that (only) 48% had some retirement savings, and thus one might reasonably assume that the remaining 52% had no retirement savings — and that would seem to be the case. However, 23% of that 52% said they had a defined benefit plan. Now, that assessment may be inaccurate (see above), but if they do, in fact, have a DB plan, that plus Social Security might well be sufficient. So, “most” have no savings, but about half of that “most” might not need savings. Admittedly, that distinction makes for a clumsy headline.

What about the 29% who were age 55 or older, and who had neither a DB plan nor retirement savings? Well, the median annual income of that group was (just) $18,932. It’s not hard to imagine why that income bracket might not have set aside any savings for retirement. On the other hand, that group is probably well served by Social Security. Despite that income level, more than a third (35%) of those in this group say they own a home with no debt. Assuming that is the case (see “self-reported” above), that could make a big difference in their post-retirement expenses and/or represent an additional resource they could draw on for retirement income.

The GAO conclusions notwithstanding, here are five things you need to know about retirement readiness (and retirement readiness projections):

1. Social Security matters — especially for lower-income individuals.
Social Security remains the largest component of household income in retirement. In fact, GAO noted that for households age 65-74 with no retirement savings, Social Security makes up 57% of their household income on average. In fact, a quarter of this group rely on Social Security for more than 90% of their income.

For all households age 65-74, median annual income is about $47,000, and Social Security makes up on average 44% of income for households in this age group, larger than any other income source. About 90% of all households in this age range receive some Social Security income, and the median amount they receive is approximately $19,000.

The median income for households age 75 and older is about $27,000, and the median Social Security income is approximately $17,000. In fact, when compared to younger households age 65-74, Social Security makes up a larger share of household income for retirees age 75 and older, with 62% of these households relying on Social Security for more than 50%, and more than one-in-five (22%) relying on Social Security for more than 90% of their income.

2. Average or even median savings amount in the abstract tell you very little about retirement income adequacy at an individual level.

People live in different places and have different lifestyles and lifestyle expectations. They may have resources available beyond that reported in surveys such as the SCF, and individual health circumstances can make a huge difference in the adequacy of reported income sources vis-à-vis actual retirement spending requirements.

3. Pre-retirement income (or a percentage thereof) may not be a reliable proxy for post-retirement needs.

Many of these studies — and those cited by the GAO were no exception — use a “replacement rate” standard which, while it may be a convenient metric to use to convey retirement targets to individuals, has some serious shortcomings when applied to these large-scale policy models for determining whether an individual will run short of money in retirement.

The reality is that what and how we spend money pre-retirement often has little to do with our actual financial needs post-retirement.

As EBRI’s Research Director Jack VanDerhei points out, “…simply setting a target replacement rate at retirement age and suggesting that anyone above that threshold will have a ‘successful’ retirement completely ignores longevity risk, post-retirement investment risk, and long-term care risk.”

4. Many retirement projection models assume a 50% probability of success.
Aside from the shortcomings inherent in relying on a replacement rate for these projections, if you try to factor in longevity risk (the risk of running out of money in retirement), and post-retirement investment risk, VanDerhei notes that if you use a replacement rate threshold based on average longevity and average rate of return, you will, in essence, have a savings target that will prove to be insufficient… about 50% of the time.

Of course, when it comes to their retirement security, individuals tend to prefer something much closer to 100%.

5. Those who have a retirement plan are much better off than those who don’t.
Those with no retirement savings had a median income of approximately $29,000, while those in the same age range who have some retirement savings have a median income of $76,000. Among those age 55-64 with no retirement savings, the median net worth was $21,000 (about half of these had no wage or salary income), while among those in the same age bracket with any retirement savings, their median net worth was $337,000. In that group, the median income of those with no retirement savings was $26,000; among those with some retirement savings, the median income was $88,000.

Compared to those with retirement savings, these households (those aged 55-64 with no retirement savings) have about one-third of the median income and about one-fifteenth of the median net worth, and are less likely to be covered by a DB plan.

All of which suggests that it would probably be more meaningful to examine the retirement readiness of those without access to a retirement plan separately from those who do.

- Nevin E. Adams, JD

7 Common Retirement Plan Mistakes

The headlines are all about revenue-sharing, conflicts of interest and statutes of limitation — but the things that are likely to get plans and plan sponsors in trouble are a lot more mundane.

Here are seven that are more likely to gum up the works for your average plan sponsor.

1. Not following the terms of the plan document regarding the administration of loan provisions (maximum amounts, repayment schedules, etc.) or hardship withdrawals.

Plan documents routinely provide that hardship distributions can only be obtained for certain very specific reasons, and that participants first avail themselves of all other sources of financing before applying for hardship distributions. (These conditions often are incorporated directly from the requirements of the law.) Similarly, loans are permissible from these programs only when they comply with certain standards regarding the amount, purpose and repayment terms.

Failure to ensure that these legal requirements are met can, of course, result in a distribution that is not authorized under the terms of the plan document. And since these types of distributions are often spent quickly by participants, and thus are not readily recoverable, it can be complicated and time-consuming to set the situation right.

Oh, and don’t forget that administrative procedures for dealing with such things have been known to be, or become, inconsistent with plan documents over time.

2. Failure to follow plan document eligibility and vesting provisions.

The plan document also spells out employees’ rights to retirement benefits and the formulas for determining them based on the correct application of service and/or age requirements of the plan regarding eligibility for participation, as well as the proper application of the plan’s vesting schedule.

To comply with those requirements, you need to maintain accurate service records for all employees. If these records are incorrect, the benefits provided may be incorrect — either in excess of what is permissible or less than what was due to the participant. Note that the failure to properly follow the plan’s provisions can cause the plan to lose its qualified status.

The plan document serves as the foundation for plan operations; simply put, it is the operating manual for the plan. Sometimes, particularly if you are relying on a document that has been prepared by a third-party service provider, certain “gaps” can emerge between what the document allows and how the plan is actually administered. As a result, it is a good idea to conduct a document/process “audit” every couple of years. Don’t assume that “the way we’ve always done things” is supported by the legal document governing your plan.

3. Not keeping your plan document up to date.

As central to the plan’s operation as the plan document should be, it needs to be updated when the tax laws affecting 401(k) plans change. The IRS generally establishes a firm deadline by which plan amendments reflecting tax law changes must be adopted. If you don’t remember the last time you updated your plan, you’re probably overdue.

4. Not starting required minimum distributions (RMDs) on time.

A minimum payment must be made to the participant by the required beginning date (RBD) and for each following year. Normally, the RBD for a participant who is not a 5% owner is April 1 following the end of the calendar year in which the latter of two events occurs: either the participant reaches age 70½ or the participant retires. For 5% owners, the RBD is April 1 following the end of the calendar year in which they attain age 70½ regardless of their retirement date.

Plan sponsors often discover that required minimum payments either have not been paid on a timely basis or have not been paid at all, especially when a non-5% owner continues working after reaching age 70½. Failure to follow the minimum payment rules as written in the plan document can lead to the loss of the plan’s tax-qualified status. If participants or beneficiaries do not receive their minimum distribution on time, they — not the plan — are subject to a 50% additional tax on the underpayment.

5. Not depositing participant contributions on a timely basis.

The legal requirements for depositing contributions to the plan are perhaps the most widely misunderstood elements of plan administration. A delay in contribution deposits is also one of the most common flags that an employer is in financial trouble — and that the Labor Department is likely to investigate.

Note that the law requires that participant contributions be deposited in the plan as soon as it is reasonably possible to segregate them from the company’s assets, but no later than the 15th business day of the month following the payday. If employers can reasonably make the deposits sooner, they need to do so. Many have read the worst-case situation (the 15th business day of the month following) to be the legal requirement. It is not.

Note also that the rules about the timing of matching contributions or other employer contributions are different than those for elective deferrals.

6. Failing to obtain spousal consent.

A common plan mistake submitted for correction under the Voluntary Correction Program (VCP) is the distribution to a participant of a benefit in a form other than the required QJSA (e.g., a single lump sum) without securing proper consent from the spouse. This often happens when the sponsor’s HR accounting system incorrectly classifies a participant as not married (or when the participant was not married at one point and subsequently married or remarried).

The failure to provide proper spousal consent is an operational qualification mistake that would cause the plan to lose its tax-qualified status.

7. Paying expenses from the plan that are not eligible to be paid from plan assets.

Assuming that the plan allows it (another plan document check), the Department of Labor has divided plan expenses into two types: so-called “settlor expenses,” which must be borne by the employer; and administrative expenses, which — if they are reasonable — may be paid from plan assets. In general, settlor expenses include the cost of any services provided to establish, terminate or design the plan. These are the types of services that generally are seen as benefiting the employer, rather than the plan beneficiaries.

Administrative expenses include fees and costs associated with things like amending the plan to keep it in compliance with tax laws, conducting nondiscrimination testing, performing participant recordkeeping services or providing plan information to participants.

- Nevin E. Adams, JD

IRS Guidance Available
 
As for plans that fall short of any of the above, the IRS has resources available to help you identify these problems before they occur — and an outline of how to go about fixing them if they do occur. And should you find a plan in one of the foregoing predicaments, you might want to check out these resources from the IRS:

• If you haven’t updated your plan document.

• If you have issues with required minimum distributions.

• If you haven’t made contributions on a timely basis.

• If you didn’t get spousal consent.