401(k) Changes Worth Celebrating

In case it's not already programmed into your calendar, this Friday is National 401(k) day. The Profit Sharing/401(k) Council of America (PSCA),which spearheads the event, is promoting the day as an "annual celebration." Of what you say? Surely not the uptick in plan participants who have recently taken early withdrawals from their 401(k), or the fact that most plan sponsors drop the ball getting employees to raise their contribution rate from the anemic 3 percent default.
Nope, this is an annual celebration "spotlighting the importance of employer-sponsored profit sharing and 401(k) plans." I'm not so sure that's cause for celebration. Given the aforementioned flaws, and plenty others (see: company stock, a lack of fee transparency, and a paralyzing menu of choice, for starters) I'd say the importance of 401(k)s --at least in their current state -- is cause for concern. The 401(k) is the primary retirement savings vehicle for most Americans, and yet the financial services industry, Congress and regulators haven't exactly been quick to fix some of its most costly flaws.

401(k) Changes Worth Celebrating.
Before I'm ready to break out the bubbly to celebrate the 401(k) I'd have to see at least a few substantive improvements over the current 401(k) model:

-Auto Enroll All Workers. It's clear that auto enrollment has been a terrific success; the vast majority of folks who are signed up stay in the plan. Only problem is that most plans apply auto enrollment to new employees. Time to make it standard practice to circle back and opt them into auto enrollment.

-Disallow Static 3 percent default rates. When employees are enrolled in the company 401(k) the most common contribution rate is 3 percent of salary. The majority of firms then just leave it to the participant to decide if it should be higher. (Yes, it should. Total employee-employer contributions should be north of 10 percent, preferably 15 percent.) What's so nutty is that because employees are defaulted in at 3 percent there is a tacit message to the employee that the plan believes 3 percent is the "right" amount. That's not it at all. The plan chose 3 percent because it wanted to pick an initial rate that wouldn't scare off folks who were auto-enrolled. Now that we know auto-enrollment is working just fine, how about a mandate to get plans to opt-in participants to annual auto-escalation of 1 percentage point a year? And maybe consider setting the initial default rate higher than 3 percent. Hewitt has anecdotal reports that employees aren't scared off by 6 percent default contribution rates.

-Add an Index Fund to every plan. Rep. George Miller actually proposed the index feature....and it was shot down pretty quick. That's despite the fact that we know the vast majority of actively-managed funds fail to outpace unmanaged benchmark indexes. And despite the fact we know that fees play a big role in retirement wealth. I am not suggesting plans only offer index funds. Just that a low-cost index fund is made available.

-Set a 10 percent limit on Company Stock. Progress has been made on this front in recent years as companies must make it easier for plan participants to easily sell off company stock they receive as a match. But we've still got a problem with too many participants making outsize bets on company stock. The news that BP's 401(k) had nearly 30 percent of the plan's money invested in BP stock is just the latest example. At the very least maybe the tweak is to stop making the company match in stock once a participant has more than 10 percent invested. I can hear the howls already. But there is no one in Washington who can argue with the basic principle of diversification that says north of 10 percent is dicey. So why is it allowed and encouraged in 401(k) plans?

-Get Serious About Helping Participants Figure out the End Game. Another piece of Congressional legislation that has gone nowhere was a proposal to mandate that 401(k) statements translate lump sum balances into an estimate of what that could generate as monthly or annual income in retirement. This has the potential to be an incredible help for pre-retirees trying to figure out whether they are on track to have the money they want for retirement. Donn Hess, managing director of product development at JP Morgan Retirement Services says lump sum values are "somewhat nebulous" for participants. So for the past few years JP Morgan now shows participants in the plans it administers the annual income their balance could generate in retirement (in today's dollars.) It's proven to be a great conversation-starter/eye opener for participants who can see in more tangible dollar amounts where they are at, and what tweaks are needed to close any retirement income gap

Hess and a cavalcade of 401(k)-wonks will be in Washington on Monday and Tuesday for a Dept. of Labor hearing on "Lifetime Income Options for Participants and Beneficiaries in Retirement Plans." The hot-potato issue of offering annuities or other guaranteed income vehicles within 401(k)s is a main focus of the hearing. But hopefully they will also spend time on tackling some issues that would be easier to get implemented sooner than later. The simple display of projected annual retirement income on participant statements seems like a good place to start.

Image courtesy of PSCA

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