Sunday, July 31, 2005

Crying "Uncle"

Of late, the retirement-plan industry has been working overtime crafting product solutions that ostensibly help participants save, or save better, for retirement. But for my money, you don’t need to look any further than the statistics on distribution practices to realize just how ill-informed participants still are about basic financial principles.

I’ve had plenty of experts tell me that participants aren’t interested in making investment decisions, and one can certainly understand that there are situations where participants legitimately can’t afford to set aside money now for 30 years in the future when they’re struggling to put food on the table this week. But when industry data continues to show what participants do with those balances at termination – well, to me, that is the real sign of trouble. The most recent example was a study from Hewitt Associates that found that 45% of some 200,000 terminating participants took a cash distribution when they left their employer (about a third left it with their current plan, and about a quarter rolled it over).

Now, think about that for a second. By choosing to take that money now, they not only did serious damage to their retirement savings progress, they did so while handing over a sizeable chunk of change to Uncle Sam. That’s 20% on the front end, which you would expect would get some people’s attention – but that’s only a down payment for most. I’d say there’s a pretty good chance that most of these will wind up in the 28% bracket come tax time, not to mention the 10% penalty on pre-tax contributions and earnings (for those under age 59.5), not to mention state taxes. Let’s face it, by the time April 15 rolls around, I would suspect that many of those who took cash distributions are having to scramble to meet their obligation to Uncle Sam.

The real problem, IMHO, is that the distribution process is just about as complicated as the enrollment process at many plans. If you want to roll it to another plan, you have to find out all kinds of details about that receiving plan – account number, mailing address, etc. Granted, it’s not rocket science, but just think about the implications of getting some of that information wrong. If you want to roll into an IRA, the process is just as complicated. Leaving it in the old plan isn’t a universally available option – besides, particularly if the termination is involuntary, who wants to leave the money with “them?”

Oh, and don’t talk to me about “paperless.” Many of the so-called “paperless” rollovers touted by many aren’t really paperless at all – they still require that forms be completed and mailed where at some point in the future funds will be sold, and a physical check be cut and mailed, and reinvested days later. Why should that money be out of the market for a week or 10 days? Worse, even if one of the providers does offer a more-or-less paperless option, odds are the other side of the transaction won’t.

From time to time, lawmakers talk about solutions to this problem – solutions that, for the most part, have to do with making it more difficult for participants to access that money before retirement. To my way of thinking, that may solve that problem – but probably dampens participation rates going forward.

If we are serious about lowering cash-out rates, we’re going to need to make the process of rolling over easier – and we’re going to have to do a better job of talking about the here-and-now tax bite, as well as the long-term impact on retirement security.

- Nevin Adams

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