Lou Harvey, president of Boston-based Dalbar Inc., which provides third-party audits and evaluation services to the financial-services industry, says that more change is coming in the area of retirement plans.
What reform do you see next on the horizon?
Harvey: Last year as part of the campaign, Obama adopted very strongly and persistently this automatic IRA proposal that had been hanging around for several years. Obama endorsed it as his solution for the retirement gap that exists.
Several weeks ago, within the preliminary budget proposal, there was funding for the automatic IRA. All of a sudden, it’s moved from the campaign discussions to front and center. Clearly, this will now be debated in the coming months.
The mood in Congress now says that it is very likely to happen, especially given the great apprehension with 401(k) plans today. I give this a relatively high probability of being enacted in some form.
Employers without a pension plan must offer it, but employees can opt out.
Within ERISA, you cannot force anyone to have a 401(k) plan. So, the push is now going to be put behind the IRA, but there will be none of the ERISA liability for the employers.
What will be the overall impact of this reform?
This shakes the deck up quite a bit. There are four key provisions. The first is a mandate for expanding the pension system via the IRA to cover all workers, rather than the half that are covered today. But if employers are forced to offer the IRA but not to administer it, why would they bother to have a 401(k) plan and its associated burdens.
If this is enacted, I would expect to see employers move away from 401(k) plans, cancel plans they have, and embrace the IRA, which is less burdensome and less costly.
Second, the government is offering to match the employee contributions to the automatic IRAs in some cases and at certain levels, say 50 percent, rather than the employer. Again, why would an employer not simply let the government fund the match?
Third, there is a cost issue. The proposal calls for a very simple disclosure of fees in all plans. The objective is to move money out of the industry’s coffers and into the participants’ pockets. This suggests that participants will go looking for the lowest costs. We have been trying to do this for years within 401(k) plans, but the 401(k) structure is simply too complex.
Fourth, there will be a requirement of a low-cost option, such as an index fund. The implication is that there is no need to manage for returns. People can choose on cost, so why focus on alpha. This could eliminate the incentive to compete on performance.
When you put all these things together, this is about introducing a change that will really suck the wind out of 401(k) growth. I’m not saying that everyone will drop their 401(k) plans, but certainly companies looking to save money may do so.
This is great news for firms, like Vanguard, with strong retail-distribution operations, and low-cost products vs. those with a more advisor-oriented structure.
And what role could advisors have?
The recent discussions in Congress indicate that advisors that receive compensation from investment firms will not be permitted to advise these new vehicles. Financial advisors could get involved with this, though. And I’d say the best job for an advisor is to be able to evaluate the plans they now serve and advise these clients about whether or not they can move into this new IRA space with its new structure.