With an economy that’s still drooping in spots and high long-term unemployment now a part of the landscape, it isn’t surprising that politicians have taken notice of the retirement crisis in America.
American workers’ lack of retirement readiness has been dropped on the doorstep of the defined contribution market and it’s been pointed out again and again that 401(k) plans just don’t offer the same benefits and guarantees that used to come with defined benefit pension plans.
But is the 401(k) industry so bad? Why is it always cast as an outlaw in the retirement readiness showdown?
Todd Berghuis, senior vice president of ERISA compliance for Ascensus, said in a recent blog post that while no industry is perfect, including the 401(k) market, people shouldn’t shoot the messenger when it comes to news about retirement readiness. Having access to a retirement vehicle is more important than finding a nonexistent perfect retirement vehicle, he said.
Numerous studies in the past year have highlighted that although 80 percent of full-time American workers have access to a workplace retirement plan, only about 60 percent take advantage of that. And those that do take advantage don’t defer enough of their salary to meet their income needs in retirement.
Greg Ward, director of the Financial Finesse think tank and a senior resident financial planner with the company, said that much of the criticism of the 401(k) industry does stem from the fact that employees are not doing enough to prepare for retirement and most don’t even know how much money they need to save.
Much of the emphasis in retirement education has been on saving for retirement, but the amount needed in retirement is a vague notion nobody cares to explore. Obviously, if a person is setting money aside for retirement, that amount will be enough. But “in reality, they should be saving more,” Ward said.
“Part of it is acknowledging that we have been telling them to save but not giving them the tools, resources or education they need to know how much they should be saving with respect to investments,” he added.
And different generations approach retirement differently. Millennials are more conservative investors, meaning they are missing out on the years when they should be taking on more risk to build their retirement nest egg, Ward said. Generation X, in contrast, is the most likely generation to invest in the stock market.
Another reason people are cynical about the 401(k) industry stems from the roots of the industry itself.
When the industry first got started, back in the 1980s, the primary source of education about the industry were 401(k) providers themselves, he said.
“There’s a lot of money in retirement plans and for many years, the 401(k) providers had a lot at stake to get people to save money. We also know a lot of revenue is generated through retail mutual funds and traditional investments. For a long time we didn’t pay as much attention to the fees as we did the performance,” Ward said.
Questioning plan expenses
When the bottom dropped out of the dot.com economy and stocks weren’t going as gangbusters as they had in the past, people began to question 401(k) plan expenses.
That’s why government regulatory agencies like the Securities and Exchange Commission, Internal Revenue Service and Department of Labor stepped in to make retirement regulations a priority, churning out fee disclosure rules for both retirement plan providers and plan sponsors and teasing the industry with proposals of a new fiduciary standard, one that would hold brokers to the same advice standards as registered investment advisors.
“Fee disclosures are now required every year, which is an improvement,” said Ward. “As the marketplace becomes more aware of the expenses associated with these programs, that may be another reason the 401(k) industry is coming under more scrutiny.”
Chad Parks, founder and CEO of The Online 401(k), plants the 401(k) industry’s bad reputation at its doorstep saying that “historically it has been less than transparent in its pricing model.”
In some cases, 401(k) plan participants pay as high as 2.5 percent of their retirement assets in fees, which adds up over time and cuts into the amount of funds retirees have available to them in the years they need it most. The fees were high for a couple of reasons. Plan sponsors could use those fees to pay for the administrative costs of setting up the plans. In addition, sources said returns were so high that mutual fund companies could charge more and customer wouldn’t know or mind.
The regulatory environment “didn’t see anything wrong with that model and didn’t realize the long-term negative effects of asset-based pricing on participant savings,” Parks said.
It was these high-fee models that opened up a door for lower priced providers like Charles Schwab and TD Ameritrade to come in and nip away at the market share of the bigger 401(k) providers, like Merrill Lynch, he said.
The retirement industry has been slow to adapt to change and have been “caught with their pants down,” Parks said. The cell phone industry is a good example of an industry that charged high fees for everything but improved once technological innovations paved the way for lower fees.
So, does the 401(k) industry deserve its bad reputation? “Yes,” he said, “because technology has improved, costs have come down and the market has expanded. In that formula, most companies and consumers of those goods see price depreciation that hasn’t happened in the 401(k) space.”
Some companies, like The Hartford, saw the writing on the wall and exited the 401(k) market. “With continuing price pressure on our fees vs. infrastructure costs, maybe it is not the best business to be in,” he added. “Companies like mine, we are a disruptor; we came into this business from the bottom up. We were never looking at it from an asset/revenue model but a flat fee for service model.”
Even with its myriad problems, the 401(k) industry is still very important and “if it hadn’t been for the advent of this industry and providers being willing to do this work, a lot of people would be a lot worse off today. It is not perfect or the leanest approach it could have been, but people are still coming out ahead because they wouldn’t have a vehicle otherwise,” Parks said. The industry “needs to continue to evolve and evolve faster.”
The industry can be blamed for some of the retirement crisis but at some point individuals have to take charge of their own behavior, including being aware of their investments and the fees being charged through their retirement plans, Ward said.
All parties have to participate in the solution. It is up to providers to give participants the resources they need to make informed decisions, including plan design enhancements, automatic enrollment, automatic escalation, target-date funds, managed accounts and online tools and resources for financial advice.
“Now more than ever we have the tools and resources to touch different generations,” Ward said. “Millennials like the technology side. Boomers like the ability to work with advisors in managed accounts.”
And while you can lead a horse to water, you can’t make it drink.
“The behavioral change is not going to come from all the features and plan design,” Ward said. “The behavioral change is going to come from the education and the social pressure that says look, just like you physically need to be healthier, eat less junk food, smoke or drink, it is not good to have financially bad behavior.”