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

Sunday, July 24, 2005

Starting “Blocks”

It’s hard not to be impressed by the newfound enthusiasm for automatic enrollment features. After all, one of the greatest challenges to a reliance on participant-directed savings is - a lack of participant savings. Most surveys (including our own Defined Contribution Survey) indicate that only about 75% of those eligible to participate choose to do so at any level, but some of those – perhaps most of them – are not signing up because they either forget to or because they are simply stymied by the forms, the process, or the daunting list of investment choices. Automatic enrollment purports to help overcome those obstacles.

And so it seems to, based on any number of studies. The most recent was by the Employee Benefit Research Institute (EBRI) and the Investment Company Institute. That report notes that, without automatic enrollment, 401(k) participation depends “strongly on age and income,” ranging from a low of 37% among young, lowest-income workers who are eligible to a high of 90% among the older, highest-income eligible workers. The study also found that the default rate of deferral, and the default investment fund(s), had a significant impact as well. The bottom line: Those who were disinclined to save on their own ended up being better prepared for retirement if the decision to save were made “for” them by automatic enrollment.

The fact is, we’ve made these programs too complicated for the average 401(k) participant. It’s ironic, having spent the past 30 years expanding the menu and beating them over the head with the intricacies of modern portfolio theory, only now to tout the “wisdom” of doing it for them.

However, automatic enrollment and lifestyle funds are not a panacea for all that ails our retirement savings system. Indeed, there appear to be some unintended consequences associated even with those programs. The EBRI/ICI study noted, for instance, that “the impact of automatic enrollment on higher-income groups is less dramatic and, in some cases, is reversed because workers in this group tend to have higher 401(k) participation rates.” In other words, since default contribution rates tend to be lower than higher-income workers choose on their own, automatic enrollment might actually put them at a disadvantage. Moreover, those same workers tend to invest in more aggressive investments than is typically the case through automatic enrollment – and thus, those same programs can tend to work against that group of workers.

The real challenge with automatic programs is also what makes them “work.” The original premise behind these programs was to get participants into the plan, at which point they would become engaged in the process once they had “skin in the game.” Except it doesn’t seem to work that way. Rather, those very same workers who couldn’t/wouldn’t fill out the form don’t seem to ever make any changes with their accounts. In that regard, of course, they are very much like the majority of plan participants (even the ones who did make the conscious effort to join the plan), but with a decided difference. They are saving at the default deferral rate, generally 2% or 3%, rather than the rate that typically draws most “active” participants, the rate at which their contributions are fully matched, which is often twice the default deferral rate.

More troubling still – there is at least one published study that indicates that, over time, the establishment of a default deferral rate seems to lower the overall rate of deferrals in the plan. Mostly, this seems to be a result of an increase in the number of workers who simply leave their choices in the hands of the default option. But it is hardly beyond the realm of reason to imagine a scenario where workers take the establishment of a default rate as being the “right” answer for them as well.

All in all, we need to remember that the results of automatic deferrals, however encouraging at the outset, should not be left unattended. An “automatic” deferral is a start, perhaps even a good start. It should not, however, be the end of the matter.

- Nevin Adams

Sunday, July 17, 2005

Redeeming Notions

Anyone who has driven our nation’s highways lately knows two things – gas prices are soaring, and there is a great disparity between what is being charged at different stations. In fact, knowing which stations offer the “best” (not that any of them are “good” these days) prices is the new home-field advantage, based on my recent vacation, where prices ranged as much as 23 cents/gallon in the space of less than five miles.

A similar scenario is beginning to emerge in the retirement plan market, this one triggered by the response of mutual fund firms to the mandates of the Securities and Exchange Commission – triggered by the mutual fund trading scandal. More accurately, the SEC has mandated that fund complexes either adopt a redemption fee (but not more than 2%) applied to sales of fund shares held less than seven calendar days, or determine that such a fee is “not necessary or appropriate” for the fund. In March, they also mandated that fund companies are to enter into written agreements with certain intermediaries (such as those recordkeepers/TPAs who maintain retirement plan participant records) to ensure that those redemption fee determinations are implemented; you may recall that at least one such retirement plan intermediary, Security Trust, was implicated in the first round of Spitzer charges (see STC Ex-Execs Hit With Criminal Charges; Regulators Force Dissolution at

The good news – sort of – is that the SEC backed off its initial mandate of a mandatory 2% redemption fee in every apparent short-term trading situation. The bad news – certainly for retirement plan recordkeepers – is that the current open-ended SEC directive seems to be creating a patchwork quilt of requirements from the fund complexes.

Plan sponsors have been slow to respond to the coming chaos, and recordkeepers, at least those who are not appended to a fund complex, seem to have been willing to adopt a wait-and-see approach (plan participants seem not to have a clue). Many, no doubt, have trusted that the industry would craft some sort of monitoring/accounting solution that would allow them to address the redemption fee issue. Unfortunately, the fund industry, left to its own devices, apparently isn’t waiting. Directives are already being issued from those complexes and, at least according to a recent report from McHenry Consulting, TPAs are beginning to take note (see Recordkeepers React to Expenses Associated With SEC Redemption Fee Rules at Some (notably Fidelity) have taken a particularly hard-line approach on the redemption fee issue, while even the more accommodating have issued requirements that are widely varied in the definition of amount and event(s). All in all, a potential nightmare for recordkeepers, plan sponsors, participants, and financial advisors alike.

There are alternatives, of course. The fund complexes could always determine that short-term trading isn’t a problem for fund shareholders, and thus not impose redemption fees at all. For the vast majority of funds traded in retirement plans, I think that is a plausible conclusion (the largest windfalls appear to lie in market-timing some international funds, or funds where there is a timing gap between a market valuation and fund valuation), though in the current environment, I can’t see fund boards coming to that conclusion.

Alternatively, the SEC is still soliciting feedback on its March proposal, and has specifically noted lingering questions on the use of first in, first out (FIFO) accounting in determining the holding period of the shares; a waiver for de minimis fees (say, $50 or less); application of such fees only on investor-initiated transactions; and a potential waiver for financial emergencies. The current rule, while imperfect, is not yet final, and advisors (and your partners and clients) can still weigh in.

The McHenry report suggests that that new level of awareness is leading a growing number of TPAs to consider mutual fund alternatives, alternatives that aren’t subject to the redemption fee directives, such as collective funds and exchange-traded funds. Certainly the application of redemption fees to participant accounts is, can be, and should be no less a factor in evaluating the appropriateness of an investment fund than the overall expense ratio. Even if plan sponsors have been slow to react to the potential for participant accounts being slammed with 200 basis point charges for inadvertent short-term trading activities, their participants surely won’t be.

- Nevin Adams

Note: The proposed final SEC rule is online at

You can comment on the rule at, or send an e-mail to You are asked to include File Number S7–11–04 on the subject line.

Friday, July 08, 2005

Bad Assumptions?

People who haven’t been saving the way they should got some good news recently – those fancy retirement savings calculators may have been exaggerating their retirement needs.

That, at least, was the assertion of a new report on retirement savings, which ran in the June issue of the Journal of Financial Planning, but which got picked up in the Wall Street Journal and The Associated Press (and that put it in a lot of newspapers). The study, by financial planner Ty Bernicke, claims that people spend less in retirement than they do prior to retirement – and that they spend less in retirement the older they get. Now, that isn’t all that radical a notion – for years planners have been telling us to plan on needing 70% of our pre-retirement income. But Bernicke, who cites data from the US Bureau of Labor's Consumer Expenditure Survey to make his point, takes issue with retirement planning calculators that push spending higher each year (by about 3%) just by keeping the current levels “even” with inflation. He also highlights statistics that suggest that workers spend less not because they have to, but just because they do, at least looking back over the past 20 years.

Bernicke’s study really only deals with that one aspect, of course – and by assuming that the spending assumptions are far too high, he is able to claim that we don’t need to have nearly as much set aside as most savings calculators claim. He calls his version “reality retirement planning.”

Well, assumptions, after all, are just that, and if the Federal Reserve with its near obsession with tracking inflation can’t predict that gauge with precision, I’m not sure that we should expect more from these calculators. But even if we spend less in retirement, what we spend money on is still subject to the vagaries of things like inflation. It’s also fine to say that Americans have tended to spend less in retirement, but the truth is that we also spend differently. Health care is perhaps the most obvious difference, and we all know that those costs have been moving well ahead of inflation in recent years. I don’t think it is beyond the realm of possibility to suggest that, as we get older, we may well be spending more on things whose costs will rise faster than that imbedded rate of inflation.

Not that I “buy” all the imbedded assumptions in these retirement calculators. That inflation assumption does more than influence the cost of living in retirement – generally, it also imputes a regular (and generally annual) rate of salary increase during one’s working career – and the projected rate of savings deferral (and employer match) is similarly “inflated” for workers who no longer receive those annual merit increases. On top of that, most calculators have a default rate of return that is wildly optimistic given most participant portfolio allocations. Mr. Bernicke may not have had issues with those “inflations” of the savings accumulation projections, but I think that may well be the greater flaw.

Speaking of assumptions, I was struck by the fact that, in Bernicke’s hypothetical example, a couple that retired (or wanted to) at age 55 already had accumulated an $800,000 balance in their 401(k) – a balance that continued to earn 8% for the next 30 years – supplemented by two social security checks (beginning at age 62) – subjected to a combined federal/state tax rate of less than 10%. With THOSE kinds of assumptions, no wonder spending isn’t a problem for his hypothetical would-be retirees.

Unfortunately, that “reality” still appears to be a fiction for many – who may well spend less in retirement, but not by choice.

- Nevin Adams

You can read the executive summary of Ty Bernicke's Reality Retirement Planning: A New Paradigm for an Old Science at

Tuesday, July 05, 2005

Generation "Gaps"

You may have missed it in your preparations for the long holiday weekend, but we crossed a milestone of sorts last Friday. That was the day on which people born on January 1, 1946, turned 59 ½. Yes, that means – and there was media coverage to that effect - that the very first of the Baby Boomers became eligible to make non-early penalty withdrawals from their retirement accounts.

Personally, I’m hoping that the coverage of that “event” was a function of a slow news day during the 24-hour news cycle. On the other hand, for people who have been waiting – and warning – about the onslaught of the Baby Boom retirements, that “pig in the python,” that “milestone” surely marks a point on that continuum (let’s hope that it doesn’t trigger a wave of withdrawal-related requests).

For years, our society has been enamored of the movements and behaviors of the so-called Baby Boomers, and given the demographics, that is perhaps understandable. On the other hand, those demographics have long been defined to include an incredibly broad swathe of the population – those born between 1946 and 1965. That’s nearly twice the span accorded to those in Generation X (1965 to 1976), for example – who, believe it or not, started turning FORTY this year (and there are about 50 million of that bloc).

I hate to break it to demographers and marketers alike, but Boomers are hardly a monolithic group. I’m what might affectionately be termed a “mid-range” Boomer. I wasn’t old enough to be protesting on college campuses in the 1960s, as were some who turned 59 ½ last week. Instead, my time on campus was spent worrying about how (if?) I would get a job in the aftermath of Gerald Ford’s “Whip Inflation Now” button campaign and Jimmy Carter’s stag-flationed malaise. I have a younger brother who snuck under the Boomer tent (at least according to demographers), but the 8.5 years that separate our births are a generational “chasm” at least as wide as that between me and any Gen Xer.

As a general rule, I abhor labels of any kind, though anyone who has ever been a kid knows that human beings seem genetically predisposed to affix them. My teenagers (and their friends) appear to rely on many of the same types of labels that every generation uses – geeks, nerds, sports, posers (one of my favorites), freaks….Notwithstanding those attempts, I’m no less family-oriented than a Gen Xer and, from what I have seen (popular characterizations notwithstanding), they are no less career-oriented. When all is said and done, these labels are simply shortcuts for dealing with people so that you don’t have to deal with people as individuals.

People, of course, defy ready labels, despite the constant push to box them in. It would, however, be a mistake of epic proportions to assume that the Baby Boomers, or any generational grouping for that matter, will approach retirement planning – or retirement – in a unitary fashion. All a generational label does – and it does this somewhat imprecisely – is hint at how long we have to get ready.