Helping clients build a better 401(k)
The U.S. retirement savings plan is broken, and while recent attempts to expand 401(k) savings has drawn mixed reviews, a consensus may be building around the need to unfurl a bigger financial safety net.
Several statewide attempts to close the nation’s retirement savings gap may cross borders and serve as a precursor to a nationwide solution. Although only 10 states and one city have acted in the past two years, industry insiders say others could follow and a federal requirement is even possible.
As many as 20 other states already have contemplated this approach, says Chad Parks, CEO and founder of Ubiquity Retirement + Savings. He attributes much of that curiosity to the midterm election cycle, noting that it predictably falls along partisan lines with Democrats showing interest and Republicans opposing the idea.
A mandate represents “the only way that we’re going to get a significant ratchet up in coverage” after years of failing to reach a much larger percentage of the workforce, according to Ted Benna, long known as the “father of the 401(k) plan.”
While not a fan of government intervention, he believes there are instances where it’s warranted to avert financial disaster. As such, Benna supports state or federal requirements that employers “at least offer a payroll deduction program.”
Without federal action, he believes more states will pass mandates if favorable results are achieved by those that already have done so and wouldn’t be surprised if 10 or more follow suit in the next two years. Benna doubts anything will happen at the federal level prior to the next election and will probably depend on who is president.
“The ideal solution,” Parks says, “would be that this becomes a federal mandate because we’re going to get 50 different flavors of nuanced mandated retirement savings, and that’s just going to make it harder to administer efficiently so that it’s fair to the employees.” But this scenario would hinge on Democrats winning back both the Senate and White House, he adds.
Oregon takes the lead
Almost half of the U.S. workforce doesn’t have access to an employer-provided retirement savings plan, Parks says, explaining the phenomenon is largely confined to businesses with 100 or fewer employees. Most advisers in the 401(k) space who charge a percentage of assets ignore small businesses because their plan balances don’t generate enough revenue.
About a decade ago, he says state legislatures began questioning the retirement readiness of residents, which laid the groundwork for state-mandated retirement plans in California, Connecticut, Illinois, Maryland, Massachusetts, New Jersey, New York, Oregon, Vermont and Washington state, as well as Seattle. New York City has also proposed a voluntary payroll deduction IRA. All generally require a 3% employee auto-deposit into a retirement savings account unless the employee chooses to opt out.
Parks is encouraged by some “better-than-expected results coming out of Oregon,” which in July 2017 became the first state to auto enroll its residents in a retirement savings plan. But all eyes are on California, long known for pioneering initiatives that spread to other states. The Golden State will require more than 400,000 businesses to auto-enroll nearly 6 million new savers during the next four years. The bluest of all states expects about 70% of plan participants to stay the course, according to Parks. He says the mandate, which took effect this year, eventually will trickle down market to five-employee companies.
Where it went wrong, he believes, is with a pricing model that can charge plan participants up to 100 basis points. This means that Ascensus, which was chosen to manage the program, will have to wait years for plan assets to reach a meaningful level. But he says it also can be seen in some circles as egregious for participants at a time when the industry is under fire for high fees and a lack of transparent pricing.
His prescribed fix: a hybrid of modest, fixed-dollar costs to the company and flat monthly fee to participants so that those charges don’t rise as assets under management balloon. Any asset-based fee, he believes, should be assessed only in the first five years with a commitment to reducing that amount over the ensuing five years.
Roth IRA vs. 401(k)
Although the payroll-deducted Roth IRA that governments have mandated as a baseline pales in comparison to the more robust 401(k) plan design, Parks considers it a step in the right direction to fill a serious national savings gap. Under this approach, he says employers aren’t expected to foot the bill — only facilitate the plan offering. The IRA infrastructure also isn’t subject to ERISA, 5500 form filings or discrimination testing.
However, he says a 401(k) is superior to the Roth IRA in terms of contribution limits, fees, the potential for matching contributions and consideration of individual risk tolerance. A 401(k) allows plan participants to defer substantially more of their paycheck each year on both a pre-tax and post-tax basis than under an IRA ($19,000 vs. $6,000 or $7000). Parks surmises that “60% of those who finally get into the retirement savings system would probably like the extra benefit of a 401(k) over the IRA.”
A Roth IRA contribution ceiling is perfectly sufficient for some small-business owners and entrepreneurs who cannot afford to defer more of their income, Benna says. He notes that this is particularly true if both a husband and wife in business together contribute up to the max.
In recent years, he has rolled out three new plan designs for small employers that don’t sponsor a retirement plan without the cost and complexity of a 401(k), which he admits doesn’t fit all small businesses. The paperwork required when someone leaves their job, for instance, wouldn’t be worthwhile in high-turnover industries. He says the way to escape extremely complex compliance and legal requirements is a safe harbor design plan, though the required 3% minimum employer contribution may not be feasible.
Given the inherent advantages of a 401(k) over Roth IRAs, “the optimal strategy is to fix the current 401(k) shortcomings that have prevented broader adoption: cost, fiduciary concerns and administrative work,” suggests David Ramirez, a co-founder and chief investment officer of ForUsAll as well as a Financial Engines alumnus. “We need to re-imagine the 401(k), not capitulate and accept an inferior solution.”
That means leveraging technology to integrate the 401(k) with payroll, automate daily administration and offer complete fiduciary protection, which includes an ERISA section 3(38) investment adviser and 3(16) plan administrator. In addition, he suggests hiring a new breed of 401(k) recordkeepers whose fees are often cheaper than a team lunch.
For participant services, his firm also has found that engaging employees via text messages with the help of virtual advisers and a one-click approach to deferrals can substantially increase the amount of money employees have at retirement. In short, companies that implement these best practices have an average of 88% plan participation with 6% to 7% employee deferrals, which Ramirez says is significantly higher than without an adviser’s assistance.
Applauding the state mandates, Parks says the U.S. needs to “look at this as the greater good. This isn’t about party politics. This isn’t about a financial institution seeking a windfall. It’s really about identifying a huge problem that is systemic in our country, which is almost embarrassing at this stage of the game, finding technology and providers who are willing to create solutions and then partnering with government.”
A sea change could be ahead even if no other governments take action. The traditional role of a retirement plan adviser will vanish within the next five to 10 years predominantly because of technology, Ramirez boldly predicts. “When you look at some of the largest financial services companies, whether it’s Goldman Sachs or BlackRock, they’re hiring software engineers,” he observes.
The focus will shift to areas where humans are most impactful, which Ramirez says involves using empathy to design communications that resonate with where people are at in life. Advisers also will need to align themselves with “a deep technology capability to deliver the next generation of 401(k) services.”