Simplicity Elusive In Retirement Planning
By Cyril Tuohy
It seems as if financial advisors and retirement plan sponsors or employers still have some work to do to bridge the gap between what employers expect from their retirement plans and how financial advisors measure an effective retirement plan.
Employers say they want simplicity from their retirement plans. That means employers want just a few funds from which their employees can choose.
Simplicity also means that employees should be able to enroll with just a few computer mouse clicks instead of filling out paper documents and submitting them to human resources departments.
There’s a good reason employers want more simplicity out of their retirement plan offerings: The more investment choices employees face, the more likely they are to pass on the opportunity to contribute to their employer-sponsored retirement plan.
In one well-known study, Columbia University professor Sheena Iyengar found that for every 10 additional investments in an employer-sponsored plan, there was a 1.5 to 2 percent drop in the participation rate.
When a 401(k) plan offered only two investment options, 75 percent of employees participated. When 59 investments options were available, the participation rate plunged to 61 percent, Iyengar’s research found.
The reaction — call it “decision paralysis” or “choice overload” — whereby employees are discouraged from making a decision, is well documented among behavioral economists.
At the end of last year, defined contribution (DC) plans held $5.9 trillion in retirement plan assets, according to the Investment Company Institute, and 81 percent of mutual fund-owning households held shares inside employer-sponsored retirement plans.
With employer-sponsored retirement plans turning into the de facto retirement vehicles for generations of Americans, responsible employers need employees to contribute to the retirement plan the day the employee is hired.
“Contribute early and often,” is perhaps the most undervalued phrase in all of investing. There’s no more insidious enemy to contributing early and often than employees paralyzed by too many options and complex enrollment procedures.
Simplicity, which implies low cost, is the friend of the investor. Every dollar siphoned off in the form of fees and “frictional costs,” is a dollar less earning interest for employees, as Vanguard Group founder and index fund proponent John Bogle pointed out.
A recent “barometer” survey of plan sponsors released by MetLife suggests employers may have turned the corner in terms of demanding simplicity from their retirement plan providers and record keepers.
“The shift toward simplicity is a potentially significant change in how plan sponsors view their role," said Cynthia Mallett, vice president of industry strategies and public policy for MetLife Corporate Benefit Funding Group.
MetLife’s Qualified Retirement Plan Barometer (QRPB) survey found that 89 percent of companies that offer access to defined benefit (DB) and defined contribution (DC) plans, and 77 percent of DC-only plan sponsors want to keep their plan designs simple.
If true, the barometer’s finding is good news.
Don’t forget that simplicity is also the employer’s friend. Like simple, low-cost index funds that benefit investors the most over time, the simpler the employer-sponsored retirement plan, the lower the cost to the employer — in theory.
The simplest measure of an employer-sponsored retirement plan’s effectiveness is whether employees are prepared for retirement.
For the moment, the answer seems to be not well enough. Too few employees participate in their employer-sponsored retirement plans, surveys find. For employees who do participate, many often don’t set aside enough money.
Whether employees ultimately are prepared for retirement isn’t necessarily how advisors measure an effective employer-sponsored retirement plan. Financial advisors tend to track different, more complex metrics.
Advisors focus more on participant rates, fees and fund choices than they do the final outcome — how prepared employees are the day they begin their retirement — said Tim Minard, senior vice president of the Principal Financial Group.
“Financial professionals who focus on fees, funds and fiduciary responsibility may not be focusing enough on participant outcomes," Minard said in a news release.
Pointing to a recent Principal survey on what employers and plan sponsors want from their advisors, Minard said it’s more important for advisors to be worried about how well participants are prepared for a comfortable retirement than it is to obsess over fees and plan participation rates.
Why offer employees 30 mutual funds from which to choose if workers succumb to decision paralysis and put nothing aside?
Advisors and employees, not just plan sponsors, need to ask themselves how prepared are employees for retirement? The question doesn’t get much simpler than that.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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