Will Democrats Tinker With Mutual Funds, 401k Plans?

As Democrats celebrate winning the White House and gains in Congress, the victory is rippling through the $11 trillion mutual fund industry in anticipation of reforms to retirement plans that could hurt earnings.

Some academics say the financial crisis raises questions about the vulnerability of a retirement system managed heavily by fund companies where many workers rely on 401(k)s and similar plans with deep exposure to volatile stock markets.


U.S. workers lost more than $2 trillion in retirement savings in the last 15 months, a loss that could lead workers to delay retirement, Peter Orszag, the director of the Congressional Budget Office, told Congress last month.

"As an outgrowth of this downturn, will we see new attempts to change 401(k)s in any way?" said Geoff Bobroff, head of fund consulting firm Bobroff Consulting Inc in East Greenwich, Rhode Island, reciting a question the mutual fund industry is asking after Tuesday's historic presidential election.

"Will Congress decide to weigh in and revise the 401(k) process plan? To some extent it would be helpful because it could enhance or encourage more savings. On the other hand more regulation could just be more burdensome," he said.

The fortunes of the U.S. mutual fund industry are tied increasingly to retirement savings and to plans such as 401(k)s that allow workers to defer taxes on some income and typically put the money in a mix of stock, bonds and other investments.

About half of the $4.3 trillion invested in these so-called defined contribution plans is managed by mutual fund companies, according to data from the Investment Company Institute, the trade group for the U.S. mutual fund industry.

Fees from those assets flow directly to fund companies' earnings.

Congressional Democrats have already expressed concern about the vulnerability of America's retirement system following decades in which employers have increasingly abandoned traditional pensions and forced workers to rely on tax-advantaged 401(k)s and similar plans with market exposure.

Rep. George Miller, a Democrat from California and chairman of the House Education and Labor Committee, has called 401(k)s, "a big failure in terms of providing an adequate retirement for middle-class Americans."

Radical Alternative

Teresa Ghilarducci, an economist at the New School for Social Research in New York, floated a radical alternative to 401(k)s at a hearing held by Miller Oct. 7.

Under her plan, workers would receive a annual $600 tax refund if they set aside 5 percent of their pay into a retirement account run by the Social Security Administration, which would then invest globally in risky assets to seek high returns.


From that pool, workers would be paid a guaranteed 3 percent a year indexed to inflation.

The change would encourage workers not to hang on to jobs longer than planned.

Because their returns would be guaranteed, workers would be able to retire on schedule, she said.

"We need people to retire when the economy tanks in order to keep up aggregate demand and to reduce pressure on the labor market. And the only way to do that is to unhook the finance markets from retirement income," she told Reuters.

But she doubts Miller will adopt her blueprint in full.

"He wants to make 401(k)s better. He doesn't want to kill the tax deduction. In my favor, he agrees I brought up genuinely credible criticisms of the 401(k) tax break as it exists now." But Democrats may draw from parts of her proposal.

"The Democrats are looking at two paths," she said.

"One is to make the 401(k) system, which is commercial and individualized, more fair, but not do anything to expand coverage or guarantee returns." The other path is to broaden coverage and guarantee returns. "I think the compromise will be a voluntary guaranteed retirement account. So that if people don't have a 401(k), or want a better alternative to a 401(k), they could put their money into a government-guaranteed fund."

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Legendary investor John Bogle, founder of No. 2 U.S. mutual fund company Vanguard Group, expects "a whole package of financial reform" from a Democratic White House that could affect the mutual fund industry by seeking to crack down on the high fees charged by some managers.

He did not comment specifically on retirement savings, but the fund industry faces pressure to disclose fees and account for returns of the 401(k) plans they manage.

"There is going to be a closer look at 401(k)s," said Russel Kinnel, director of fund research at market research company Morningstar, adding that this would reflect a general tightening of regulations in the financial industry in the wake of weeks of turmoil in global markets.

He said economic reforms proposed by President-elect Barack Obama that include raising capital-gains and dividend tax rates also offer an opportunity for mutual fund companies to press lawmakers to bring the industry in line with stock investors who pay tax on capital gains only when profits are realized.

Currently, many mutual funds held in taxable accounts—rather than tax-favored retirement accounts such as 401(k)s—are forced to pay tax on capital-gains distributions even if their investments sour and make losses.

"One of the things the mutual fund industry has wanted for some time is to have that mutual fund tax disparity eliminated," Kinnel said. "If Congress is revisiting capital gains, possibly this would be an opportunity for the fund industry get that on the table."