Risk & Reg Reform

vice president, SunGard’s wealth management business

Participant directed investments: good, bad, indifferent

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Imagine a 401(k) plan that does not allow participants to direct the investment of their accounts, a plan where trustees make investment decisions on behalf of the plan as a whole. Some might consider that blasphemy. Participants want – no, they have a right – to direct the investment of their retirement accounts.

As radical as it sounds, it was not that long ago when participant investment direction was rare. Technology has been the single biggest factor in enabling plans to permit participant directed investments. Throw in a threat of fiduciary liability, some marketing, and we have a train that cannot be stopped. I am not suggesting that this train needs to be stopped. I do, however, think it is time to step back and take a look at where this train is headed.

Over the years I have asked attendees at retirement industry conferences whether they think participant directed investments are beneficial for participants. In most cases, the answer is NO. There are a small number of individuals who have independent investment advisors who need the ability to direct their investments and manage their entire portfolio. But, for the vast majority of participants and plan sponsors, it is difficult to determine the benefit/cost analysis.

The most touted benefit of participant investment direction is control: each participant is able to make an investment decision that is best for his or her individual circumstances. I think there is also a social benefit that cannot be overstated. Financial literacy is a national concern, and the retirement plan industry has not only highlighted the problems we face, but also made progress in solving the problems.

We know that the retirement plan is the single biggest savings for many participants. Retirement plan providers are able to give participants access to extensive educational materials and tools, including more cost effective access to investment advisors. This is a benefit that extends beyond just retirement plans. Some providers also believe that participants will not make deferrals to their plan if they are not able to control the investment of these deferrals. This is debatable, as some providers believe participants are paralyzed when confronted with investment decisions, and this may inhibit, not enhance, participation. Lastly, from a plan sponsor perspective, there is concern about fiduciary liability. The Employee Retirement Income Security Act (ERISA) provides protection to fiduciaries where investment losses are due to a participant’s own investment decisions. Thus, some believe that allowing participants to direct their investments helps minimize fiduciary liability.

The costs of participant investment direction are equally as difficult to quantify. Providers spend countless dollars to create all of the tools and materials that are needed to educate and enable participants to direct their investments. This may be wasted money if it is true that the majority of participants just do not care. Hence, default investment options are needed when no investment decisions are made, leading to the proliferation of target date funds. Rather than educate participants on portfolio management, providers create the “easy button.”

Another cost is the risk of participants making poor investment choices. Unfortunately, the cost of poor investment decisions can be devastating if it results in individuals not having sufficient assets for retirement. While ERISA may protect the plan fiduciaries from liability for these poor investment decisions, permitting participant investment direction might also increase liability. There are more investment transactions that can go wrong (e.g., I instructed the plan to invest in Fund A, and due to a processing error, the trade did not take place, and I missed a market uptick). In that case the loss was caused by the plan, not by a poor investment decision.

One final cost that is particularly acute this year is the implementation of new Department of Labor fee and investment disclosure requirements. All of the new disclosure requirements for participants (as distinguished from disclosure to plan sponsors) apply only to plans that permit participant investment direction. This will increase costs in the short-term, but the hope is it will increase financial literacy and enable participants to make more informed investment decisions.

I recently came across a 401(k) plan using a plan design that I have been thinking about for quite some time. Participant investment direction is not permitted until an individual nears retirement (e.g., is age 55 or older). This is similar to Employee Stock Ownership Plans where certain older participants have the right to diversify their investment out of company stock. The theory is that as one nears retirement, he or she may want to invest in less risky investments, and he or she may actually be willing to take on investment decisions because money management will be critical in post-retirement years.

There is no right or wrong answer when it comes to participant investment direction. I welcome your thoughts.

 

manager, product solutions, SunGard’s wealth management business

Participation versus investment vehicles: where should we focus?

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According to InvestorWords.com, a defined contribution plan is “A company retirement plan, such as a 401(k) plan or 403(b) plan, in which the employee elects to defer some amount of his/her salary into the plan and bears the investment risk.” While there are many other sources for this definition, I chose this one for a reason. The primary purpose for participating in a defined contribution plan is for participants to save for their own retirement. While I sometimes understand people need to be protected from themselves, participants should be responsible for bearing the investment risk, rather than the plan. Plenty of rules and regulations are already in place to protect the interests of plan participants.

A defined contribution plan is a useful tool that can be utilized to help people save for their own retirement. Yet, participation rates are decreasing. Thus, I think we should get back to the basics and try to simplify what appears to be an overcomplicated process in order to encourage more participation.

For many, contributing to a retirement plan is their first experience with investing. The basic benefits are explained to them: tax savings, compounded annual growth, dollar cost averaging, and free money from the company via profit sharing or match contributions, quite possibly, even better living in retirement than during working years. One of the hardest obstacles to overcome when educating employees on the benefits of investing in a retirement plan is the employee’s perception toward the affordability of participation. Not enough time is being spent to illustrate to participants why they can afford it, especially when considering that low participation rates ultimately can have adverse effects on the overall plan.

Once a participant is enrolled, he or she is shown how to invest his or her contributions. But, this is where it gets difficult. Could it be that so many owners, in an effort to have every investment option available to them, have muddied the waters and made it too complicated for most plan participants to make comfortable investment decisions? Instead, potential participants throw their hands up in the air. They give up and fail to participate, and as a result, participation rates fall. Remember, Generation X and Y workers are tech savvy and have access to mounds of information. They want everything now, but may not read anything longer than a text message.

Many decision makers have tried to chase performance by adding different investment vehicles to plans: including, exchange traded funds, target date funds and insurance products, etc.  With each presents its own unique challenges. Are all of these in the best interests of the average plan participant (who may not read anything longer than a text message)? Would our time be better spent addressing the investment needs of plan participants, or revisiting the basics and focusing on teaching plan participants about the value of a retirement plan?

 

senior vice president, product marketing, SunGard’s wealth management business

Does the disclosure of fees mean huge savings for millions of Americans with a 401k?

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According to a recent Wall Street Journal article 401k Plans Step into the Sunshine: New Labor Department Rules Will Require Fee Disclosures, “The rules governing America’s most popular retirement vehicle are about to change, and that could mean huge savings for millions of workers building nest eggs for the future.”

As we seem to be closing in on the final requirements and dates for participant level fee disclosures, I question how the disclosure of fees could actually mean huge savings for millions of Americans.

The topic of fee disclosure has captured our attention for some time now. For years, providers have been focused on these mandates and on how to implement them from an operational stand-point. Operationally, the mechanisms needed to properly address fee disclosure reporting can be and, to some degree, have been implemented. However, will the millions of participants who receive these statements understand the costs associated with administering their retirement plans relative to the value they are receiving for their participation in that plan?

It is unrealistic to expect participants to truly understand all of the details and tasks that go into administering a plan, including front- and back-office activities. And as a result, when participants receive their statements containing the fee disclosures, employers and providers will experience an influx of misinformed concern. What parts of plan administration are necessities? What parts commodities?

What will be pertinent is providing education on the value of the administered costs associated with a plan’s fees. I spend a great deal of time talking to retirement plan providers regarding fees, and they are always quick to let me know that they are the best deal around. For some, that means low cost. For others, that means premium services. But for all, it means the value they provide to their participants.  And, the value needs to be communicated and reported to participants, along with the disclosure of fees.

I think articles such as this one published in the Wall Street Journal are misleading. The act of fee disclosure does not necessarily mean that participants’ nest eggs will automatically grow in size just because they have been informed of the costs associated with administering a plan. While a decrease in asset-based fees do have a dramatic impact to a participants’ long-term investment performance (assuming all other variables remain the same), there are other benefits that can come from better participant education. My hope is that the fee disclosure requirements result in better participant education on the overall value associated with retirement plans, which then leads to an increased interest in saving, peer-to-peer communication, and a greater overall retirement preparedness and participation.

How do you think participants will respond to receiving their statements disclosing fees? Will fee disclosure lead to participants more ready for retirement…sponsors with participants who understand the value their sponsor provides? Will assets and participants increase for the providers as a result?

(Wall Street Journal: “401k Plans Step into the Sunshine: New Labor Department Rules Will Require Fee Disclosures; 1-31-2012, Greene and Tergesen: http://online.wsj.com/article/SB10001424052970203920204577193444258923460.html)