Monday, May 31, 2010

Compliance “Deportment”

Recently, the Internal Revenue Service (IRS) announced that it was sending a questionnaire out to about a thousand 401(k) plan sponsors. The IRS said it developed the questionnaire because of the “critical role 401(k) plans play in our private retirement system” (see “IRS Provides 401(k) Questionnaire Details”).

Make no mistake: It’s going to take some effort to respond to the questionnaire—and respond you must. Described as a “compliance check,” the IRS notes that “failure to complete the Questionnaire will result in further enforcement action.” So, what does the IRS want to know?

Well, there’s a lot of information to be gathered about the plan from plan years going back to 2006: the number of employees, participants, their deferral levels, eligibility standards, service and age requirements, the existence and administration of loans and hardship withdrawals, the results of nondiscrimination tests, the determination of top-heavy status, the level(s) of match, and any changes to those levels.

The more interesting part of the questionnaire, IMHO, is the other questions the IRS asks; things like, Have recent financial conditions led to an uptick in hardships and loans? Does the plan allow for Roth contributions (and how many participants have opted for that feature)? Can participants use a debit card to take a loan? And, for plans that embraced automatic enrollment, did they do so retroactively or prospectively? And I’m curious not only about what plan sponsors have to say about the impact of factors like age, compensation, matching levels, and plan communications on participation levels—but what the IRS might do with that information.

There are, however, some areas that seem a bit like a baited trap: questions about if notices are provided timely, if excess deferral contributions were returned within the legal timeframes, even if the respondent as a SIMPLE plan exceeded the contribution limits.

And, make no mistake, this is a prelude to something deeper. In unveiling the project, the IRS noted that its Employee Plans Examinations previously conducted a baseline study of 79 market segments, and “the findings indicated that 401(k) plans are by far the most non-compliant plan type in the retirement plan universe,” going on to note that “since these plans make up over 60% of the retirement plan universe, it is important to the future of the private retirement system that these plans maintain the highest level of compliance possible.”

What will the IRS do with the information? It says that it will “ultimately result in a report published by the IRS describing the responses and identifying those areas where additional education, guidance, and outreach is needed”—and, perhaps somewhat more ominously, help the IRS focus its enforcement efforts “to address and/or avoid non-compliance related to these plans.”

All in all, I wish the IRS questionnaire wasn’t quite so long, complicated, and—for lack of a better word—intimidating. For plan sponsors, I’m sure it’s going to wind up being one more thing that has to be done when they already don’t have enough hours in the day—and one that could serve to plant a big red flag on their plan, to boot.

Here’s hoping that some good comes out of it—that the IRS does indeed discover some areas in which they can help plan sponsors do a better job of keeping these important programs in compliance—and that, perhaps, it will find that the programs are in better shape than they seem to think they are.

—Nevin E. Adams, JD

More information is at http://www.irs.gov/retirement/article/0,,id=223440,00.html

A version of the online questionnaire is online HERE

Sunday, May 23, 2010

Decision Decisions

As a parent, you spend a lot of time telling your kids what to do, and perhaps more time than you think you should convincing them that it was their idea. If you’re lucky, you get to watch them make the “right” choices on their own—and to see them turn out well in the end. What you really try to avoid doing, certainly as they enter adulthood, is to make those decisions for them.

With defined contribution plans, over the last three decades or so, mostly we told workers what to do (or at least what people very much like them should do). And, despite a lot of hand-wringing to the contrary, most did. There were, of course, “holdouts”—a stubborn and/or inattentive group that resisted those entreaties, at least up until the point at which we did the right thing “for” them by automatically enrolling them in these programs. One might have thought that their resistance was thoughtful, perhaps principled, and maybe economic—and yet, survey after survey shows that those who were defaulted in stayed there. Were they lazy, afraid to make the wrong decision, unable to make any decision, or merely inattentive? Perhaps all of the above. Regardless, the debate about whether we should “impose” on them our sense of the right thing to do—to make that decision for the “recalcitrant” minority—would seem to be over.

The New Frontier

The new frontier in participant decision-making appears to be retirement income or, more precisely, helping individuals make arrangements for a suitable stream of income post-retirement. There is a general—and perhaps increasingly pervasive—sense that the solution to this challenge is already at hand (or could be with a tweak here and there): the annuity.

That assumption was in evidence last week at a presentation by a panel of behavioral finance academics at an event sponsored by Allianz (1). As part of its response to the Labor Department’s RFI on retirement income, Allianz had worked with the inimitable Schlomo Benartzi to assimilate a wide range of behavioral finance techniques to better understand participants’ reluctance to embrace annuities (at least in large numbers), and to help remedy “the annuity puzzle” (yes, it even has a name, apparently). Certainly from an academic perspective, there is no valid reason why an individual seeking a dependable stream of income in retirement wouldn’t take advantage of a product that purports to do just that. And yet, in the “real” world, individuals continue to defy those expectations.

All of which, to my ears, began to beg the question, Should we be helping participants to do the “right” thing about retirement income, as we did about retirement plan enrollment? Should we be making that decision for them as well?

It is an idea that is already “out there,” and one that seems of interest to the Obama Administration. Certainly there is a concern that many take their multiple defined contribution distributions between “now” and whenever retirement finally occurs in cash and deploy them for purposes other than retirement. This “leakage” from the system almost certainly depletes the accumulative effect of retirement savings for many younger and lower-income workers, leaving them to literally start over at their next place of employment (there is some evidence that larger balances accumulated by older workers are more routinely rolled over into tax-advantaged vehicles such as an IRA).

Which again leads one to ask, what WOULD be the harm in letting a default mechanism make the “right” decision for them, certainly so long as they could opt out? Hasn’t our experience with automatic enrollment shown not only that people are willing to let good decisions be made for them, but that they appreciate it as well?

We once resisted automatic enrollment as a design choice for reasons that seemed just as daunting: We didn’t know the “right” deferral percentage, weren’t sure how it should be invested, worried that it would lose value between the time it was withheld and (potentially) returned, and were bothered by the potential conflicts between state wage law and federal directives. The Pension Protection Act effectively resolved those issues, provided a structure for a valuable safe harbor protection, and yet managed to avoid mandating its approach. As a result, it’s more likely than ever that more savers will have more savings to manage at retirement, perhaps for longer in retirement, than would otherwise be the case.

Now, for most situations at present, the retirement income amounts involved may well be too small, the products available too expensive and/or complicated, the protections for employers and participants alike too vague, the portability and/or access to the funds frustratingly problematic. And, let’s face it: Current annuity designs (2) don’t really come in a convenient “trial size.”

Still, IMHO, we need to focus on creating workable, sound default decisions—because the alternative for many until we do will be making decisions by default.


—Nevin E. Adams, JD

(1)All in all, it was a fascinating presentation, and the report summary that accompanied it is well worth a read (see “Annuities Get a Behavioral Finance Makeover” ). Those reports included notions that workers, and especially older workers, pay too much attention to recent stock market movements, suffer from a “hyper” aversion to risk, and, after their mid-50s supposedly have a particularly tough time making complex financial decisions. All of which purported to explain not only why workers don’t make good investing decisions at retirement, but perhaps even to suggest that they wouldn’t want to (ironically, one study indicated that, given the opportunity to make an active decision to purchase an annuity, a surprisingly robust 49% did).

(2)For the record, I’ve no particular affinity for the annuity concept per se vis-à-vis an alternative that provides the reliable stream of income at retirement for a reasonable price, and no reason to think that an adviser-led participant solution couldn’t compete very effectively with an annuity, much as an adviser-led investment program can do as well (and perhaps better) as a qualified default investment alternative. Of course, every participant doesn’t have access to an adviser, and many don’t have accounts large enough to warrant those attentions—and we need solutions for those participants as well.

Sunday, May 16, 2010

Live Long and Prosper?

I’ve been a huge “Star Trek” fan all the way back to when I had to watch the original episodes on a tiny black-and-white, 13-inch television set with rabbit ear antennas (and, yes, adorned with aluminium foil). Unlike most of my friends at the time, my favorite character was Mr. Spock, whose understated strength, brilliant mind, and quiet commitment to logic had an appeal to a young kid who fancied himself to have all those attributes (thankfully, my ears weren’t pointed).

Perhaps as a result, early on, I mastered the “infamous” Vulcan salute that many people struggle to perform unassisted (it consists of raising your hand and spreading your fingers apart between the middle and ring finger), and the Vulcan greeting/blessing that accompanied the gesture—“Live long and prosper”—always struck me as being as elegant as it was simple.

While we all hope to prosper and live long, a recent Issue Brief released by the Center for Retirement Research at Boston College reminds us of the financial challenges that are often attendant with living long, but that tend to be glossed over in retirement planning. That particular study claimed that those who are in good health heading into retirement had better brace themselves for higher, not lower, health-care costs in retirement—since the researchers determined that the expected present value of lifetime health-care costs for a couple turning 65 in 2009 in which one or both spouses suffer from a chronic disease (defined in that research as diabetes, cancer, lung disease, heart disease, or stroke) is $220,000, while the comparable tally for a healthy couple was projected to be—$260,000 (see “Being Healthy Could Cost You More in Retirement”). Now, as usual in such matters, there is a certain amount of interpolation and extrapolation at work. Still, without wandering into the statistical “weeds,” a primary reason for that somewhat counterintuitive finding is that people in good health can expect to live significantly longer than their less-healthy counterparts—and thus, according to the report, are at risk of incurring health-care costs over more years(1).

Now, the point of the report wasn’t to encourage an unhealthy lifestyle; rather, it seemed designed simply to underscore the need to set aside money (2)—and a significant amount of money at that—for health-care expenses in retirement, regardless of how healthy you are (or expect to be).

Healthy or not, all other things being equal, the longer we live, the longer we must rely on our retirement savings. Not surprisingly, confronted with the potential of outliving one’s retirement savings, participants frequently fall back on an assumption that they will simply work longer. Now, that’s a good solution, at least in theory; saving, rather than spending, for additional years can do wonders to shore up one’s financial security—as long as you can count on being able to actually remain employed, that is. Unfortunately, even those physically able and willing to do so don’t always have that option.

That’s a reality that participants don’t always appreciate—and, IMHO, one that is all too often shrugged off in the retirement planning process.

The better option, if one hopes to both live long AND prosper, is to prepare as though you won’t have the time or the luxury to do so; to take action here and now, rather than banking on the opportunity to “make good” later on.

Anything else would be—illogical.

—Nevin E. Adams, JD

1 The report also acknowledges that, over those longer lives, those relatively healthy individuals may, nonetheless, eventually contract one of those chronic diseases.
2 More precisely funding. The report notes that “Households that delay purchasing insurance until their health declines run the risk of facing higher premiums, or for long-term care insurance, being denied coverage altogether.”

Saturday, May 08, 2010

Grecian 'Formula'

While the markets were in an apparent freefall last week, I could hear former Treasury Secretary Hank Paulsen on the TV in the next room telling (lecturing?) the Financial Crisis Inquiry Commission that the problems that led to the 2008 meltdown could, and should, have been dealt with sooner, and that we could, and should, have moved faster—and with more to stave off the crisis. The criticism then—as it was last week in Europe—was that this was a time to act, not to think; that if we didn’t act—act now, act decisively, and without question—well, the results would be catastrophic.

It is a theme that runs through Paulsen’s recent book, “On the Brink,” as he drags the reader from one impending crisis to another during those fateful weeks of 2008. In Paulsen’s retelling, those who back his “need for speed” are thoughtful and prescient; those who don’t, well, their motivations are generally painted as either blinded to the seriousness of the situation or hopelessly ideological. From the former Goldman Sachs CEO’s perspective, we weren’t bailing out Wall Street, we were saving the very financial system itself (though he was willing to let the politicians claim that they were saving jobs). And perhaps we were, so we set aside our doubts and concerns, gave the experts what they said they needed—and plenty of it—and hoped they knew what they were doing.

Now, in fairness, the financial system did stabilize and the markets did—eventually—return to some semblance of normality. Until ….

Now I, perhaps like many of you, am not yet quite sure what to make of the crisis bubbling in Greece, much less the response of the EU and the International Monetary Fund (IMF), and what that might mean to us. But the chorus—we must act, act now, act decisively, and without question, or else—well, it’s a little too familiar to those of us who thought we had already been there, done that. But, once again, we’re told that if we don’t, things will get worse, much worse—and we’re (again) afraid that’s not an exaggeration.

Déjà View

But make no mistake: There are some clear and disturbing parallels between this “rescue” and the ones that have gone before. Once again you have a sudden infusion of apparent wealth on paper that fueled a borrowing binge that fueled a spending spree that fueled more borrowing, until things reached a point where the system was no longer willing to loan money (despite lucrative fees)—at which point, the whole thing should fall apart. But at that point the outstanding debt is so large that that same system that empowered that situation now claims that failure is not an option. It’s not just that bank, or that automobile company, or that country…it’s all the other things that depend on them….

We’ve seen this before—and more than once—from investment banking to the foreclosed house down the street.

Now, if this was your compulsive gambler of a brother-in-law on the wrong side of another “can’t miss” bet that put him (and perhaps your sister) in trouble with his bookie’s “collection agency,” you’d doubtless bail him out, and insist that he check into rehab (at least the first time). Indeed, that’s what the Greek “austerity plan” is all about: raising the retirement age to 63 (from 61), freezing pay and cancelling year-end bonuses for public-sector workers (no simple thing that, when something north of a third of the population works for the government), hiking the nation’s VAT to 23% from 21%, and cutting retirement pensions by 14% (by some accounts, those pensions currently provide an 80% replacement ratio, adjusted for wage inflation).

This, of course, is also what set off those riots in Greece last week—and the concerns about what that portends for the implementation of this new bailout, and its ability to stem the tide, took a bit of “austerity” out of all of our retirement security last week.

Once again politicians have been led (many willingly and happily) down the primrose path by so-called financial experts—told that there was, after all, a free lunch; lured into a sense of complacency and then, abruptly, told something else. It is a formula that has, again, taken us to what is being painted as a pivotal point, a crisis beyond which a chasm lies. We worry—that they are right, that it won’t be the last, that we’re not doing enough, or that we’re doing too much - again.

And then, somewhere in the dim reaches of consciousness perhaps, we realize that the folks telling us what we absolutely have to do now—without thinking, without questioning, without hesitation—look suspiciously like the folks who got us into this mess in the first place.

—Nevin E. Adams, JD

Saturday, May 01, 2010

IMHO: Why Bother?

Here’s a question to ask yourself: “Why do you offer a 401(k) plan?”

I’m guessing that many, perhaps most of you, would say simply, perhaps without giving it much thought, “to attract and retain good employees.” That’s what more than half of the plan sponsors canvassed in a recent Wells Fargo survey said (see “Survey Suggests Gaps in Plan Sponsor Goals, Roles”), and it’s one of the top reasons cited by none other than the Department of Labor ). I’m guessing a similarly high number of you might say you “have” to offer the plan as part of your benefit offerings to be competitive.

In fact, I was surprised that 45% of the respondents to that Wells Fargo survey indicated that a primary goal of the program was to provider workers with the means to arrange for a financially sound retirement. Not that that isn’t in the back of plan sponsor minds; I just don’t think it looms large as a rationale for the time, energy, and expense of establishing and keeping these programs in place.

Still, I think for many employers, these programs remain a “take-it-or-leave-it” proposition. Oh, they want employees to take advantage of them—and participation rate remains a key metric for many programs. But I suspect that most employers think that, if they offer a program that allows workers to save efficiently and effectively (and at a reasonable price), well, I suspect they feel that they have lived up to their end of the bargain.

Of course, we all know that the employer plays a key role in the true success of these programs, and that an active and engaged plan sponsor is worth their weight in gold (literally) in terms of getting workers to participate, and to participate at levels that eventually can help ensure their financial independence.

We all know who they (you?) are. Generally speaking, those are the ones who go above and beyond the mere requirements of the law regarding plan information and communication. They are the ones who not only inspire confidence in their plan, but in the ability of their co-workers to take an active role in helping ensure their own financial well-being.

They are the ones who adopted automatic enrollment before it was “cool” (or sanctioned via the Pension Protection Act); who probably know exactly how much their plan costs; and, yes, who probably, early on, saw the advantages in bringing the help of a financial adviser to their program. And, yes, if that’s you, odds are you are responsible for a plan that not only has higher participation and deferral rates, but a more motivated group of participant savers, to boot.

Now, I’m sure many who don’t take those steps are nonetheless attentive to the requirements and obligations of their duty as a plan fiduciary—they simply lack the time, energy, or volition to make that kind of commitment. Some, I’m sure, worry that going beyond the law’s requirements places their firm—and them personally—at risk.

But, in my experience, employers who adopt no more than a “take-it-or-leave-it” approach often find that that is exactly how their workers feel about their retirement plan.

—Nevin E. Adams, JD