Saying No to the 401(k)
No matter what fund companies do, Americans just don't seem to think with urgency about their 401(k) balance. And fund companies are doing a lot.
The problem seems simple, and in some ways, like it should already have been solved. Given the advent of IRS-sanctioned tax-deferred savings plans like IRAs and 401(k)s, the opportunity for automatic enrollment in these plans, the elimination of most company-sponsored defined benefit plans and the threat to Social Security, who wouldn't want to do all they can to make sure they are prepared for their retirement?
Yet fund company CEOs say that increasing the number of people directing a percentage of their paycheck to retirement funds and figuring out how to persuade employees that increasing the amount they divert to their retirement plans each year will pay off in the long run remains a huge industry challenge.
"Younger investors need to start thinking about investing and retirement," Marie Chandoha, president and CEO of Charles Schwab Investment Management, said at the Investment Company Institute's annual conference.
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Many are failing to do that. According to commentary from an oft-quoted Merrill Lynch Help2Retire webcast, half of eligible employees younger than 34 don't contribute at all to their employer-sponsored 401(k) programs. Of those who do, 40 percent don't put in enough to take advantage of the employer's matching program.
Speaking on that webcast, John Pelletier, director of the Center for Financial Literacy at Champlain College in Burlington, Vt., said:
"If you're lucky enough to get a job where you have a 401(k) and you have an employer match, I always start by asking a question: If I could guarantee you 100 percent return, would you take it? And everybody says, 'Yes.' What if I could guarantee you a 200 percent return, would you take it? Everybody says, 'Yes.' But what the statistics show is that over 40 percent of people don't take advantage of their employer match. And some employers match 50 cents on the dollar, a dollar for a dollar or $2 for a dollar. And that's guaranteed return money."
"Things like company-based retirement plans are now almost gone, and who knows what will happen with Social Security," Chandoha said.
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Education programs are one of the few tools fund companies and plan sponsors have at their disposal to convince the American workforce of the necessity of saving for retirement. They have found that many workers want to contribute to their retirement plans but need help figuring out which funds would best serve them, based on the number of years they have left before retirement and their risk tolerance.
The responsibility of providing retirement education to investors lies with the employer and its plans sponsor.
Most employers and plan sponsors endorse more aggressive literacy campaigns designed to entice their employees to invest, said Michael Falcon, head of retirement at J.P. Morgan Asset Management. However, federal regulation limits what plan sponsors can say when it comes to providing investment education.
"Employers are eager to get information out to people, but they want to make sure it's good, objective information," Falcon said. "They are wary of the appearance of a conflict of interest and the lack of safe harbor in terms of regulation that would allow them to do more."
Schwab has been leveraging outside firms, such as Morningstar, to provide participants in its plans with investment guidance in a way that helps to eliminate any conflict of interest.
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Chandoha said a great deal of change in the past decade has moved most 401(k) plan providers away from offering only their investment management company's funds within plans, which represented a conflict of interest. Open architecture—offering funds from a variety of fund families—is now the industry standard.
For instance, if Schwab is running a company's 401(k), acting as a plan sponsor and an investment manager, it offers mutual funds from other companies within the plan. "Companies and plan sponsors are demanding more open architecture to reduce that kind of conflict of interest," Chandoha said.
The increased implementation of auto enrollment and re-enrollment plans is another way the industry is pushing employees to start investing in their 401(k) plans. The idea is to put the onus on the employee to opt out of contributing to a retirement plan.
Re-enrollment plans are also starting to pop up, so that existing employees, as opposed to just new employees, are also automatically enrolled in their company's 401(k) plans. "With companies that are doing this, we are seeing an uptick in contributions, participation, diversification of investment and enrollment in target date funds," Falcon said.
Once an employee is enrolled, and even if investment guidance remains a challenge, target date mutual funds are serving as a bridge to help plan participants get a handle on their optimal asset mix and risk tolerance.
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"Many people in 401(k) plans don't have the time or don't feel knowledgeable about making investment decisions, or are just not interested in it," Chandoha said. Target date funds use a diversified approach, allocating an employees' portfolio to a variety of funds, structured in a way that as the person reaches retirement age, more of the portfolio is moved from equities into fixed income. "The idea is that the easier you make it for employees to invest their money, the better," she added.
When all else fails—or at least, when the most simple tools at a fund company's disposal are not enough—there is cutting-edge economic research as a tool. Allianz Global Investors' Center for Behavioral Finance is exploring investor behavior and concepts like "framing" to persuade people to save and invest more.
For example, how to turn the conversation away from investment return and toward income as an individual ages can make for a more convincing case to stay on track with retirement contributions.
"We go beyond product and look at how we get people to make the right decisions about how and when to invest," said Elizabeth Corley, global CEO of Allianz Global Investors.
Given the inability to solve the savings riddle, it has not been welcome news within the fund industry that the White House's recently released 2014 budget proposal includes measures to limit retirement plan tax advantages.
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As the government continues to look for ways to reduce the deficit, one proposal would prohibit taxpayers from making contributions and accruals when the accumulated value of their retirement savings is more than the amount necessary to provide the maximum annuity allowed for tax-qualified defined-benefit plans—currently an annual benefit of $205,000, beginning at 62.
According to the Treasury Department's Green Book, the maximum permitted accumulation for a person 62 today is about $3.4 million. Another budget proposal would only allow contributions into a retirement plan to be reduced from taxable income up to the level of the 28 percent tax bracket.
Fund companies have expressed anxiety over and distaste for the budget proposals on many grounds, though the chance of these retirement tax reforms being enacted is not high, even according to tax experts who believe there is a good case to be made for reducing some retirement tax breaks.
"The problem is that we have all become habituated to the idea that we don't save enough, and the government should subsidize saving through tax-advantaged retirement plans," said Edward Kleinbard, a professor of law at the University of Southern California and a former chief of staff of Congress' Joint Committee on Taxation.
There is a legitimate debate to have over the level at which the government should stop offering preferential tax treatment to upper-income savers, Kleinbard said. But the administration would need to explain why there is "too much of good thing" when it comes to retirement savings, he said. And it would be a difficult case to make, even to middle of the road politicians.
"The budget is a wish list for the administration," Kleinbard said.
It's not exactly a selfless appeal from investment managers on the retirement bully pulpit. After all, the more assets in retirement plans—the fund company's primary asset base—the more fee revenue the fund companies and plan sponsors generate.
Those retirement-plan fees came under fire again in a recent Frontline examination of the market. Yet it is hard to argue with the logic that it's in somone's best interest to start contributing to a retirement plan as early as possible to maximize the savings opportunity.That's a simple investment truth, even if the response to it from both investors and fund companies is much more complex, and still evolving.