It is certainly not news that most Americans are ill-prepared to retire with 70% income replacement. We can blame high fees, which the press and regulators seem to focus on, and a decade of low or negative returns, but the real problem is that most participants are not saving enough and are not actively engaged in the process of preparing for retirement. Then, some industry professionals are still implying that their services are free. But with sweeping disclosure regulations about to become law, that myth will be quickly debunked. It's time to debunk other myths and tell plan sponsors and participants the hard truth.
A step further
Though the "auto" plan features of the Pension Protection Act of 2006 were a good start, we need to go further. Automatic enrollment is a great way to get more participants into their 401(k) plan, but deferring them at 3% into a one-size-fits-all target-date fund filled with an overwhelming percentage of active equities is not the solution that will get participants to a successful retirement.
With obvious exceptions, most should start at 10%, increasing with each raise. Some people cannot afford it, and some do not need it, but double-digit deferral applies to the other 90%. Worst case is that participants will be saving more money than they need.
Just as the U.S. government is being forced to make hard choices about the national budget after a decade of overspending, participants have to make tough decisions about where they live, what they drive and how much discretionary income they spend.
Even if participants save enough, bad investment decisions can limit or even wipe out the benefits. Giving participants 18 funds to choose from or a one-size-fits-all equity-based target-date fund will not substantially increase their chances for a successful retirement. Participants are managing their personal defined benefit plans. When companies manage a DB plan, they do not try to beat the market - they try to manage their assets to meet their liabilities, asking what return do they need to fully satisfy their retirement liabilities. Should a fully funded participant be taking the same risk as someone who is woefully underfunded?
Target-date funds only need a participant's age as opposed to risk-based, which requires participants to answer questions. But do participants really know how to answer those questions? Isn't the choice of risk-based allocations funds for each participant already clear based on readily available data such as a participant's age, income, deferral rate and account balance?
The key players that can positively affect participant success are advisers and plan sponsors. Advisers decide which vendors will be used and oversee plan design. They also interact with participants. Though plan sponsors may be unwilling to take on substantially more risk, work or costs, without their support, nothing will change. Advisers that do not sugar-coat the hard truth, focus on participant success and partner with world-class providers and forward-thinking plan sponsors will not only have more business than they can handle, but they also will have a positive impact on participants.
Reach The Retirement Advisor University's Barstein at Fred.Barstein@TRAUniv.com.
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