AdvisorNews - June, 2011
March 25, 2011 (PLANSPONSOR.com) The adoption of new cash balance plans had slowed to a trickle since the passage of the Pension Protection Act of 2006 (PPA'06) because of the absence of clear regulations, according to Sibson Consulting, a division of Segal.
However, employers received much of the clarity they were waiting for about the design and structure of cash balance plans when the Internal Revenue Service (IRS) issued proposed and final regulations (see IRS Corrects Hybrid DB Plan Rule), and Sibson says the hybrid appeal is worth another look in light of this legal clarity (see Bright Future Seen for Cash Balance Programs).
In a Spotlight report, Sibson says the potentially compelling reasons for employers to consider a cash balance plan are:
Financial Efficiency A traditional DC plan is the approach to follow for employers that want to "set it, and forget it" because the cost of the plan is fixed: x percent of pay. However, in a simple cash balance plan the apparent cost of the plan is x percent of payroll, but the expected economic cost of the plan can be much less. The source of this savings is the differential between the rate that a plan will credit on employee accounts (which is often the 10-year or 30-year Treasury rate) and the discount rate. Under funding and accounting rules, the discount rate is based on corporate investment grade bonds. Given recent market conditions, this differential can result in a 1 to 2 percent spread, potentially saving as much as 2% of payroll each year (or more, if emerging investment performance exceeds the rate earned on corporate bonds).
Mitigating a Significant Financial Risk Compared to a Traditional DB Plan A traditional DB plan is exposed to both an investment risk (through its assets) and an interest-rate risk (through its liabilities). When the two risks go the wrong way - assets going down while liabilities increase - plan sponsors have experienced a "perfect storm." And, while a cash balance plan is a DB plan, under a typical feature where the annual interest credit is set at a market rate (e.g., 30-year Treasuries), the interest-rate risk on the liabilities is significantly muted without needing to introduce complex interest rate hedging techniques that one would need in a traditional DB plan. The reason for this is simply that whereas lower discount rates drive up a typical DB plan's present value of future benefits (i.e., the plan's liability), lower discount rates usually reduce a typical cash balance plan's interest crediting rate, thereby offsetting the increase in the liability due to lower discount rates.
Universal Coverage If employers shift the primary retirement vehicle from a traditional DB plan to a traditional 401(k) plan, one group of employees is left out in the cold: those employees who are unable to save money in the 401(k) plan and, therefore, receive no employer match. Although typically not a substantial portion of the population, it is nevertheless a group about which the human resources department is often concerned. A cash balance plan fills this gap because, like a traditional DB plan, it covers all employees.
Balance of Risk Many employers believe that their assumption of 100% of the financial risks of the retirement program is too far to one extreme. However, a growing number of employers think that having employees assume 100% of the risks goes too far in the other direction. A cash balance plan operating in tandem with a DC plan provides a reasonable middle ground.
Benefit Design Flexibility Because a cash balance plan is a DB plan, it can be used to meet employers' personnel goals in ways that are not available to DC plans. For example, they can be (although not often are) the basis for providing early retirement windows and spousal benefits.
Passing Non-Discrimination Testing Many DB plan sponsors closed their DB program to new hires in the past few years. If this has not already created non-discrimination problems, it is likely to do so in the future as the DB population ages and becomes higher paid. Redirecting a portion of current DC accruals into a cash balance feature in the DB plan (effectively allowing new participants into the DB plan) may make it easier to pass the non-discrimination test for the closed DB plan.
Advantages of Cash Balance for Employees
In its Spotlight report, Sibson Consulting said from the employees' point of view, there are two main advantages of a cash balance plan:
Preservation of Investment Principal Cash balance plans typically provide a feature that DC plans do not provide under the commonly elected investment options: account values that can only increase from year to year. Essentially, cash balance plans act like stable-value funds providing a dependable floor of protection. Further, although the interest credit in a cash balance plan might seem conservative compared to traditional DC investments, participants could compensate for this conservatism by allocating a larger portion of their DC accumulation to equities.
Longevity Protection Surveys have shown that one of the two major fears of employees who are about to retire is outliving their money. (The other is a medical catastrophe that wipes out savings.) Because a cash balance plan is a DB plan, it must offer the option of receiving a lifetime payout rather than a lump sum. To some extent, this also serves as a floor of protection against outliving one' money.
Sponsors of defined-benefit plans have shifted their attention over the past few years from a focus on returns to more of a focus on making asset decisions in the context of liabilities -- or a more individualized rate-of-return model, according to one survey. Another found that more than four of five sponsors were concerned with interest-related risks and general market uncertainty.
By Andrew R. McIlvaine
Marking a development that, experts say, bodes well for the long-term survival of traditional pension plans, two recent reports find that sponsors of defined-benefit plans are more aware of the potential risks facing their plans and are more focused on mitigating those risks than they've been in the recent past.
The 2011 U.S. Pension Risk Behavior Index from New York-based MetLife finds that plan sponsors are focusing on a smaller number of risks and paying greater attention to them than in 2010, when MetLife's survey found plan sponsors placing nearly equal importance on all the risks facing their plans.
In MetLife's 2009 survey, plan sponsors were focused mostly on asset-related plan risks.
"We've found that plan sponsors have moved from having an asset-centric outlook to looking at assets in terms of each plan's specific pension-plan liabilities, and that's great, because the old rate-of-return model was one-size-fits-all," says Cynthia Mallett, a vice president in MetLife's corporate benefit funding group who oversaw the study.
"What we see now is an emerging recognition that not all plans are the same and that plan sponsors are looking at making asset decisions in the context of liabilities," she says.
The new focus on individual plan risks is especially welcome because plans can vary considerably from company to company, says Mallett. "You can have differences in the distribution of ages and years of service, differences in benefit-plan formulas, differences in the form of payments.
"Typically, these factors weren't even thought about -- plan sponsors focused on the single present value of future obligations that was prepared for accounting purposes and for use in financial reports," she says.
This year's MetLife study surveyed 149 plan sponsors from among the 1,000 largest U.S. defined-benefit plan sponsors.
Mid-sized DB plan sponsors have also gotten more focused on risk control than in the recent past, according to a new survey from Vanguard, the Valley Forge, Pa.-based investment-management company.
Vanguard's Survey of Defined Benefit Plan Sponsors 2010 queried plan sponsors with $100 million to $1 billion in assets.
Eighty-five percent of them rated pension risk as "very" or "extremely" important, with the importance of risk increasing with a plan's asset size relative to company size. The two risk concerns most-cited by sponsors were interest-rate risk (cited by 85 percent of respondents) and uncertainty in the equity markets (80 percent). Eighty-nine percent said their plans are underfunded.
"The focus on risk over returns is interesting because it's a departure from what we've seen over the years," says Kimberly Stockton, an investment analyst for Vanguard and author of the study.
A majority of respondents to the Vanguard survey said they intended to "de-risk" their plan by implementing so-called liability-driven investment strategies, increasing their portfolio's fixed-income allocation and duration, and decreasing their equity allocation.
It also found that respondents who rated their plan as more risky were more likely to make changes to their investment strategies -- including liability-driven investment strategies -- and to freeze or terminate their plan or make benefit changes.
These strategies are not without potential drawbacks, says Stockton.
"If you're moving to an asset that's expected to have a lower rate of return, you could end up with lower funding ratios and higher costs overall," she says. "Nevertheless, you'd still have less volatility, so you're not going to have these 'contribution surprises,' where the company has to come up with this huge contribution to make up for an unexpected loss."
Mallett also says she expects to see more plan sponsors changing their strategies, moving toward partial risk transfers and special investment strategies.
"It's important to note that the results of these actions will take some time to show up," she says. "There are market forces beyond the plan sponsors' control that may obscure the effectiveness of these changes during the first couple of years."
The effects of these changes may have been reflected in the rates-of-return performance of DB plans versus defined-contribution plans in 2009, according to a just-released Towers Watson analysis.
Although DB plans outperformed DC plans in 2008 by the widest margin since the beginning of the decade, DC plans had the edge in 2009, slightly outpacing DB plans for the first time since the bull market of 1995-2000.
"Larger allocations to equities in DC plans may have led to better investment performance in 2009," says Chris DeMeo, head of investment for North America at Towers Watson. "Meanwhile, many DB sponsors had already shifted toward investment strategies that were more closely linked to the underlying liabilities, which mitigated their 2009 losses but also may have hindered their overall performance in 2009."
March 22, 2011
Copyright 2011 LRP Publications
Roger Wohlner, On Wednesday March 30, 2011, 10:02 am EDT
Target-date funds are a staple of many 401(k) plans. Most target-date funds are funds of mutual funds. The three largest firms in the target-date space are Fidelity, T. Rowe Price, and Vanguard with a combined market share of about 80 percent. All three firms use only their own funds as the underlying investments in their target-date fund offerings. Some other firms offer other formats, such as funds of exchange-traded funds, but the fund of mutual funds is still the most common structure.
Here are a few considerations to think about when deciding whether to use a target-date fund option in your company's retirement savings plan:
The fund's glide path may or may not be important. Much has been made of whether the glide path (a leveling of the fund's allocation into retirement) should take investors to or through retirement. Through retirement assumes you will keep your money in the target-date fund into your retirement years. You may or you may not. For example, you might leave your current organization prior to retirement, in which case you might roll your retirement dollars into your new employer's plan. Or at retirement you might roll your 401(k) assets into an investment retirement account (IRA). In either case, you would be moving out of your current plan's target-date fund choice.
How does the allocation of the target-date fund fit with your other investments? Many 401(k) participants invest their retirement dollars in a vacuum--meaning they don't take investments outside of the plan into consideration when making their investment choices. This is a critical mistake. Given that target-date funds are funds of funds you might become over or under allocated in one or more areas and not know it as your account grows. Factoring the allocation into your overall portfolio is just as critical.
The fund closest to your projected retirement date may not be right for you. For example, a 2020 target-date fund is conceivably meant for someone who is 56 and retiring in nine years. If you were to take three 56-year-olds and look at their respective financial situations and tolerance for risk, it is likely that they are all fairly different. Plan providers need to do a better job of communicating to plan participants that the fund with the date closest to their projected retirement date may not be the right fund for their needs. Look at your own unique situation and pick the target-date fund that best fits your needs.
Understand the underlying expenses. In some cases, the overall expense ratio may be a weighted average of the underlying funds. Others may also tack on a management fee to cover the costs of managing the fund. As with any investment, understand what you are being charged and what you are getting for your money.
Target-date funds don't equate to low risk. Many participants are under the mistaken impression that investing in a target-date fund is a low risk proposition. As we saw in 2008, nothing could be further from the truth. Many investors in 2010 funds saw losses in excess of 20 percent. A recent review of more than 40 target-date funds showed the share of stocks in the funds ranged from about 25 percent to about 75 percent. As with any mutual fund, look under the hood and understand the level of risk that you will be assuming.
Target-date funds can be a good vehicle for 401(k) participants and others who are not comfortable allocating their own investments, or who would simply like a professional to take on this task for them. Unfortunately, target-date funds are not a set it and forget it proposition. Investing in target-date funds requires periodic review to ensure that the target-date fund you have chosen is still right for your situation. Retirement plan providers and sponsors also need to do a better job of communicating the benefits, pitfalls, and potential uses of these funds to plan participants.
Dramatic changes in the 401(k) business offer plenty of opportunity for top-notch financial advisors to increase their business.
By Ary Rosenbaum
For the financial advisor who is not in the 401(k) business and wants to be or the financial advisor who wants to dramatically increase their small book of business, this is the perfect time. With dramatic changes in the industry involving fee disclosure, the definition of fiduciary, and target-date funds, financial advisors who are serious in doing a top notch job as a 401(k) advisor will find plenty of opportunity to develop and increase their book of business. As I always say, if you don't do it right, don't do it at all. A 401(k) advisor who will do it right by doing their job and making sure their clients do their job will find the 401(k) plan business very rewarding.
A large part of my practice as an ERISA attorney has been working with financial advisors and assisting them with their clients. I have further developed that practice by serving as counsel for a few registered investment advisory firms including a couple that are new to the 401(k) plan business. While this arrangement involves a flat fee, monthly retainer where my hourly fee is discounted by 60% (my old law firm's managing partner would flip), I believe that assisting financial advisors who are my clients and those who are not will help 401(k) plan sponsors handle their fiduciary responsibility more carefully, which can only benefit plan participants and help narrow the retirement crisis that our society is suffering as a whole.
Develop your niche. While Peter Gabriel proclaimed in the 1986 hit, Sledgehammer, that he would be anything you need, a financial advisor can't be everything for everybody. A financial advisor cannot handle 401(k) plans from $1 in assets to $1 billion in assets, As a financial advisor, you have to determine what your market is and which 401(k) plans you will target. Will you target larger plans or plans that are smaller in asset size? If you are a registered investment advisor, you will also have to determine what your fiduciary role will be, will you be a co-fiduciary, ERISA 3(21) or ERISA 3(38) fiduciary? If you are a broker, be mindful that the Department of Labor is implementing rules that may define you as a fiduciary.
Attend 401(k) Rekon. There are many ways to start and develop your 401(k) practice and most of those ways involve the spending of money. 401(k) Rekon is not one of them. 401(k) Rekon is the brainchild of a North Carolina financial advisor named Ross Marino who decided that national retirement plan conferences where retirement plan providers would present were costly in both money and time to the financial advisors who attended these events. So Ross developed 401(k) Rekon as the way to bring these types of events to local markets. The events are free for advisors to attend where they get presentations from some of the large plan providers. These presentations are not sales gimmicks, the presentations provide relevant information for advisors who are new to the 401(k) business or simply wants to learn ways to build their practice. I was the first ERISA attorney to be a sponsor and speaker at these events and I have thoroughly enjoyed all of the presentations made by plan providers, including one or two that have been very critical of. The events are not about selling product, it's about teaching advisors how to build their 401(k) plan book of business. 401(k) Rekon has been a tremendous success in its short history, so there will be an event in your area soon. Check www.401krekon.com for further details.
Surround yourself with smart 401(k) people. In the movie, Back To School, Rodney Dangerfield's character stated that if you wanted to look thin, you should surround yourself with fat people. For 401(k) advisors with limited retirement plan expertise, to look smart on 401(k) plans, surround yourself with smart 401(k) people. Being a financial advisor is difficult enough, so you aren't expected to become retirement plan experts. However, there are too many financial advisors who don't have the knowledge and don't care to have that knowledge which puts their clients at a disadvantage. As a financial advisor, you need to augment your services and show why your services have a value compared to the competition and the best way to do it is to rely on retirement plan consultants and ERISA attorneys for advice, consulting, and knowledge. While many financial advisors often rely on the expertise of the third party administration firm that they refer business to, but that advice is not independent. In my practice, I have always had an open door policy to advisors and I will always assist advisors like you without an immediate bill due. As far as retirement plan consultants, I am hard pressed to find anyone better than Sheree Tallerman of Plan Perfect Retirement. A former co-worker of mine at a TPA, Sheree has developed her firm as a provider neutral, infrastructural support to allow new 401(k) advisors to expand their practice to the retirement plan arena. Check www.planperfectretirement.com for further details. If you are unsure of what portfolios to use, consider Scott Pritchard of Advisors Access whose company can do it for you since they are a turnkey asset management provider. Check www.advisorsaccess.com for more information.
Don't rely on one plan provider. Whether it's a plan provider like a TPA or a custodian, there is not one provider that is a perfect fit for each client. So instead of picking a plan provider that you are comfortable with, it's more important to find the right provider for each client. TPAs come in all shapes and sizes with their own strengths and weaknesses. It's important that the retirement plan needs of the client are met with the plan provider that is the best fit.
Avoid the producing TPA. I always get in trouble for saying it, but my experience working for a producing TPA requires me to say it. Producing TPAs are firms that also have an advisory business. While people can argue about the value of producing TPAs, you have to realize that since they are in the 401(k) advisory business, they are also your competition. My old TPA had a terrible reputation in the industry for stealing clients from advisors who brought us business, so why refer your clients to the competition?
Develop an IPS. When it comes to participant directed 401(k) plans that intend to meet ERISA 404(c), advisors are more concentrated on picking a mutual fund lineup. The need for a financial advisor in an ERISA 404(c) plan is less about fund picking and more about assisting the plan sponsor in managing the fiduciary process. One of the most important roles in the fiduciary process is the development of an investment policy statement (IPS). The IPS sets the criteria for selecting and changing investments and is a necessary tool to limit a plan sponsor's liability under ERISA 404(c). It has become so important that the Department of Labor has been asking for the IPS when conducting plan audits. While an IPS is a necessary tool, it is not the second coming of the Magna Carta. Many mutual funds companies and plan providers have sample statements that you can tailor and that they would be willing to provide, even I have a sample if you need.
Provide education to participants. In addition to the IPS and fund selection, a necessary component of an advisor's job is to ensure that participants can get the education they need. Participants need to be educated on the investment options in the plan in order for the plan sponsor to get ERISA 404(c) liability protection. If you feel that you can not offer enough education to plan participants, you should delegate that role to companies like RJ20 or Smart 401(k) that not only offer participant education, but also participant advice.
Find the right prospecting/benchmarking tools. Whether it's Brightscope, Fiduciary Benchmarks, Judy Diamond, Larkspur, 401(k) Exchange, Plan Tools, fi360, or some other company, you will need to find the best prospecting and benchmarking tools to prospect new clients and review current clients. What is the best tool out there? The one you feel most comfortable with. Get some demonstrations and see what you like. Check with mutual fund wholesalers and plan custodians who may give you access to these tools for free. As far as research engines, you should try out Matrix Financial Solutions' Retire Tool (k)it. Matrix has really been the one provider that has been an easy fit for both brokers and advisors, as well as a great educator through their Matrix U. events.
Harness The power of social media. The biggest mistake I ever made when I started my own practice was hiring an old time public relations advisor. This advisor stressed the use of old time media like newspapers and magazines to build up my practice. To be honest, no one hired me because I was in the Long Island Business News or DailyFinance.com. My advisor had the chutzpah to tell me to take some time off when things were slow after I started. That advice cost him his job because I picked up a copy of "The New Rules of Marketing and PR: How to Use Social Media, Blogs, News Releases, Online Video, and Viral Marketing to Reach Buyers Directly", by David Meerman Scott. Through writing articles like this, the use of LinkedIn, Twitter, JDSupra, and blogging, I have been able to build my practice at very little cost. My appearances in the pages of The Wall Street Journal and marketwatch.com were actually because of my social media work, not the work of my former p.r. advisor. I know the problems you may have with compliance, but see what you can do.
Building any type of business isn't easy. It will take time. If you are dedicated to your clients and dedicated to the role of a 401(k) retirement plan advisor, you will succeed as long as you show a value to the service you provide. With so many changes to the retirement plan marketplace through regulations like fee disclosure which will have plan sponsors reconsider their current plan providers, it may be the opportunity you need to exploit and build a 401(k) advisory business.
Ary Rosenbaum is an ERISA/ retirement plan attorney for his firm, The Rosenbaum Law Firm P.C. http://www.therosenbaumlawfirm.com/ based in Garden City, N.Y.
May 2, 2011 By Heather Trese Discuss
It's not just your clients who are getting ready for retirement - it's your colleagues, too.
According to Boston-based consulting firm Cerulli Associates, 36 percent of brokers at the end of 2009 were age 55 or older - a percentage that has been increasing over the past few decades. Meanwhile, the total number of financial advisors in the U.S. slipped 1 percent to 334,000 between 2004 and 2009.
If this trend keeps up, demand for retirement advisors could far outweigh supply. If that happens, what does it mean for the future of the retirement industry - and is there any way to prevent it?
An aging population
Allen McLellan, associate dean and assistant professor at the American College, said the dwindling retirement advisor population is definitely a cause for concern - one that will grow more and more evident with each passing year.
"It's not something that kind of explodes on the scene immediately," he said. "It's something that'll play out over the next decade or 15 years. The reality is that many of the advisors are also baby boomers themselves, so they're aging right along with the baby boomer cohorts."
And since the first baby boomers have started to turn 65 this year, retirement advisors are right there with them.
Along with aging advisors, there's also a noticeable lack of younger people entering the retirement advisor work force. Frank Woodruff, CEO of Sapient Financial Group, thinks the problem is two-fold.
"I think for most of the industry, it's a very heavy commission-based compensation," he said. "It takes several years for most people to make a good or above-average income, and it's just a small group of people who are entrepreneurial enough that they're willing to come in and struggle through the first three or four years. Because of that, it's a natural that people who have a bit more resources will come in and do it as a career change."
And generally, people with the proper resources are in the second careers, and have had time to save up.
Another way that Woodruff says people often become retirement advisors is by meeting with retirement advisors themselves, exploring their own retirements, and seeing how important a career as an advisor can be. For most people, that doesn't come until they're in their 30s, though, Woodruff said.
McLellan says something as simple as focusing on mentorship and recruiting in the right places could help grow the younger generation of retirement advisors.
"In recruiting, I think two sources are going to be more important for companies," McLellan said. "Military veterans, because they have really gone through some extensive training, maybe not in finance but in working as a team, and they're often looking for a new career path. And two, recruiting young people who have real life experience in retail or other sales, because they will have acquired skills that are easily transferable.
"So take that young person, you give them the skills, and make that commitment to them and pair them up with an older advisor."
McLellan adds that companies may also want to consider bringing retired advisors back in on a consulting basis to work with new advisors, making the transition easier on clients who may leave along with their retiring financial advisor.
Changing the future of retirement planning
Until the population of retirement advisors is built up, though, those currently in the field should expect their demand to increase drastically over the next several years.
Woodruff said his company is already seeing the effects of increased demand.
"It's easier for us to keep our schedules busy with interviews," he said. "I think we're much more valuable now and I think we're better accepted. Before, people were thinking they could do it themselves, but the DIYers have a pretty poor track record."
McLellan has seen the start of the upswing of demand, but he thinks it's just the beginning.
"I believe we'll see another golden age of financial planning where there will be far, far more prospects available then there are advisors," he said. "Advisors really need to prepare for that by having the knowledge and the training. I think you're already seeing the beginning of the that; the really good financial advisors right now have almost more clients than they can handle."
One thing's for certain, though: if more advisors don't enter the market to take place of the retirees, it will change the way retirement advising is done.
I think the general population is going to have to hunt harder and it's going to be more difficult to find good advice, simply because of the sheer smaller number of people," Woodruff said. "Hopefully, the industry can build new financial distribution systems and resources where people can more easily access their information, basic planning skills, etc., and then find people who can coach them when the crucial decision making time comes."
But McLellan doesn't think the dwindling population of advisors is all bad. In fact, for someone just entering the profession, he thinks there is tremendous opportunity.
"Knowing what I know now, I would love to be a 25- or 30-year-old advisor in the situation that we're now seeing," he said. "I think it just cries for competent and trustworthy advisors who can help their clients navigate the minefield of estate planning retirement preparation, even insurance and long term care."
The biggest crisis that's not talked about is that the inadequate employer contribution to 401(k) accounts, typically equal to 3% of pay, makes it impossible for most Americans to retire. But there are other myths as well: that 401(k) participants need investment advice, that fee disclosure would enable them to "shop" for lower-fee investments, that 401(k) plans benefit the wealthy and that Americans would be better off with regular pensions.
Myth 1: That their biggest flaw is that they shift risk to investors. Truth: it's that they shift the cost. Many other countries offer successful defined contribution plans that work--the difference is that the employer contribution rates are higher. A report issued in 2008 showed that Australians between the ages of 30 and 34 are projected to have assets of more than $540,000 in today's dollars in their version of our 401(k) accounts by the time they are ready to retire; those between 20 and 24 will have nearly $700,000. In contrast, only three percent of Vanguard's participants have accumulated more than $250,000 and the median account balance for those over 65 is a paltry $52,000. What's more, older workers haven't accumulated much in their rollover accounts from other employers; the median balance for those age 60 to 65 is $68,249, according to the Employee Benefit Research Institute. So a typical aging Boomer has only accumulated around $120,000 in total savings, about twice the median salary for that age group when would-be retirees need 10 times their salary. Why are Australians better off? Their employers are required to contribute the equivalent of 9% of pay to employee accounts compared to the voluntary 3% contribution in the U.S.
Myth 2: That 401(k) participants need advice about how to invest. Truth: they need to know how much to save. As long as 401(k) participants are offered a target-date index fund with a prudent asset allocation strategy, investment decisions have wisely been made for them (although it's too bad there isn't a Global 500 index fund, reflecting that the "investment world is flat.") The most important advice that participants need and aren't getting is how much to save in their 401(k) accounts, not where to save it. With the input of pension actuary James E. Turpin of the Turpin Consulting Group, I developed formulas for contribution rates required based on the current typical employer match of 3%. I presented these findings to the Department of Labor's (DOL) 2007 ERISA Advisory Council's Working Group on Financial Literacy and the Role of the Employer. As a result, the Working Group recommended to the DOL that employees be told how much they need to contribute.
What I reported is that assuming a typical employer contribution rate of 3% of pay, even participants who are savvy enough to start contributing at age 25 must save 10% of their salary. Waiting until age 35 to start saving increases the contribution rate to more than 17%, waiting until age 40 increases it to more than 23% of pay and waiting until age 50 requires nearly a five-fold increase from the rate at age 25, to 48% of pay. Needless to say, this over-50 requirement flies in the face of the meager current $5,500 limit on "catch-up contributions" currently allowed by the IRS.
Myth 3: That fee disclosure will enable participants to choose funds that are more cost-effective. Truth: It's likely the employer's size, not the investment manager, that is driving the fees. Small businesses often have to "outsource" the cost of compliance with ERISA, such as filing Form 5500s, instead of having them less expensively done in-house, as might be the case with a Fortune 500 company. Why don't small employers address this issue by banding together to "bulk purchase" these services in order to lower fees for their employees? Because they'd all be liable if any of the members of the group violated ERISA.
Myth 4: That affluent 401(k) participants are doing just fine when it comes to retirement adequacy. Truth: Contribution limits prevent them from contributing enough. The Bipartisan Policy Center has proposed tackling the federal deficit by halving the amount that employers and employees can contribute to 401(k) accounts (since contributions are tax deductible). The total combined contribution would be limited to 20% of an employee's annual earnings or $20,000, whichever is smaller. In doing so, "qualified plans no longer will be a vehicle for wealthy individuals to convert a substantial share of their assets into tax-free retirement assets."
Except that they aren't. My household is in the top bracket, thanks to my husband's salary, which is in the low seven figures. While he has been participating in his employer's plan for nearly 25 years, always contributes the maximum and his employer contributes the equivalent of 9% of pay, his current account balance is less than one third of his current salary. Why? Because of the contribution ceilings, catch-up contribution ceilings for those over 50, annual compensation limits of $245,000, as well as "non-discrimination" testing. While other companies may have created "non-qualified plans" to help their highly compensated employees retire, his has not and it's not clear whether the majority of employers do. What's more, even the wealthiest companies in the U.S. are cutting back on pension coverage. While at the end of 1998, 90 of the Fortune 100 companies offered some sort of pension benefit, according to Towers Watson, today only 17 of them offer them to new hires.
Myth 5: That people would be better off if we had mandatory defined benefit plans. Truth: If that were the case, the vast majority of employees would likely not be "vested," that is, have ownership of the employer contributions, because of job changes. A 2010 Bureau of Labor Statistics study showed that Baby Boomers born between 1957 and 1964 held an average of 11 jobs from age 18 to age 44 alone. While defined benefit plans, or pensions, are more generous than 401(k) plans, they tend to have stricter rules about when employees "own" employer contributions. In a defined benefit plan, using the "cliff vesting" approach, a company can require that employees work five years before they are vested or with "graduated" vesting could require that an employee stay for seven years. On the other hand, with a 401(k) plan, a company must allow 100% vesting after 3 years with the cliff approach or 100% after six years if there is graduated vesting.