Workplace retirement plans, specifically 401(k)s, need a major overhaul, say advisors, who have to navigate them because they're essential if many clients are to reach their retirement goals. But familiar as 401(k)s are, planners love to hate them, and they'll readily cite long lists of faults with the plans themselves, as well as the way the $2.8 trillion 401(k) industry operates.
The most often cited problems with the plans: Not enough fiduciary advisors watch over them, participants don't know where to learn more about them, and fund choices are overly complex and don't go far enough to hedge risk. Considering that most Americans rely heavily on 401(k)s to build their portfolios, it's no wonder financial planners want to see the industry change.
Though most retirement planning specialists say Americans should set up their 401(k) plans with the hope of replacing 80% of their peak earnings through retirement, studies by the U.S. Census, among others, have found that the population is not socking enough away. Census researchers calculated in October 2010 that Americans aged 55 to 62 had accumulated between 66% and 75% of their peak incomes for retirement overall, including funds from 401(k) plans.
Why aren't Americans maximizing their 401(k)s to save for retirement? Planners say one problem is that choosing from a menu of investments is overwhelming for many savers, and judging and selecting service providers is sometimes a hassle for plan sponsors. For planners, the 401(k) industry has built-in complexities that make incorporating the plans into their practices a challenge. "It is daunting for financial advisors to understand the various products and platforms - and to market them," says Katie Umile, CEO of Boston-based iCapital, a retirement plan advisor. Advising on large plans, and even some mid-market plans, is expensive and involves a long lead time to reap rewards. These issues need to be sorted out because the stakes are high, Umile says. "Otherwise, we could be looking at the first generation of Americans who will not be able to retire," she says.
MAKING IT SIMPLE
Industry professionals like Umile do have ideas - many - on how to improve the plans. There are three ideas that would go a long way in simplifying the retirement planning process, says Ted Benna, who created and implemented the first 401(k) plan three decades ago. Benna is co-founder of Malvern Benefits, a 401(k) consulting firm in Jersey Shore, Pa.
Benna's three major suggested fixes? Adapt automatic enrollment, put participants into target-date maturity funds and automatically increase contributions by 1% a year. If plan sponsors and advisors did this, more employees would accumulate retirement assets, unless they elected otherwise.
Benna says one further change is trickier - enacting legislation preventing savers from withdrawing money from their 401(k)s when they change jobs or a plan is terminated. "They would have to leave the funds in a retirement account instead of taking a check and buying a boat," he says. Benna's chief misgiving about 401(k) plans is that the investment selection process has become unwieldy and needlessly complicated.
"The investment part was always easy"- until lately, Benna says. "The early plans limited participants to just two options: a fixed and a guaranteed investment. It was very easy for them to choose a stock and bond ratio. We've gotten away from that."
SHINING A LIGHT
This year, the U.S. Department of Labor, which regulates 401(k) plans, has started requiring retirement plan providers, like mutual fund companies and discount brokerage firms, as well as third-party administrators, to disclose the fees they charge to employers who are plan sponsors. The plan sponsors, in turn, have to disclose to participants what fees they pay.
The agency hopes to prompt employers and employees to examine the value of the services for which they are paying. Advisors say they welcome the changes, but add that fee disclosures will not solve far bigger problems. "They are taking their eyes off two other factors: the savings rate and diversification," says J. Timothy Corle, president of Tycor Benefit Administrators in Berwyn, Pa.,
"Plan participants should be asked: 'Do you understand how much you have to save and where you need to invest it?'" says Corle, who is close to earning his CFP credentials. "We need to switch the conversation so that employers feel good about what they are offering and employees feel good about what they are getting."
Industry professionals say plan providers should also probably revamp participants' 401(k) account statements. Instead of only displaying quarterly balances and fees, statements should show participants a projection of what their monthly retirement income would be based on the current balance, says Kurt Jackson, founder of Central Coast Wealth Management of Pismo Beach, Calif. Perhaps if plan participants saw that their accumulated funds would not replace their peak income, it might be the wake-up call they need to make changes, he says.
THE FIDUCIARY STANDARD
Some advisors say that all professionals who provide investment advice to 401(k) plans should be required to act as fiduciaries. The Labor Department is hoping to craft an official definition of fiduciary and require all advisors under its watch to comply, but it is getting push back from industry organizations, including the Financial Services Institute, which represents independent broker-dealers, about what specific requirements advisors must meet when interacting with clients.
Umile says the financial advisory business is replete with conflicts of interest. Not only do planners need to disclose those conflicts carefully, but plan sponsors might not understand what all of the conflicts mean.
"You could be engaged to manage a retirement plan in a fiduciary capacity and not have to disclose your conflicts of interest on your investment management business," Umile says. Yet a proposed fiduciary requirement is still a step in the right direction, she says.
One of the reasons registered reps and other financial advisors do not follow the fiduciary standard of care is that those professionals are often personally liable for the advice they dispense to clients, Corle says. Advisors operating under the fiduciary standard are often very restricted about what they can discuss with clients.
"I would remove the personal liability element, and still keep the meat around prudent decision-making," Corle says. "The vast majority of us who do operate under the fiduciary standard really want to help people."
Greater accountability also means that plan advisors should be willing to be judged, at least in part, by how their investment recommendations perform, Umile says. "Most plan sponsors don't have the data necessary to tell whether consultants or investment managers are doing a good job," she explains. "We get engaged by clients as the prudent expert to select plan investments, and we should be reviewed like any other investment manager gets reviewed."
Companies that offer retirement plans also need better guidance on the investment choices available to the participants, Umile says. "I can't tell you how many lineups I see where there are a ton of funds in the same asset class," she says. "How does an average participant decide which large-cap growth fund you should use if there are 15?"
GETTING IT ALL INTO PLACE
Sometimes employers themselves can play a bigger role in improving the 401(k) industry. Some company 401(k) plans lack investment committees. Companies that offer retirement saving plans to employees should have a fiduciary investment committee in place whenever possible, Umile says.
"Otherwise, how can you prove that you are managing in the best interest of a plan participant?" Umile asks. "Best practices would substantiate that," she says.
UNDERSTANDING HOW IT WORKS
To best serve 401(k) clients in such a complicated landscape of products and platforms, advisors can earn credentials as a retirement plan specialist. One organization, the Retirement Advisor University, based in Jupiter, Fla., offers advisors certification in the defined contributions market.
The university is primarily aimed at advisors who run dedicated defined contribution practices, and requires that they meet specific criteria to complete the course and be rewarded the certified 401(k) professional mark, CKP. The CKP course is focused on helping advisors guide their clients and their retirement investment plans to better outcomes, says Fred Barstein, the Retirement Advisor University's founder and executive director.
The program is affiliated with the UCLA Anderson School of Management, and offers three days of on-campus instruction from UCLA professors, Barstein says. "We felt like the industry needed this training program, and having UCLA involved forced me to help make it rigorous," Barstein says.
The Retirement Advisor University follows behavioral finance principles espoused by Shlomo Benartzi, a professor and co-chair of the behavioral decision-making group at UCLA's Anderson School; and Richard Thaler, a professor of behavioral finance and economics at the University of Chicago Booth School of Business, who co-founded the discipline. To qualify for the CKP program, advisors need to have at least three years of experience in the defined contribution industry, and manage 10 plans with roughly $30 million in assets.
The 401(k) industry is approaching an important crossroads, where regulators and industry professionals will have to make choices about how to best serve clients. Planners can have an enormous input in that conversation and be rewarded for their efforts if they get involved now, industry professionals say.
"This is a very difficult problem," Barstein says. "How can we help participants be more successful? We don't have all the answers, but we are asking all the right questions."
Donna Mitchell is a senior editor of Financial Planning.