Sunday, August 27, 2006

Goal Oriented

I only discussed retirement investments with my dad once, and the conversation didn’t take place until he had already decided to retire. He had a pretty good idea about what he wanted to do – he just couldn’t figure out how to accomplish that via the all-too-typically complicated distribution request form. Consequently, at my mother’s instigation, he called in an “interpreter” – in this case, the son with the law degree.

It was a complicated discussion. Since hundreds of miles separated us, he had to read the form to me (I suggested faxing, but that was “more trouble than it was worth”; I chose to assume that was a reference to his difficulty with operating the fax machine on his end, and not the quality of advice he was hoping to get from mine). Fortunately, there is something of a boilerplate design to most of these forms and, in reasonably short order, I was able to wrest an English version of his options from the document.

Having outlined the options for him, I asked him if he knew what he wanted to do. Much to my consternation, he wanted to go with an annuity. Now, the market was still on its way up, and while, even then, we all “knew” a pop was coming, it was hard for his financially astute son to accept that he would want to trade the upside potential of having the money in his own hands/account and the ability to draw down that sum at a pace commiserate with his needs for relinquishing that to the notoriously expensive and somewhat inflexible option of an annuity. But what my dad wanted – more than anything else - was the certainty of a regular income stream. If I couldn’t guarantee him that result with the other options, he wasn’t interested.

Goal “Tending”

Ultimately, regardless of how (or when) we get there, the goal of saving for retirement is to have an income in retirement - a regular, secure paycheck that continues even after we are no longer gainfully employed. On the other hand, today’s approach to retirement savings is largely predicated on accumulating enough money to be able to, after retirement, have enough to live on. The problem, of course, is that if you get to retirement with the “wrong” amount of savings, it is darned near impossible to right the wrong.

Still, if what you ultimately want to wind up with is regular retirement income - an annuity, essentially - why wait 40 years to do so? Why “gamble” on the potential upside of making investment choices in a retirement plan – particularly when you don’t know how much it will cost or how much money you will have at retirement to purchase that annuity?

There are reasons, of course. Participants frequently don’t have any appreciation for what their income wants – or needs – will be in retirement. Indeed, that is what makes retirement savings so problematic for many; they lack a specific goal and, thus, tend to save what they think they can afford, rather than what they may need. But if participants really are weary of having to make, and revisit, all those investment and savings decisions, then perhaps we also need to rethink our traditional approach to helping them achieve their goal. Perhaps their retirement savings investments should be directed, not to the selection of mutual funds from a retirement plan menu, but to a more direct investment in a retirement income stream.

Work to Do

Not that we don’t have work to do. Most of the offerings out there at present are even more complicated than the retirement plan decisions participants already struggle with. Participants still will need help setting goals, evaluating choices and, no doubt, managing an accumulation of these investments over time. Imbedded under the auspices of employer-sponsored retirement offerings, plan sponsors also will doubtless be presented with significant challenges, both administrative and fiduciary, as we work toward a new goal-based solution.

Still, there are already a few firms that have applied this notion to retirement plan savings – that allow participants to invest in an annuity as an option in their 401(k) plan. If our goal truly is to help the participant achieve retirement income security, perhaps it is time we actually figured out the best way to help them make that investment sooner, rather than later.

- Nevin Adams

Saturday, August 19, 2006

Happy Returns

One of the “promises” of the newly enacted Pension Protection Act of 2006 (PPA) is that it will foster, if not encourage, greater levels of retirement plan participation. And while there are several areas that ostensibly facilitate this growth – notably the removal of EGTRRA’s sunset provisions and the expansion of investment advice – the thing that is really supposed to make a difference is automatic enrollment.

So, how does the PPA encourage automatic enrollment? First, it resolves the current dilemma faced by plan sponsors in states that prohibit (or appear to) deductions from a worker’s pay without their explicit permission. While this has been a relatively recent concern, the certainty that federal, not state, law governs these transactions is a welcome relief, and one that is provided immediately. Will it persuade employers who were not already actively considering automatic enrollment? Probably not.

The PPA also lays the groundwork for some much-anticipated clarity from the Department of Labor on the issue of an appropriate default investment election. Still, there seems little doubt that, when we do see the final rules, the DoL will officially embrace the use of some form of asset allocation vehicle. Of course, we were expecting this even if the PPA didn’t pass. Consequently, it will help tidy things up, but isn’t likely to transform current trends. This will be effective for plan years beginning in 2007.

Ironically, the biggest change – and it won’t take effect until 2008 – is the creation of something called a “qualified automatic contribution arrangement.” Implementing this special version of automatic enrollment exempts a plan from both top-heavy and average deferral percentage (ADP) testing (ACP - average compensation percentage – testing as well, if applicable). To qualify, a plan has to implement the program for all eligible workers prospectively; automatically defer in accordance with a schedule stated in the law (see Pension Reform Influences Automatic Enrollment Designs); match those contributions (the law specifies a schedule); 100% vest those matching contributions within two years; give participants notice of the program, the default options, and their right to opt out in a timeframe that gives them an opportunity to do something different – oh, and it must provide for that initial contribution to be increased annually in accordance with another provision in the law.

In my initial reading of the law, this was the provision that I found most questionable. Not in its ultimate result, or goal – but it struck me as making things just complicated enough mathematically to slow, not speed, the adoption of automatic enrollment. Why? Not the match requirement itself, or the vesting applied to that match – both are comparable in effect to the current safe harbor provisions (there are differences, however). No, what may make a difference to many plan sponsors, IMHO, is the requirement to increase those employee deferrals – and, at least potentially, the employer match associated with those deferrals.

The impact of the latter is obvious – and cost concerns alone may well keep plan sponsors from taking advantage of the option. The former – the decision not only to take money from workers’ paychecks without their involvement, but to increase that initial deferral – could be just as problematic. While I have found that plan sponsors generally are in favor of the concepts behind automatic enrollment, they are less inclined – at present, anyway – to combine that decision with taking even more from those paychecks without “permission.”

On the other hand, workers retain the ability to opt out at any time. They don’t appear to do so very frequently – but that option remains for anyone who truly can’t afford it (or thinks they can’t). But one of the larger concerns for plan sponsors with automatic enrollment is the accumulation of small balances – those deferrals that workers don’t notice until three paychecks later, at which point they stop the deferrals, but then discover that “I wasn’t paying attention to the automatic enrollment notices” doesn’t qualify as a reason for hardship withdrawal.
That’s why, IMHO, one of the real gems in the PPA is the ability, within 90 days of that first contribution, to return those contributions to the worker. In my experience, the inability to do so under current law has been perhaps the largest impediment to these programs – and its inclusion in the new law may make all the difference in the world.

- Nevin Adams

You can read more about the details of the automatic enrollment changes HERE. More about the likely impact from the perspective of employers and providers HERE. More about the Pension Protection Act of 2006 HERE.

Saturday, August 12, 2006

Market's Timing?

About a week ago, a friend of mine asked me how my retirement plan investments were doing. Now, we’ve had conversations about asset allocation from time to time over the years – we’ve even compared “answers” on our individual 401(k) plan choices – so it wasn’t as though the question was out of left field. The truth was, I hadn’t checked on them since early July – but I answered, “OK, I suppose – why?”

As I waited for his response, two obvious answers to my question popped into my head. Either his account returns were sizzling, and he wanted to rub that in, or his account returns were not-so-impressive, and he was looking for some reassurance on the choices he had made in his account (that he was merely interested in the status of my retirement savings account didn’t really seem plausible under the circumstances). Then, I remembered – the last investment choice he made was to invest in a lifestyle fund – and, sure enough, he wasn’t thrilled with his return.

There have been several studies published in recent months about the relative performance of lifestyle/lifecycle funds and, frankly, from what I can call from memory, they all suggested that those funds have outperformed what typical participants choose on their own (setting aside for the moment the “inconvenient” fact that those results are generally put forth by the very same firms that are touting their asset allocation fund wares). In view of how most participants invest, that is perhaps not as high a standard as we should impose. Still, the notion of a fund choice that offers participants a potentially better return for less involvement on a consistent basis is a winning proposition for most.

Of course, “average” covers a broad swathe – and often obscures as much clarity as it yields. Still, as lifestyle funds proliferate on retirement plan menus, and as things like the new automatic enrollment provisions (see Pension Reform Influences Automatic Enrollment Designs) further accelerate their adoption as default investment choices, I wonder if it will affect how participants view – and review – their retirement accounts.

The cynical answer, of course, is that they don’t pay attention now, and they – certainly the defaultees - probably won’t pay any more attention in the future. However, my sense is that participants do pay attention to their retirement plan statements, if only to make sure that their payroll withholdings were actually deposited. Moreover, while it’s become very trendy to talk about how uninvolved participants are, I can recall a time – and not so very long ago - when we fretted with good reason about how often people were checking out their account balances.

My guess is that, as participants begin to believe that there is good news in those retirement plan statements, they will, once again, pay more attention to the contents. What remains to be seen is if they will continue to value the balanced discipline of lifestyle funds during the cycles of the market that may well yield a higher return to a less balanced approach.

- Nevin Adams editors@plansponsor.com

Saturday, August 05, 2006

'Global' Positioning?

During our recent family vacation, I decided to add the GPS (global positioning satellite) option to our rental vehicle. While I have never had one in my personal car, we were going to be traveling in some VERY unfamiliar territory, and at hours of the day when I didn’t want to be trying to read maps, much less trying to guess how far to the next gasoline station in the middle of nowhere.

Over the long haul, it was a godsend. We got clear, quick, and for the very most part, accurate, directions to just about every location on our itinerary. Just about. Basically, the longer it had to react to the destination, the better it did. In close quarters – urban settings where the streets come up on you faster, and the opportunities to turn somewhat limited by traffic restrictions – well, let’s just say that my wife understands how I drive, and how I need to be directed - better than the satellites circling the earth, communicating with my car.

The analogy isn’t perfect, but when it comes to advice, some folks prefer to do it themselves – and they don’t mind unfolding a road atlas, mapping out a course, and keeping to it. Some prefer automated solutions – it was easier for the most part, and frankly more fun, keying in locations to obtain directions than it was to study a map and try to pick the best route. And some, of course, prefer to get their direction from a trusted source – someone who knows who the recipient of that counsel is, and expects…someone who can respond to “real-time” developments with concern, as well as expertise.

I think too often our industry attempts to compartmentalize investment advice delivery. We say that X% want to do it themselves, some other percentage wants to be able to get a quick automated sense of what to do, and some other percentage simply wants someone else to do it for them. But I think most people, actually want – and need – to tap into different kinds of investment advice at different points in time. They are happy to rely on an automated solution to fine-tune direction, or perhaps even to set it – they may well want to try to figure it out on their own, once they have developed a certain level of comfort with their ability to do so – and, when things get “hairy,” they’d much prefer the reassurance that most often comes from the voice of a real human being who knows their name.

Advice, in other words, shouldn’t be targeted at people as though they were simply a certain type of investor, IMHO. Rather, choosing the “right” medium for investment advice is, and should be, a decision based on an individual investor’s particular needs at a particular point in time.

- Nevin Adams editors@plansponsor.com