Will Your Participants be Able to Retire?
By Carl J. Colombo, CFA, Second Opinion Associates, a San Diego, California, Registered Investment Adviser. You can contact Mr. Colombo at 858.536.8100 or SecondOpinion@sbcglobal.net.
What is a plan sponsor's liability in a DC world?
For the sake of argument, let us assume that we have three different employee age groups. Our oldest group is within a few years of retirement. We also have a group of twenty something employees who only have a few years of tenure with us in this industry. The third group is composed of people in their late thirties, forties and even a few in their early fifties. We suggest that each of these demographic groups reflects a different set of financial planning needs. If we try to provide the same solution to each group, we are likely to deliver solutions that do not solve their financial problems. This does seem to be common sense. However, how often do we hand out the same educational materials to all of our employees regardless of their age? When we have a 401k workshop or employee benefits fair, do we ever try to focus on a particular group's needs or do we just assume someone from that group will ask a pertinent question?
Close to Retirement
How do we judge whether we have been successful in helping this group of employees to retire in a few years? What should we be doing for them now? Should we focus on the long-term benefit associated with investing in the stock market? Should we provide education on what the sources of post retirement income will be? Should we help our employees develop a spending policy for their retirement years? Who will provide healthcare insurance for the retiree? We see these as important questions that should be addressed more than the typical six months before an employee is scheduled to retire. We also believe that several of our 401k vendors should provide help with this group of participants. It should be remembered that a retiring secretary needs the service more than a retiring CEO does.
Young and Glad of it
There is growing evidence that our youngest employees are not getting the message that the 401k is really for them! Do you remember all of the advantages of defined contribution plans over defined benefit plans that were listed by people trying to do away with the later benefit plan? We recall portability being one of the advantages and that is true. However, that is only an advantage if young people contribute! Quick vesting and the ability to invest your own money anyway you wish to are also listed as benefits. The twenty-two year old engineer with 100% of his 401k account invested in a GIC fund may be misguided, but at least he is doing it his way! We contend that these are the accounts that should be audited for suitable asset allocations and appropriate deferrals. There is enough time to be able to heal the damage caused by poor judgment. A small increase in deferral and a more robust asset allocation with thoughtful diversification will go a long way toward pointing these participants in the right direction.
Middle of the Pack
What about those participants in the middle of the demographic age pack? There is less room for investment error in these accounts. An audit of their strategy is an important first step. Will they need to step up their deferrals, change their asset allocation or modify how they will live in retirement? Many of these employees are already making plans to sell the large single-family house in favor of a condominium on a golf course in South Carolina. Some will continue to work full or part-time after retirement to supplement their post retirement income. It is important for this group to have access to professional financial planning assistance. Do we currently offer this to our employees? Is it cost prohibitive? Can we work with a Registered Investment Adviser to bundle investment option selection and monitoring with financial planning advice for our employees? What fiduciary risk do we accept if we do not provide this as a service? Is this a service that can be provided to employees with a certain number of years of service for free and at a subsidized cost to other shorter tenure employees?
Assets Equal Liabilities
As my friend the CPA likes to remind me, in the end assets must equal liabilities or you have Enron! In the case of this employee benefit world, your future ability to spend will reflect the number and size of your future post retirement sources of income. Here is a short list of some of the sources you might expect:
This source of income must be balanced off against future expenses. Where will we live? How large a mortgage will we have at retirement? How much in the way of property taxes will we pay? Insurance on our home is a necessity and how much will it be? That depends on where we will be living doesn't it? What will be our primary source of transportation? Will we live near mass transit? Medical expenses are becoming a bigger and bigger segment of the average retirees' disposable income. How will we pay for that? Will we work to be covered by an employer's insurance coverage?
A healthy exercise is to estimate what the living costs will be in your ideal retirement village and then try to determine whether your projected income will be sufficient to cover it. If there is a shortfall, how will we cover it? Will we have to rethink living in that gated golf course community near Santa Barbara? What changes do we need to make to our plan? What percentage of your IRA or other retirement account did you plan on taking as current income each year? A well-diversified investment account may be capable of throwing off a 4% real (inflation adjusted) level of income and maintain the purchasing value of your investments. Should we attempt to save more prior to retirement? Is there an inheritance available that will help to ease our migration into retirement?
We do not think that plan sponsors realize the important demographic differences that exist within their participant populations. If a plan sponsor is to minimize their fiduciary risk, it is essential to manage the education and advice provided to different demographic employee segments. It is also essential to audit the investment accounts in an effort to determine whether asset allocations and deferral levels are consistent with the financial goals, objectives, and risk preference of the participant. If there is a disparity, corrective education or advice needs to be provided. This can be done by requesting it from one of the vendors currently servicing the plan. If a service provider is unable to provide this participant financial planning service, the plan sponsor should determine whether there are other qualified Registered Investment Advisers who would be able to provide the service.
Each of the groups we have described has their own particular problems and challenges. Under ERISA it is our contention that the plan sponsor is obligated to work with the participant to help them solve them.
401khelpcenter.com is not affiliated with the author of this article nor responsible for its content. The opinions expressed here are those of the author and do not necessarily reflect the positions of 401khelpcenter.com. This article is for informational and educational purposes only and doesn't constitute legal, tax or investment advise.