Saturday, July 26, 2008

“Know” Way

Last week, the Department of Labor’s Employee Benefits Security Administration (EBSA) released its much-anticipated proposal regarding participant fee disclosures (see "EBSA Finishes Regulatory Package with Participant Disclosure Proposal".

The industry’s response, by and large, has been positive (a notable exception: Congressman George Miller, author and sponsor of the 401(k) Fair Disclosure for Retirement Security Act of 2007—see “Miller Fee Bill Cruises through House Committee”), though one got a sense that there would be a LOT of comments forthcoming on the proposal, not the least of which was timing. After all, the DoL is soliciting comments through September 8 (so much for vacation), and says it plans to have the new rules in place by January 1.

My first thoughts on opening the proposal doubtless mirrored many of yours—“Holy cow, 103 pages!” And then, also perhaps like many of you, I set it aside for a time when my brain could handle 103 pages of proposed government regulation (I realize some of you are still waiting for that time). Now, as it turns out, something like two-thirds of the document is spent analyzing the costs/benefits of the proposal. In fact, most of it is spent outlining the costs and the assumptions associated with complying with the new proposals.

The Proposal(s)

Despite those initial concerns, the proposal itself seems relatively straightforward: It purports to require disclosure of certain plan- and investment-related information (including fees and expenses, of course) to participant-directed account participants. It identifies three categories of annual disclosures (to be furnished on or before their eligibility date, and at least annually thereafter), and further requires a quarterly disclosure of specific dollar amounts charged to the participant’s account for specified administrative expenses.

In the case of the latter, the DoL says the information should be “sufficiently specific to inform the participants or beneficiaries of the actual charge(s) to their accounts and enable them to distinguish the administrative services from other charges and services that may be assessed against their accounts.” On the other hand, the DoL’s proposal calls only for the charges to be shown in total, noting that it “does not believe that it is necessary, or particularly useful, for participants to have administrative charges broken out and listed on a service-by-service basis.” (For more details on the disclosures, see “EBSA Finishes Regulatory Package with Participant Disclosure Proposal”.)

The proposal’s import notwithstanding, the DoL tossed in some extra “nuggets” worth mentioning.

First, it took the “opportunity to reiterate its long held position that the relief afforded by section 404(c)….does not extend to a fiduciary’s duty to prudently select and monitor designated investment managers and designated investment alternatives under the plan,” and that a “fiduciary breach or an investment loss in connection with the plan’s selection of a designated investment alternative is not afforded relief under section 404(c) because it is not the result of a participant’s or beneficiary’s exercise of control”—a comment that struck me as a shot across the bow of federal courts that have, in a number of the recent revenue-sharing cases, been a bit “generous” in their application of 404(c)’s protections.

The DoL also tossed in its belief, “as an interpretive matter, that ERISA section 404(a)(1)(A) and (B) impose on fiduciaries of all participant-directed individual account plans a duty to furnish participants and beneficiaries information necessary to carry out their account management and investment responsibilities in an informed manner.” Now, in my experience, plan fiduciaries have long attempted to provide participants with a host of materials designed to help them make good investment choices—and doing so is perhaps just a practical application of common-sense principles. However, I found it interesting that the DoL slipped in to the proposal a duty to do so.

The DoL also said that the lack of fee disclosure means that participants may underestimate the impact that fees and expenses can have on their account balances—and thus may undervalue the importance of the disclosures. Further, that if employees undervalue disclosure, plan sponsors might “under provide” it—a position that the DoL found support for in the “wide dispersion of fees paid in 401(k) plans” (though it acknowledges that some of the variation could be explained by the varying amounts of assets in plans and their accompanying economies of scale, as well as the fact that some plans might offer “more, or more expensive, plan features”).

Finally, despite the obvious increase in reporting effort and costs, the DoL thinks that “small plans will benefit from the proposal, because it will clarify what information must be disclosed to plan participants.”

Potential Impacts

Personally, I think that most plan participants will, as they always have, choose investments based on net returns, not fees specifically. And, though the DoL references the importance of evaluating more than fees in its proposal, it also states unequivocally that it expects the disclosures will result in the payment of lower fees for many participants—assuming that participants will more consistently pick the lower-cost comparable investment alternatives under their plans. However, they also estimate that (only) about a quarter (29%) of plan participants are “likely to benefit from reduced search time and corresponding reduced costs” in reviewing this information. It’s possible that even that modest assessment is optimistic since, IMHO, the fee disclosures illustrated in the DoL’s model comparison chart) are no more (and perhaps in the DoL’s defense, no less) useful than those currently found in most mutual fund prospectuses.

A more likely consequence, IMHO, is the DoL’s notion that the requirements may lead plan fiduciaries to give additional scrutiny to fees, and “consequently to select less expensive comparable investment alternatives.” The fact of the matter is, plan sponsors have a duty to know what these fees are, and, IMHO, participants have a right to know how much they are paying.

- Nevin E. Adams, JD

Comments on the proposed regulation should be directed to the U.S. Department of Labor, Employee Benefits Security Administration, Room N-5655, 200 Constitution Ave. N.W., Washington, D.C. 20210, Attention: Participant Fee Disclosure Project; electronically to or via

Sunday, July 20, 2008

A Sure Thing

By some accounts, I just spent the past week in “retirement”—driving around sightseeing, reading some good books, and yes—even sitting on a beach.

And I have to tell you—if that was retirement, I don’t know how I’m going to afford it.

Now, I realize that isn’t the stuff of most “real” retirements, though it is frequently the stuff of retirement planning brochures. My week was a family vacation, and it was spent doing the things that families do on vacations. And it served as a stark reminder that, whereas sitting on a beach doesn’t cost much, making arrangements to stay—and eat—in proximity to the aforementioned beach is a whole other financial consideration.

Having said that, there were plenty of older folks sunning themselves out there—and most had the equipment and tan lines that suggested they got to do this kind of thing more often than yours truly (in fact, an entire busload descended on our hotel at 6 a.m. one morning, making the kind and volume of noise generally associated with drunk teenagers).

Still, I couldn’t help thinking this week about the thousands of retired salaried workers at General Motors who got word that their health-care coverage was about to change (see “GM Puts the Brakes on Health Care VEBA”). Don’t get me wrong—as disruptive as the change will likely be for those GM retirees, they’re still better off than the vast majority of retirees. Oh, sure, they’ll have to arrange for their own health-care insurance, but they’ll get a $300 boost in their monthly pension to help deal with that at a time when many workers don’t have the benefit of employer-sponsored retiree health insurance, much less a program as generous at GM’s. And they’ll get access to “counseling” to help them adjust to the change. Indeed, when all is said and done, those retirees may very well find the elimination of the common stock dividend (another cost-saving measure by the automaker) a bigger disruption to their financial plans.

Disruptive Influences

“Disruptions” are the bane of a fixed income, of course. Just when you think you have it all balanced out, you have to spend (a lot) more for gasoline, pay a higher real estate tax bill, scrape up some money for a new prescription drug, deal with the financial consequences of an unexpected medical emergency. That this happens at the same time that your investment portfolio is taking a sustained “hit,” and that you are told the house you are living in is worth a lot less than it was (on paper, anyway) a year ago, all contributes to the sense of economic pessimism that garners so much press (and presidential candidate) attention in this election season. Things cost more than they did, and those on fixed incomes (and that includes a growing number of current workers who perhaps haven’t gotten a pay increase in a while) have to make adjustments—sometimes painful adjustments.

It’s been said that the only sure things are death and taxes—but the lesson for those of us still drawing a paycheck, IMHO, is the importance of preparing for that third “sure” thing: uncertainty.

- Nevin E. Adams, JD

Saturday, July 12, 2008

Motivationally Speaking

As anyone who has (or has been) a teenager can attest, motivation is a tricky business. Once upon a time, it took little more than a smile or a “good girl” to motivate my children to do the right things (alongside the occasional threat to rely on corporal punishment). But as they have grown older, the “motivations” have become more “challenging” (and, unfortunately, frequently louder); not because they are not interested in doing the right things—it’s just that they have other priorities.

Of course, teenagers are really just human beings (despite the occasional rumor to the contrary), and as such, they don’t always do the right thing, or do it as soon as a parent might prefer. So it also goes for adults—specifically, adults in the context of saving for retirement. Realizing that, we have long used certain subtle means of encouraging them to do the right things. We impose vesting schedules to encourage their continued employment, we offer “free money” in the form of company matches to spur their willingness to put some of their own money aside, we allow them to borrow against their savings so that they feel more comfortable about saving larger amounts than they might otherwise—heck, we even offer 401(k) plans to entice them to come to work for us in the first place.

In large part, those motivations have succeeded. Far more people participate in these programs than not, and the vast majority contribute to the exact level to obtain the full company match. More recently, a series of initiatives was first touted, and then legislatively sanctioned, to “motivate” those workers who, for a variety of reasons, had nonetheless been disinclined to take advantage of these programs: automatic enrollment to get them “in,” contribution acceleration to help them get to the right amount, and asset-allocation funds to help them get—and stay—optimally invested.

“Thinking” Caps?

Now, if these new tools work—and, by all accounts, they are working well—then, IMHO, it might well be time to give some new thought to our long-standing assumptions about participant motivation and plan design.

For example, why should the company contribution only go to workers who think they can afford to save? That, after all, is what a matching contribution does. And if you’re going to match contributions, why not do so with a smaller amount applied to a larger range of deferrals? Instead of 50 cents on the dollar up to 6% of pay (which leads participants to stop deferring at the 6% level), why not 25 cents on the dollar up to 12% of pay? Participants will likely save more—and employers might well save some money.

Why maintain these enormous menus of investment options that have to be selected, monitored, and explained—and which require participant involvement to rebalance—when it is so much easier to focus your due diligence efforts on a QDIA solution? And do you still need to offer loans to get workers to participate, when you no longer even require them to fill out an enrollment form?

I don’t mean to suggest that these changes won’t be viewed unfavorably by some. After all, if you used to get a 50% match for only deferring 6%, it’s hard to imagine a scenario in which a 25% match for the same deferral doesn’t look like a benefit reduction. And, as much bother as those bloated investment menus are, many participants like at least the illusion of broad choices—and may well feel a bit hemmed in by a QDIA. As for loans—well, you take that away, maybe more of those automatically deferred participants will actually expend the energy to opt out.

It’s hard to know just exactly how this new era of defined contribution plans—and plan participants—will respond to change. What we do know is that not considering the possibilities associated with these changes can mean that we overlook opportunities.

- Nevin E. Adams, JD

Saturday, July 05, 2008

“Diss” Ingenuous

Over the past several years, it has become “fashionable” in some quarters to bash the workplace retirement savings plan; most frequently, the 401(k). Critics have long bemoaned “anemic” participation rates as a sign that the programs aren’t working, faulted what were perceived as inadequate savings rates as an indication that participants didn’t grasp the need, and pointed to less-than-optimal investment allocations as proof that those who did save were not capable of, or not interested in, making those decisions.

In fairness, much of that “criticism” has been of a constructive nature—from professionals who care about retirement savings adequacy, who believe strongly in the support of the employer-sponsored system, and who truly want to see people have the opportunity to do the right thing, and to do the right thing with that opportunity. However, those well-intentioned voices were sometimes employed in contexts that, over time, have hinted (and sometimes done so more overtly) that there were inherent problems with that system that were perhaps beyond remedy. And there are suggestions, from time to time, that the retirement savings crisis is overblown, a concoction of investment providers and advisers who simply want to ensure their own retirement security.

More recently—and more insidiously, IMHO—is a growing voice that 401(k)s are little more than tax dodges for the better-off. That they, like any tax-advantaged program, provide disproportionately higher value to those who actually pay taxes—those who, by definition in our current “progressive” income tax scheme, have higher incomes.

Alternative Courses

Those opposed to the current employer-sponsored system do have alternatives. One is to remove the tax benefits from the 401(k) altogether, either as a “fairness” move (e.g., since everyone doesn’t have a 401(k), no one should), or that put forth by those trying to establish some fiscal responsibility “cred,” is the need to save the federal government money by not deferring taxes on those contributions and/or earnings and by no longer giving employers tax benefits for their contributions on behalf of participants. Some want to replace the current workplace savings program with something else; generally, some grand government-mandated savings program (yes, in addition to Social Security which, let’s tell it like it is, is not a savings program), while those opposed to “Big Government” hold out the notion of a government-sanctioned/mandated payroll IRA, where each worker would have the “opportunity” to set up their own account anywhere they chose to do so.

At the heart of each of these initiatives—yes, even the seemingly innocuous proposal to mandate IRA payroll deductions—is the weakening or outright elimination of the employer-sponsored retirement system.

Those of us who work with these programs in the real world can anticipate where that would leave retirement security. Without the encouragement of an employer match, the convenience of signing up in the workplace, or the incentives of pre-tax deferrals, most would not save at all, or would certainly save at a more modest rate than they do at present. One could, of course, simply mandate savings—but it is hard to imagine that we would be willing to enforce the level of savings necessary to achieve reasonable retirements (short of forcing it into some kind of pooling system like Social Security, and some have recommended just that – see “IMHO: Conspiracy Theories”).

What all too often gets lost in our criticisms of the current system is just how often it works well. Perhaps only three-of-four eligible to participate in such programs choose to do so, but on an employer-by-employer basis, participation rates north of 90% are not impossible to find—and that’s before the adoption of mechanisms like automatic enrollment. Contribution acceleration programs have allowed workers to readily do what was once a cumbersome process. Target-date funds have, in incredibly short order, gained the favor of plan sponsors and participants alike—with as yet incalculable benefits for those retirement investments. Those, and a whole new generation of retirement income alternatives are coming to market—alternatives that, unlike the prior generation, will benefit from the scrutiny of plan fiduciaries trying to make sure that a lifetime of accumulation isn’t decimated in a single moment. These innovations have come to light, and to market, because of the employer-sponsored system. What kinds of innovations have been brought to those disciplined enough to set aside money in a retail IRA?

In the real world, a lucky few know how to save and invest properly; somewhat more have access to the counsel and advice of a trusted adviser. But for most of us, the workplace retirement program is our first and only “investment” account. It is the one place where even those with relatively small balances can have access to professional advice, alongside the opportunity to gain the purchasing power of a group. But they might not have any of that without the involvement of their employer, the funding of that company match, and the tax incentive from the government to do the right thing.

Those that would take all that away have lots of reasons for throwing out the support of the employer-sponsored program—but they would really, IMHO, be throwing the baby out with the bathwater.

- Nevin E. Adams, JD


See “They’re Baaaack, Again!”

See also “IMHO: Vanishing Points?

IMHO: “Wonder Land”

IMHO: “Crisis Management”