Are 401(k)s Contributing to the ‘Retirement Crisis’?

Commentary

We’ve been at this for almost 3 years -- the DOL Fiduciary Rule. The Rule’s intent was to increase transparency in fees paid by consumers, decrease conflicts of interest caused by variable compensation and to put all investment advice under a uniform standard of care.

Sadly, the department places the most cumbersome and difficult requirements on IRAs and independent investment and insurance advisors.

The 401(k) was “invented by accident,” as a Morningstar report says. It began its life as a clause inserted in the tax code in 1978 to address the tax status of profit-sharing plans. Then it morphed into a savings plan when companies decided to get out of the defined pension business.

Its strange origins give the 401(k) an arcane structure requiring legal consultation, fiduciary obligations by the plan sponsor, paperwork, filings with the IRS, record-keeping and loan provisions for participants. These features provide opportunities for consultants, lawyers, advisers and accountants to charge additional fees, hindering investors striving for simplicity and frugality.

In January, many news outlets reported that the creators of the 401(k) worried about what they started. A significant worry since 401(k) plans and planning is a multi-billion dollar industry. In one exchange, a Wall Street Journal reporter said:

“No one predicted that the 401(k) would sort of underperform or underserve, you know, a mass range of workers. I don't think anyone would've signed on. You know, one sort of mistaken perception heading in - these people all thought Americans would see it in their best interest to save as much as they could for retirement. And what we've learned in recent decades is that more people are willing to spend, or want to spend, rather than save.”

Or perhaps, save for themselves rather than let an “underperforming or underserving” product do it for you?

According to an Investment Company Institute report, as of March 31, 2017, 401(k) plans held an “estimated $5 trillion in assets and represented 19 percent of the $26.1 trillion in U.S. retirement assets. In comparison, 401(k) assets were $2.8 trillion and represented 17 percent of the U.S. retirement market in 2006.”

Did the DOL get it all wrong? Would the time have been better spent looking at the current marketplace of 401(k)s? How about an analysis of opaque fees (just try doing a search on “average 401(k) fees”)?

Also, what about the conflicts of interest with revenue sharing and the lack of quality and consistent advice available to plan participants. In fact, could 401(k)s be driving the retirement savings problem? Americans for Annuity Protection (AAP) suggests they may be and here’s why.

Sporadic Personalized Advice

Since the 401(k) plan has become the dominant retirement savings tool available to workers, many employers can now offer a plan who previously couldn't afford to. But, the 401(k) is different from the defined-benefit pension plans that dominated in the past. Employers hired professionals to manage those pension plans and determine savings rates to meet guaranteed benefits. With the 401(k), that responsibility is now on workers.

Sadly, instead of guaranteeing payouts like fixed annuities and life insurance do, 401(k) plans can and do expose retirement savings to steep fees and major swings in the stock market. While some workers may enjoy the added flexibility offered by a 401(k), many have a hard time getting ongoing advice and avoiding investment pitfalls.

Currently, the law does not allow employers themselves to advise employees on how to invest their retirement money. Department of Labor rulings, however, encourage them to offer advice from an independent provider. Even so, many employers worry they might be held liable if an employee is unhappy with the results of the advice. Congress is considering legislation that would clarify the liability question. We wait with bated breath.

Job Demographics

Then there’s the lack of portability. In a recent report by TheBalance.com, the average person changes jobs ten to 15 times (with an average of 12 job changes) during his or her career.

Many workers spend five years or less in every job, so they devote more time and energy transitioning from one job to another. That means a patchwork of 401(k)s scattered across multiple employers with no on-site access to your human resources manager or plan advisor.

Poor Administration

Compounding the lack of personalized and experienced advice is the automatic enrollment dilemma. Auto-enroll has exploded in popularity over the past decade, and is widely seen as a best practice in 401(k) plans to boost participation and employee savings.

But why isn’t auto-enrollment working? Apparently, implementing auto-enrollment at companies with a high degree of employee turnover and relatively low wages — the retail and hospitality industries, for example — can create several small accounts that contribute to administrative headaches and increase plan fees. Leading many companies to throw those small accounts overboard. Speaking of fees…

High Fees

All of us know that a 401(k) plan is an expensive employee benefit. Primarily because 401(k) plans impose many compliance requirements that must be monitored (by lawyers usually) and ongoing service and administration functions that must be provided. What's more, many education, communication and reporting services are mandated by the government.

Given these impositions and mandates, it is highly likely that the participant pays. The costs are numerous and complicated: participant fees; supplemental asset-based charges; itemized costs for services such as loans, hardship withdrawals and qualified domestic relations orders; and, perhaps more important, higher fund expenses. Don’t even get us started on custodial fees – the fees paid to the custodian of the plan’s funds. Costs are highest in small plans, where a lack of economies of scale fosters much higher expenses.

In our recent article on fees we discussed recent studies revealing the true all-in cost averages about 1.65 percent and can be over 2 percent in smaller plans (under $2 million in assets).

In contrast, fixed annuities, including fixed indexed, charge no additional fees other than transparently disclosed fees for additional annuity benefits (e.g., guaranteed income) selected by the customer.

In Closing

The AAP Board of Directors continue to scratch their collective heads over the DOL Rule. Why don’t we make it easier for employees to consolidate and roll over high-cost, poor performing 401(k) assets into products that meet their financial goals, time horizon and risk tolerance? Why doesn’t the regulation focus on fixing the 401(k) marketplace?

In the coming days, the DOL needs to approve the delay until July 2019. AAP believes annuities and life insurance provides the consumer a choice of qualified and experienced professionals who have access to a variety of strong products?

During the interim, AAP will use the time wisely and make sure FIAs are not lumped in with securities products under the Best Interest Contract Exemption creating an un-level playing field and disadvantaging consumers. Consider joining our cause!

Kim O’Brien is a 35-year veteran of the insurance industry specializing in guaranteed annuities and life insurance. She is the current CEO of Americans for Annuity Protection and Founder of AssessBEST, Inc., a sales and compliance software system. Visit www.AAPnow.com or www.AssessBEST.com for more information.

This article is provided for educational and informative purposes only and not for the purpose of providing legal advice. Readers should consult with their own legal and compliance counsels to obtain guidance and direction with respect to any issue or question. Contact Kim at [email protected].

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