Wednesday, November 21, 2018

A ‘Retirement Ready’ Thanksgiving List

Thanksgiving has been called a “uniquely American” holiday, and though that is perhaps something of an overstatement, it is unquestionably a special holiday, and one on which it seems appropriate to reflect on all for which we should be thankful. And so…

I’m thankful that participants, by and large, continue to hang in there with their commitment to retirement savings, despite lingering economic uncertainty and competing financial priorities, such as rising health care costs and college debt.

I’m thankful that so many employers voluntarily choose to offer a workplace retirement plan – and that so many workers, when given an opportunity to participate, do.

I’m thankful that figuring out ways to expand that access remains, even now, a bipartisan concern – even if the ways to address it aren’t always.

I’m thankful that so many employers choose to match contributions or to make profit-sharing contributions (or both), for without those matching dollars, many workers would likely not participate or contribute at their current levels – and they would surely have far less set aside for retirement.

I’m thankful that the vast majority of workers defaulted into retirement savings programs tend to remain there – and that there are mechanisms (automatic enrollment, contribution acceleration and qualified default investment alternatives) in place to help them save and invest better than they might otherwise.

I’m thankful that a growing number of plan sponsors are choosing to improve on those automatic defaults, particularly by raising the starting contribution rates.

I’m thankful that more plan sponsors are extending those mechanisms to their existing workers as well as new hires.

I’m thankful for qualified default investment alternatives that make it easy for participants to create well-diversified and regularly rebalanced investment portfolios – and for the thoughtful and on-going review of those options by prudent plan fiduciaries.

I’m thankful that, as powerful as those mechanisms are in encouraging positive savings behavior, we continue to look for ways to improve and enhance their influence(s).

I’m thankful that a growing number of policy makers are willing to admit that the “deferred” nature of 401(k) tax preferences are, in fact, different from the permanent forbearance of other tax “preferences” – even if governmental accountants and certain academics remain oblivious.

I’m thankful that the “plot” to kill the 401(k)… (still) hasn’t. Yet.

I’m thankful that those who regulate our industry continue to seek the input of those in the industry – and that so many, particularly those among our membership, take the time and energy to provide that input.

I’m thankful for objective research that validates the positive impact that committed planning and preparation for retirement makes. I’m thankful for the ability to take to task here research that doesn’t live up to those objective standards – and for those who take the time to share those findings.

I’m thankful for all of you who have supported – and I hope benefited from – our various conferences, education programs and communications throughout the year.

I’m thankful for the team here at the American Retirement Association, generally, as well as all the sister associations - ASPPA, ACOPA, NTSA, NAPA and PSCA, and for the strength, commitment and expanding diversity of our membership.

I’m thankful to be part of a growing organization in an important industry at a critical time. I’m thankful to be able, in some small way, to make a difference.

But most of all, I’m once again thankful for the unconditional love and patience of my family, the camaraderie of dear friends and colleagues, the opportunity to write and share these thoughts – and for the ongoing support and appreciation of readers like you.

Here’s wishing you and yours a very happy Thanksgiving!

- Nevin E. Adams, JD

Saturday, November 17, 2018

Better Than Average(s)

Nobody likes to be thought of as “average” – so why do people spend so much time worrying about the “average” 401(k) balance?

These averages are reported with some regularity by any number of providers (based on the records for which they have access), and sometimes by academics drawn from government databases.1

The short (and less cynical) answer to “why” is most likely that the math is “easy.” You simply take the total assets (from whatever recordkeeper/plan balances you have), divide it by the number of participants in that group, and “voila” – you have an average.2

Now, when you stop and think about it (and many don’t), you realize that doing so adds together the balances of individuals in widely different circumstances of age and tenure – everything from those just entering the workforce (and who have relatively negligible 401(k) balances) with those who may have been saving for decades. It can also, in the case of government databases, add together those that have had an opportunity to save with those who haven’t, or who chose not to. That averaging also smushes together the accounts of individuals of vastly different income and financial status, who may (or may not) have other means of support, who may (or may not) be a primary source of retirement preparation in their household, who live (and may retire) in very different places – and, let’s face it, groups together individuals who are not only dealing with very different financial circumstances, but also likely have widely varying retirement security needs.

Moreover – and this generally isn’t highlighted – when you consider results from single provider estimates, all those differences are potentially magnified by the reality that individuals change jobs, and employers change 401(k) providers, and so, those “averages,” of necessity, include the experience not only of different individuals at a time, but different individuals from one year (and reported averages) to another.

As a consequence, while the math is easy, the result is not generally a very accurate barometer when it comes to assessing actual retirement accumulations.

So, how much could an “average” assessment distort things?

Consider the EBRI/ICI database maintained by the Employee Benefit Research Institute. At year-end 2016, the average 401(k) plan account balance was $75,358. On the other hand, the average of individuals who were in that database consistently – meaning that you are at least considering the same group of people during the period 2010 through 2016 – was $167,330. That’s right – twice as large.

However, as I’ve already noted, there are plenty of issues with focusing on averages. But if you take the average of a more homogenous group – say the individuals in this database who have not only been in the database consistently for the specific six-year period, but who have more than 30 years of tenure with their employer – it’s possible to get a much more accurate picture.

Even though some of that group may not have been eligible for, or participated in, a 401(k) throughout their career, it turns out they have accumulated significantly more – $338,735, in fact – an amount that could, even at today’s interest rates, provide an annuity of $1,909 per month (for a male age 65). By comparison, in 2017, the average monthly Social Security benefit for a 65-year-old male was $1,348.70 (for women, $1,076.19).

The math may not be as “easy.” But the answer, certainly in evaluating retirement readiness, is surely more accurate.

- Nevin E. Adams, JD
  1. There are any number of issues with the underlying data, even from otherwise reputable sources. For more insights, see Crisis ‘Management,’ CPS Needs a New GPS, Data ‘Minding’ and Facts and ‘Figures.’
  2. See also Why an Average 401(k) Balance Doesn’t ‘Mean’ Much.

Saturday, November 10, 2018

The Birth of a Notion

"Unintended consequences” are generally a bad thing. But not always. The 401(k), for example.

This week we celebrated the birthday of the 401(k) – because it’s the anniversary of the day on which the Revenue Act of 1978 – which included a provision that became Internal Revenue Code (IRC) Sec. 401(k) – was signed into law by then-President Jimmy Carter.

That wasn’t the “point” of the legislation of course – it was about tax cuts (some things never change) – reduced individual and corporate tax rates (pulling the top rate down to 46% from 48%), increased personal exemptions and standard deductions, made some adjustments to capital gains, and – created flexible spending accounts. But it did, of course, also add Section 401(k) to the Internal Revenue Code.

That said, so-called “cash or deferred arrangements” had been around for a long time – basically predicated on the notion that if you don’t actually receive compensation (frequently an annual bonus or profit-sharing contribution in those times/employers), you don’t have to pay taxes on the compensation you hadn’t (yet) received. That approach was not without its challengers (notably the IRS) and, according to the Employee Benefit Research Institute (EBRI), this culminated in IRS guidance in 1956 (Rev. Rul, 56−497), which was subsequently revised (seven years later) as Rev. Rul. 63−180 in response to a federal court ruling (Hicks v. U.S.) on the deferral of profit-sharing contributions. Enter the Employee Retirement Income Security Act of 1974 (ERISA), which – among other things – barred the issuance of Treasury regulations prior to 1977 that would impact plans in place on June 27, 1974. That, in turn, put on hold a regulation proposed by the IRS in December 1972 that would have severely restricted the tax-deferred status of such plans. But ERISA also mandated a study of salary reduction plans – which, in turn, influenced the legislation that ultimately gave birth to the 401(k).

So, how did something that became America’s retirement plan get added to a tax reform package? Rep. Barber Conable, top Republican on the House Ways & Means Committee at the time, whose constituents included firms like Xerox and Eastman Kodak (which were interested in the deferral option for their executives), promoted the inclusion which added permanent provisions to “the Code,” sanctioning the use of salary reductions as a source of plan contributions. The law went into effect on Jan. 1, 1980, and regulations were issued Nov. 10, 1981 (which has, at other times, also been cited as a “birthday” of the 401(k)).

Now, it’s said that success has many fathers, while failure is an orphan. The most commonly repeated story is that Ted Benna saw an opportunity in this new provision, recommended it to a client (which, ironically, rejected the notion), but then promoted it to a consulting firm (Johnson & Johnson), which then embraced it for their own workers. The reality is almost certainly more nuanced than that, though Mr. Benna (who now derides what he ostensibly created) has managed to be deemed the “father” of the 401(k) by just about every media outlet in existence (it may be worth noting that while I am the father of three children, their mother was much more involved in the actual delivery).

What we do know is that in the years between 1978 and 1982, a number of firms (EBRI cites not only Johnson & Johnson, but FMC, PepsiCo, JC Penney, Honeywell, Savannah Foods & Industries, Hughes Aircraft Company and a San Francisco-based consulting firm called Coates, Herfurth, & England) began to develop 401(k) plan proposals, many of which officially began operation in January 1982.

Within two years, surveys showed that nearly half of all large firms were either already offering a 401(k) plan or considering one. Two years later the Tax Reform Act of 1984 (again, among other things) interjected nondiscrimination testing for these plans – and two years after that the Tax Reform Act of 1986 tightened the nondiscrimination rules further, and reduced the maximum annual 401(k) before-tax salary deferrals by employees. And yet, despite those – and a number of other significant changes over the intervening years – employers have continued to offer – and America’s workers have continued to take advantage of these programs.

Now, it’s long been said that 401(k)s were never intended (nor designed) to replace defined benefit pensions – true enough.

However, in 1979, only 28% of private-sector workers participated in a DB plan, with another 10% participating in both a DB and a DC plan. In contrast, the Investment Company Institute notes that, among all workers aged 26 to 64 in 2014, 63% participated in a retirement plan either directly or through a spouse. As of June 2018, Americans have set aside nearly $8 trillion in defined contribution plans, and there’s another $9 trillion in IRAs, much of which likely originated in DC/401(k) plans.

Those who know how defined benefit (DB) plan accrual formulas work understand that the actual benefit is a function of some definition of average pay and years of service. Moreover, prior to the mid-1980s, 10-year cliff vesting schedules were common for DB plans. What that meant was that if you worked for an employer fewer than 10 years (and most did), you’d be entitled to a pension of … $0.00. And, as you might expect, certainly back in 1982, even among the workers who were covered by a traditional pension, many would actually receive little or nothing from that plan design. But then, certainly in the private sector those plans were funded, invested (and paid for) by the employer. Nothing ventured,1 nothing gained, right?

The reality is that the nation’s baseline retirement program is, and remains, Social Security. But for those who hope to do better, for those of even modest incomes who would like to carry that standard of living into post-employment, the nation’s retirement plan is, and has long been, the 401(k). And – despite a plethora of media coverage and academic hand-wringing that suggests they are wasting their time, the American public has, through thick and thin, largely hung in there – when they are given the opportunity to do so.

That may not have been the intent of the architects of the 401(k), or its assorted foster “parents” over the years. But these days it’s hard to imagine retirement without it.

So, happy 40thbirthday, 401(k). And here’s to 40 more!

Nevin E. Adams, JD

I know that some would argue that workers effectively bargained for lower wages in return for the pension benefit. Maybe once upon a time, certainly in labor situations where there actually was an active bargaining component. But I suspect that most non-union private sector workers post-ERISA felt no such trade-off.

Saturday, November 03, 2018

5 Things That (Should) Scare Plan Fiduciaries

Halloween is the time of year when one’s thoughts turn to trick-or-treat, ghosts and goblins, and things that go bump in the night. But what are the things that keep – or should keep – plan fiduciaries up at night?

Well, there are the things like…

Getting Sued

Plan sponsors will often mention their fear of getting sued (actually, their advisors frequently broach the topic), and little wonder. The headlines are (still) full of multi-million dollar lawsuits against multi-billion dollar plans, and if relatively few seem to actually get to a judge (and those that do have – to date – largely been decided in the plan fiduciaries’ favor), they nonetheless seem to result in multi-million dollar settlements. Oh, and not only has this been going on for more than a decade, the issues raised are evolving as well.

As a plan fiduciary, you can be sued, of course; and let’s not forget that that includes responsibility for the acts of your co-fiduciaries, and personal liability at that (see 7 Things an ERISA Fiduciary Should Know).

That said – and more than a decade after the first series was launched – those cases (still) seem to involve a relatively small group of rather large plans. If it’s (still) astounding that some of the plans do the things they are alleged to do (and not do), for those familiar with the math of contingent fee litigation, there’s little mystery to the big plan focus.

Of course, most plan sponsors won’t ever get sued, much less get into trouble with regulators. And those who do are much more likely to drift into trouble for things like late deposit of contributions, errors in nondiscrimination testing, or not following the terms of the plan.

Still worried about getting sued? As one famous ERISA attorney once told me, they might as well worry about getting hit by a meteor.

Plan Costs

Whether you feel that the aforementioned wave of litigation has been a force for good or ill, it has certainly contributed to a heightened awareness of fees by plan sponsors – and one that finally seems to be moving beyond squeezing that extra pound of flesh from recordkeepers (though there’s still plenty of that).

These days it’s as likely to show up in questions about shifting to passive options, or at least an inquiry about a different share class. Questions are good – actions potentially better.

Regardless, it would seem to be difficult to live up to ERISA’s fiduciary admonitions to ensure that the fees and services provided to the plan are reasonable if you don’t know what you’re getting, or how much you’re paying.

Target Date Fund Glidepaths

Remember 2008 – when so many discovered for the first time that target-date funds and their glide paths really are  different? Over the last decade, the sheer amount of money that has been invested in these QDIAs (most defaulted along with the expansion of automatic enrollment) – nearly $2 trillion at the end of 2017 – means that participants are likely better diversified than ever before, with portfolios that are regularly and professionally managed and rebalanced.

With luck, things like the 2008 financial crisis won’t recur in our lifetime. On the other hand, on the offhand chance that that – or something like it – does, this might be a good time to look under the bed – er, glidepath – and make sure that the assumptions incorporated there are consistent with expectations.

Personal Liability

Most of the aforementioned concern about being sued seems borne from a concern about the damage – both reputational and financial – to the organization that sponsors the plan. While that is certainly a well-founded and rational concern, plan fiduciaries, particularly plan sponsors, often seem oblivious to the reality that their liability as an ERISA fiduciary is… personal.

You can, of course, buy insurance to protect against that personal liability — but that’s likely not the fiduciary liability insurance that most organizations have in place. And it may not be enough.

Failing to Engage the Knowledge of a Prudent Expert

ERISA’s “prudent man” rule is a standard of care, and when fiduciaries act for the exclusive purpose of providing benefits, they must act at the level of a hypothetical knowledgeable person and must reach informed and reasoned decisions consistent with that standard.

The Department of Labor notes that “[l]acking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions.”


Because, when it comes to the former, most people do – and as for the latter, many still don’t.

- Nevin E. Adams, JD