WASHINGTON -- The Retirement Savings Project, a leading policy research group backed by The Brookings Institution, The Heritage Foundation and Georgetown University, and affiliated with FINRA and the AARP, is advocating new approaches for defined contribution plans, Social Security and tax policies to insure Americans' retirement future.
David C. John, deputy director of The Retirement Security Project and a frequent Congressional witness, sat down with Money Management Executive Editor Lee Barney to discuss new laws and regulations that will reshape 401(k) plans and offer new challenges and opportunities for the mutual fund industry-most notably reaching the 78 million Americans who have no workplace retirement savings at all.
MME: Before the 2008 financial crisis, fund companies were adept at offering products that met the hottest investment trends of the moment. Are the absolute-return, guaranteed and alternative strategies being offered now the right solutions?
David C. John: The trend I am seeing among asset management firms is an increasing interest in their consumer base for some sort of risk management. Of course, this is the flavor of the month, so we will have to see if this continues.
But right now, people are very much aware of the downside, and those who hold funds for retirement savings are now aware that they could reach the age of 60, and another market crash could put them 10 years out from their retirement savings goals. We are seeing an increasing number of ways to integrate safety, whether it's an annuitization or a limitation on losses, so yes, I think that's what is really needed.
We are also seeing a refocusing by the Department of Labor, Securities and Exchange Commission and Treasury on what is the best retirement solution for a 401(k), 403(b), 457 or other type of defined contribution plan, and the fact that the industry is already moving in this direction makes it much easier to reduce the impact of potential legislative or regulatory changes.
MME: How is the Retirement Security Project working with the powers that be in effecting some of these changes?
John: The Retirement Security Project is a curious organization, and loads of fun to be part of, actually. You are meeting me here today at Heritage, which is a small, conservative think-tank. RSP is a joint venture of Georgetown and Brookings, which is a centrist/liberal think-tank.
The principals of these groups started working together about five years ago on a couple of retirement savings ideas with the goal of trying to lift this issue out of the partisan, ideological mire that so much of Washington politics is trapped in. I was formally asked to join the project in January 2007.
Again, what we are trying to do is not, for instance, focus solely on Social Security, which often is a very partisan issue, but to actually improve retirement savings in the U.S.
We look at a variety of issues. One big issue one is coverage. As you are aware, only about half the workforce has access to a 401(k) plan, regardless of whether they take it up or not.
Mark Iwry, deputy director of the Treasury, and myself have devoted our efforts to promoting the Automatic IRA, which is a retirement savings vehicle for small businesses. The Automatic IRA has gained bipartisan support, having been endorsed by both presidential candidates John McCain and Barack Obama in 2008, and it's part of the Obama budget.
We go beyond that to the original purpose of the RSP to address automatic enrollment. We work on automatic enrollment within 401(k)s plans, and we are trying to use the same vehicle as Automatic 401(k)s to finance techniques in other aspects of retirement savings, such as state pension plans.
The Retirement Security Project, in turn, is part of the group called Retirement Made Simpler, which is a coalition of RSP, the AARP and FINRA, both of which are respected advocacy, regulatory, and policy organizations. The campaign was created specifically to provide companies with the tools and information they need to automate their 401(k) plans, including real-world experience from other companies that already have made the switch.
MME: The fund industry has successfully penetrated the large 401(k) market. Still, why is half the American population without a workplace retirement savings plan?
John: What we are going to see among the large fund companies that manage the nation's biggest large 401(k) plans is a continuing fight for market share as sponsors and investors seek a better deal, with the focus on cost. The variety of investments and the new type of investments that workers are interested in, will change.
And to a large extent, we will certainly see one fund administration company going after the business of another, as well as increasing pressure on the funds offered on the platform.
But the mutual fund companies continue to focus most of their energies on the largest plans because the smaller plans aren't always profitable.
Many of the companies we talked to operate on the theory that they want large amounts of capital per person. When we talk to them about setting up the Automatic IRA, they say, "Fine, but we only want people with $10,000 or more in assets." Well, if you are only making $30,000, that $10,000 is going to take you a while to accumulate. Others suggest, "Maybe $5,000 should be our threshold."
The Automatic IRA is certainly open to all mutual fund companies that are interested in providing it, but most of them have been somewhat reluctant. So, we will structure this in a way that initially, depending on the legislation that is introduced to the House and the Senate, where the employer may choose to have a form of a government bond as an accumulator account. Once an individual's savings has reached a certain size-the bill currently proposes $5,000 to $6,000-at that point, the money would roll into a default option. At the moment that is a variation on a target-date fund.
MME: Shouldn't this streamlined, forward-looking way of running Automatic IRAs be appealing to the fund industry?
John: If mutual funds continue with their traditional business model, they are likely to miss this opportunity. While many of them have focused on the early years and concluded that all this means is large numbers of fairly small accounts, and a significant number of accounts that will become orphaned as a worker leaves a job, etc.-in the long run, what we are going to see is a mechanism that is much more mature.
And if the mutual funds don't choose to get involved with this market now, they will miss out.
We are already seeing, for instance, some of the back-office providers starting to put together groups that make money a new way. Instead of making their money on X-dollars in fees per individual, they will make money from small fees charged to a large number of people. And they are already up and active, even though the legislation hasn't passed yet. They are ready.
Some mutual funds may expect they can turn around and go into the Automatic IRA business later on, but they may be shocked to find they have lost first-mover advantage on gaining the business of new workers as they enter the workforce.
This is not just going to be a matter of capturing the business of the small savers but the far more important issue of retirement rollovers from workers who have been saving for some time and move to a new employer.
We are trying to create a seamless retirement savings system that may start with a small business employing a 20-year-old who is in an Automatic IRA but who at age 25 moves to a Fortune 500 and has a 401(k). They may then switch back to an Automatic IRA and then back again to a 401(k). The idea is that the money will readily move along.
And as time goes on, the Automatic IRA is going to become the home of significant rollovers for people in their 40s or their 50s who have sizeable assets.
MME: So, if fund companies don't move now, they would be late to the rollover game.
John: They would be very late to the game. It could be an interesting challenge going forward.
MME: Would the Automatic IRA serve as a lifetime umbrella for various types of retirement savings vehicles, including, potentially, a retiree's portfolio?
John: Yes. The Automatic IRA is going to be, once Congress passes it, a mandatory offering with automatic enrollment in a traditional IRA for any firm that has more than 10 employees. It will be voluntary for smaller companies.
MME: Would the Automatic IRA embrace the Roth?
John: Yes, the default could be a Roth, and as you are aware, a significant amount of the new money going into IRAs is Roth anyway.
MME: Your idea makes rollovers easy.
John: Exactly. The idea, again, is to have a perfectly seamless retirement structure. For the individual, it's a great deal, because they won't have any gaps in savings or the temptation of cashing out of their portfolio.
For the country as a whole-and I write on research policies, so I think on that level, also-this will prevent us from having a large number of people who are going to reach retirement dependent only on Social Security, which as you know are is underfunded anyway. It may extend for another 20 or 30 years, but people in their 20s or 30s now are going to find that because Social Security has significant deficits, its benefit promises will be reexamined.
So, not only is Social Security already not enough to retire on, there's really no room to increase Social Security benefits to help people who haven't been able to save. We want to set up a system that will get people to save for retirement from age 21 or whenever they go into the workforce full-time, all the way through to the point when they retire.
MME: How have your ideas been received here in Washington?
John: It's been pretty well received in Washington. It's not universally well-received; in this political atmosphere, you could have a resolution in favor of motherhood, morality and the flag, and it wouldn't get bipartisan support.
But we have worked on this for many years now and have reduced, we think to the maximum extent possible, the burden placed on the new employer. We have tried to make this product as simple as possible for an employee to try and set it up so that they don't have to be an MBA to get good results-and so that it fits within an the overall retirement savings system.
We think, overall, that we've made the case, or will be making the case, to get this national problem taken care of once and for all.
MME: The 401(k) isn't living up to its potential. The participation rate is only about 70% of the people in large plans.
John: True, but once they automatically enroll, it goes up to about 80% and as high as 90%. So, as you have auto enrollment, that solves a fair amount of the problems with the 401(k).
But there are many other problems we also have to deal with. For instance, there is some indication that even with automatic enrollment, saving behaviors may be different among different populations: national groups, gender groups, racial groups, etc. And it may well be that automatic enrollment is an essential part, but it's not sufficient, and we need to do something in addition to that.
And then there's education. Education is essential, but unfortunately much of the education that's out there is basically produced by the marketing departments of investment companies, and it more reflects their interests and ideas than it reflects the needs and desires of the worker.
The enrollment seminar I went to was a complete waste of my time. Realistically speaking, you are telling someone how to do something before they have any practical experience with it. Now, on the other hand, once the investor has reached a certain dollar level and/or age level, then, at that point, it is the right time for an asset management firm to come in and say, "OK, now you've got some experience with this. Here's how to make it even better."
MME: In other words, plan sponsors and fund administrators could tailor their messages to different age and income groups, rather than blanketing all with one message.
John: Absolutely, because at a certain level, you are focused mostly on accumulation, but especially in this day and age, you also have the residual worry of risk. There are other needs as you continue, such as locking in savings and guarantee lifetime income.
MME: What about the growing debate at the DOL and Treasury on introducing annuities to 401(k)s?
John: One of the other things we've concentrated on at RSP is annuitization. One idea is trial annuitization.
What was intriguing to me is that I did a presentation on trial annuitization to insurance company CEOs. After my presentation, one CEO of one of the largest insurance companies in the U.S. stuck up his hand and said, "I don't see how this works in the slightest, and if we did offer this sort of thing, I don't see how we would make any money, and we certainly wouldn't be very proud of how much we would have to charge for it."
Well, another CEO sitting behind him was looking like the Cheshire cat because they already had a product that fit.
Likewise, Mark Iwry and John Turner, director of the Pension Policy Center at Brookings, have an idea where you gradually shift into annuitization starting at about age 45 or so. You would shift a portion of your savings into an annuity over 20 years, period. Another insurance company already has products for that. There is no reason why mutual fund and other financial companies cannot develop similar product types. But they're not, so far, willing to do the extra due diligence.
MME: Are any mutual fund companies evolving toward a better way of communicating these needs to their customers?
John: Actually, not yet. What we are seeing is an increased understanding. I have been very interested in some of the speeches we have been hearing from Putnam Investments. They are clearly thinking strategically and recognizing some of the long-term implications. Prudential and Fidelity are also both doing some very interesting work at the moment.
But the focus of this discussion is it's really not here today's retirees or near retirees. It's the understanding that is starting to develop. We're really not talking about educating people who are 50. The important impact of this will be for those who are in their 20s and 30s right now.
MME: With the burden of preparing for retirement shifting from companies to the individual, isn't it critical for the mutual fund industry, employers and the government to get this right?
John: The problem with the 401(k) and the other variations is that they were an accident. This was not planned policy. It never has been planned policy.
The 401(k) was, as you have implied, intended as a supplement. Going forward, it won't be.
One recent study by the Employee Benefit Research Institute found that younger workers who stick with saving can actually expect to accumulate many multiples of their annual earnings, and that's what they're going to need to have.
For better or worse, we now find ourselves in a situation where the 401(k), Automatic IRA, privatized, and some form of Social Security-related account or some other national retirement savings plan-must now incorporate the best features of a DB plan so that we come out with better outcomes for younger workers.
That is going to mean automatic enrollment and automatic escalation well above 3% contributions, automatic rollovers and better definitions for default funds.
The industry was caught in a crossfire because initially, default target-date funds were intended to slide to a low proportion of 0% or a low percentage of equities by age 65. Then, in response to the longevity argument, fund companies increased the proportion invested in equities at retirement.
MME: The longevity argument is at complete odds with the failure of historical norms that happened in the financial crisis of 2008.
John: Historical norms are wonderful until you have some sort of an odd event that you never planned for, and sadly, in American business, it's not just at financial companies that strategic planning is not terribly well appreciated. Especially if it interferes with a business model that is working well right now.
So, then we face the question of, how do you make a person's retirement savings last long enough, and that's going to be a very huge challenge, and the mutual fund industry has the option of either ensuring a stream of lifetime income, or it is going to watch its best customers, once they've reached their highest accumulation, shifting money out of mutual funds into insurance products, bank products or some new type that we haven't even imagined yet.
MME: Aren't these new ideas healthy?
John: They are very healthy. It's exactly what we need. Especially if you recognize that the U.S. political system rarely makes revolutionary changes. Usually it's evolutionary. All of this will lead to a fairly detailed discussion on the future of retirement in America. That's a different debate than mutual funds and financial lobbyists are used to dealing with.
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