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Guest Editorial Why 401k Reform Must be on the Presidential Campaign AgendaBy Jane White, President of the Retirement Solutions LLC and a former financial journalist. She can be reached via email at Jane@retirement-solutions.us. The Retirement Solutions Foundation is a non-partisan organization dedicated to educating the public about saving for retirement. It may be too late to reverse many Baby Boomer fortunes; some of them will probably have to keep working into their 70s or later. But reversing the retirement shortfall for their younger cohorts could be readily accomplished by adopting the 10-step legislative reform proposal that tackles three key issues: increasing 401k coverage, boosting 401k account balances and mandating prudent investment practices. Rather than proposing reforms that will get bogged down in partisan bickering, a better approach is to create a plain-English "public wealth" campaign to help workers start saving early in their careers, adopt a buy-and-hold-strategy and refrain from dipping into their savings when changing jobs. At the same time, while acknowledging that free enterprise drives the American economy, reforms would require successful small businesses to offer a 401k plan and larger companies to match employee contributions. Challenge One: Increase Coverage in the Workplace and the Workforce 1. The problem: The reason why 401k balances are so low is because Americans contribute "too little and too late" to their accounts, waiting until their mid-40s or later to start contributing. The solution to low balances and inadequate participation rates: Require that employers who offer 401k plans recruit new employees to the 401k plans as soon as they are eligible through "auto-enrollment" or "default enrollment." Through "default" enrollment, new hires are automatically enrolled in the plan once they are eligible unless they choose not to join. For those employees who don't feel confident about choosing an investment allocation or contribution rate, the "default" investment allocation should be a lifestyle fund, in which the investment mix shifts from growth (mostly stocks) to income (mostly bonds and cash) over the working life of the participant. In addition, the "default savings rate" should be 5% of pay. Companies that have used default enrollment (motivated primarily by an interest in passing non-discrimination tests) universally show increased participation rates-from 80-95% in many cases. Unfortunately, fewer than 14% of employers currently use the practice, according to one study. 2. The problem: Two in 10 employees of companies that offer a 401k plan never join the plan. The solution: Require that employers who offer 401k plans actively recruit these employees through an annual written communication warning them of the consequences of not saving for retirement, demonstrating how large their account might be had they contributed 5% of pay to a lifestyle fund had they joined the plan as soon as they were eligible. Companies could also recruit employees through the same "default enrollment" technique used for new hires. 3. The problem: While 64% of all employees at companies with more than 100 workers are covered by a retirement plan, only 34% of all workers with companies in small plans are covered. The solution: Require that all employers with a) more than 25 employees or b) who have in business more than 10 years offer a 401k plan. Unlike employee health insurance, in which companies face the Hobson's choice of paying big premiums or "self-insuring" and paying big costs, an employer offering 401k coverage can shift the retirement funding costs to the employee and simply bears administrative expenses. After start-up costs, which can range from $500 to a few thousand dollars, annual fees should be no more than 1.5% of a plan's assets. For some small business, the startup costs may be essentially zero, since companies with fewer than 100 employees get a $500 tax credit for the first three years. Contrary to popular opinion, few small businesses that offer a plan say that a major reason for doing so is an increase in profits or an ability to offer a plan without employer contributions. Bottom line: the employers who don't offer the coverage don't do so because they're not required to, not because they can't afford to do so. 4. The problem: Many employees of small companies don't realize they aren't covered by a pension plan and don't think they need to worry about it. The solution: The small employers who don't meet the criteria outlined in Step 3 and don't offer a plan should be obligated to disclose this fact to prospective employees during the job interview-a particularly vital tool for low-wage and younger workers who probably don't have the issue of retirement security on their radar screens. This disclosure would give prospective employees the opportunity to consider looking for a job elsewhere and issue a wake-up call to employers to reconsider offering a plan. Challenge Two: Boost Nest Eggs by Mandating Matching Contributions in Certain Circumstances, Warning Against Cashing Out When Changing Jobs and Defining Target Nest Egg 5. The problem: It's not just small companies that typically neglect to offer a match to employee contributions; nearly 40% of large employers don't, including PepsiCo Inc., Xerox Corp., Phillip Morris USA, and J.P. Morgan and Co. Without this match, even those participants who start contributing in their 20s will come up short. Retirement Solutions research has demonstrated that even when an individual starts contributing 5% of pay to a 401k account at age 25 he or she will accumulate only 70% of the nest egg required at age 65 without at least a 50% matching contribution. The solution: Require that all companies with more than 100 employees provide a minimum 50% match on employee contributions. 6. The problem: A 2003 study by Hewitt Associates showed that nearly half of all workers who changed jobs in 2002 "cashed out" of at least part of their 401k accounts instead of rolling them over into a new-employer plan or an IRA. While the Department of Labor recommends that employers warn against this self-destructive practice, the only required disclosure is a 6,000-word IRS document-and this is a summary! The solution: Require that all employers present departing employees with a 100-word or less, plain English warning that cashing out would be hazardous to their retirement health. The optimal solutions would be to require employers to accept an immediate rollover from job-changing employees to their plan, since these job-changers may not feel confident about rolling the money over into an IRA (and may lose track of the money). At a minimum, a plain-English document should disclose that departing participants can leave account balances greater than $5,000 in the old plan. 7. The problem: The annual tax deferred limits on retirement savings are unreasonably low, specifically the tax-deferred contribution ceilings ($13,000 a year in 2004) and the "catch-up contributions" ($3,000 a year in 2004) for people over 50. What's more, the investment education that participants receive at work rarely helps them "define" the contribution that will lead to an adequate benefit. The solution: If the evidence of abysmally low 401k account balances isn't sufficient to convince Congress to raise the ceiling on tax deferred contributions, workers need plain-English disclosure of how much money they need to accumulate to retire comfortably. For example, they need to be told that they need to amass a nest egg equal to at least 10 times their salary at retirement and will need to contribute at least 24% of their salary to do so if they have waited until age 45 to start saving, a requirement that necessitates saving outside of their accounts. Mandate Prudent 401k Investment Practices that Stress Diversification, Low Fees and Low Turnover 8. The problem: Incredibly, despite the Enron debacle, a 2003 survey of nearly 700 large employers by Deloitte Consulting found that of those respondents that offer company stock as a match, 88% of them allow unlimited investments in employer stock, a 14% INCREASE since 2002. The solution: Since legislative attempts to limit employer stock holdings in these plans have proved futile, simply require all employers that feature a stock match to disclose to participants that this lack of diversification could be hazardous to their retirement wealth. This measure would have two salutary effects: force companies to reconsider the practice and force employees to consider whether they would be better off working for an employer with a cash match. 9. The problem: Currently, investors in managed funds fork over more than $100 billion a year in fees, 10 times the fees on index funds: expenses that are bound to cut their returns by 20 percent or more over time. Unfortunately, these investors are "paying for under-performance," since eight in 10 managed mutual funds under-perform the S&P 500 over a 10-year period due to excessive turnover of 90-100% a year. The solution: Require that employers with 401k plans feature index funds as investment choices, as a way of tackling the twin threats of excessive fees and poor investment performance. In addition, employers must prominently disclose the fees and 10-year track record of each investment offering. 10. The problem: Among certain 401k plans, participants can engage in "late trading" or buying and selling after the market closes but at pre-close prices-a questionable practice that may reduce the investment return of other fund investors. Among other problems, these traders can create trading costs that get passed on to other participants while at the same time hindering the fund's performance by forcing it to increase its cash holding and potentially unload profitable stock positions. The solution: Require employers to put restrictions on trading. The most effective strategy Hewitt has observed to stem this activity is the "aging of money," requiring that money transferred into a fund must remain in it for a period of time-anywhere from seven days to one month. This strategy led to a 98% decline in "excessive trading" in the cases studied. Bottom line: Right now the candidates are fiddling while the retirement clock is ticking. If we wait until the next Presidential election to address the retirement crisis, it won't be an expensive problem. It will be an unsolvable problem. ENDNOTES: 1. Vanguard Group, "How America Saves 2003," forthcoming.
### 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. | ||||
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