401(k) co-creator: Next financial crisis may be worse

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Ted Benna, widely regarded as the co-creator of the 401(k), has published a volume that’s part history book, part how-to manual for plan participants. The book also sounds an alarm about some predicted economic perils. The title, “401k — Forty Years Later,” is a clear reminder of just how long 401(k)s have been the dominant retirement savings vehicle.

Employee Benefit News asked Benna what’s on the horizon and what benefits professionals should be focused on. Excerpts follow.

Employee Benefit News: In your book, you expressed serious concern over the level of diligence that many plan sponsors exercise in the oversight of their 401(k) plans, particularly in regard to plan costs. Hasn’t highly publicized litigation changed things?

Ted Benna: I certainly hope so, because some of the legal settlements have been big enough that it ought to get their attention. But the examples I have cited in the book are real historical events, and I think it’s important for people to be aware of them, as a cautionary tale.

EBN: And it’s not just about plan expenses, right?

Benna: That’s right. For example, say you only had five fund choices, and each was presented to participants with simple asset allocation pie charts and clear explanations of what they mean. Then you start adding more and more funds to expand to 10, then 15, then 20 and beyond, just to respond to demands from participants. And now it’s getting so that even socially responsible funds are getting subdivided into very narrow categories. Sponsors aren’t necessarily fulfilling their fiduciary duties when they keep adding more and more options this way.

EBN: Well, isn’t there is a way sponsors can provide more choices, without overwhelming participants?

Benna: As a matter of fact a long time ago I helped a plan supplement its qualified default investment alternatives, or QDIAs, with a mutual fund brokerage window that gives participants the opportunity to pick just about any mutual fund they might want. The sponsor is not responsible for the choices the participants who use it make. But the way it worked out, over 90% of participants stayed in the default target maturity series, and less than 10% went out and said, well, “We want to try and run on our own.”

EBN: Is it fair to say you’re not a big fan of target date funds?

Benna: What concerns me about them today is a change in the way people perceive risk. Bonds are viewed by many people as a safe place to be relative to stocks in bad times. But over the next five and maybe 10 years, I don’t see bonds being a safe haven because, as you know, when interest rates rise, bond prices drop.

EBN: So are you suggesting that the asset allocations of target date funds should be adjusted more often, or that you don’t like the typical glide path?

Benna: When you’re in the accumulation stage, this is not an issue. But for, say, a 63-year-old, or anyone older, I don’t think most can afford the downside to risk that lies within the typical target date fund. I did a historical look-back and ran the numbers to see what would happen. Suppose you were in the drawdown stage 10 years ago in 2008, and you’re drawing out what’s supposed to be a conservative rate of 4% a year Then you get hit with a 20% drop in your supposedly conservative target maturity fund you’re in. Man, that’s ugly. Bonds got hammered as well as stocks, and that’s not supposed to happen.

EBN: What happens over time to that target fund investor in that circumstance, in your analysis?

Benna: The problem is when you’re drawing down, by definition you’re not putting new money in and acquiring discounted shares. If your game plan is to withdraw $15,000 a year, let’s say it’s 4% of your next egg, and you take a 20% loss, then you have to sell more shares. So it’s the reverse of buying discount shares. Instead you’re having to sell discounted shares to raise the cash you need to live on, and you can’t catch up.

EBN: So what’s the message?

Benna: My point isn’t anti-target maturity funds in general; it’s the fact that most retirees right now in this market can’t afford what they’re in — unless we magically skip another 2008. But I’m not counting on that.

EBN: In fact you write that we shouldn’t think of 2008 as a once-in-a-lifetime occurrence.

Benna: 2008 was pretty nasty, but I’m expecting the next one to be worse because individuals, municipalities and the federal government are in much worse shape financially today in terms of their debt loads, than they were going into 2008. So they won’t be as well-equipped to step in and provide assistance.

EBN: So are you suggesting that sponsors should think twice about using target date funds as their QDIA?

Benna: No, because most participants who are defaulted in are younger and in the accumulation stage, so they’re not as vulnerable.

EBN: So should sponsors reach out to target date investors who are on the cusp of retirement and warn them of the risk they face?

Benna: No, I think it’s too risky for employers to do that. The market’s just too unpredictable. I think they should stick with it, because I don’t think they have a better alternative to generally recommend. I guess that’s the bottom line. For employers to tell 55-year-olds, “You really ought to think about getting out of that and moving your savings to a stable value or CDs” — that’s a tough game for employers to play.

EBN: Or a no-win situation? You wrote that early in your career you decided that helping wealthy executives minimize their tax obligations wasn’t what you wanted to devote the remainder of your career to. You wrote about a personal mission to turn 401(k)s into principally a benefit for average workers. How do you feel about things now?

Benna: I don’t want to put too noble a wrap around it. But given the stage of financial markets right now, I do have a concern about older folks who are entering into retirement or are already retired of being aware that they may be taking more risk than they can afford.

EBN: So that leads to what you in your book call “Operation Freedom,” encouraging people to take funds out of 401(k) plans when they can without penalty, and roll them into an IRA, save on fees and do better for themselves. You’re placing a lot of faith in these people to do the right thing on their own.

Benna: I’m addressing that to participants who may not know what they’re paying in fees today. Maybe they’re paying too much, and hopefully they’ll be responsible enough, either with or without help, to get the expenses knocked down. Often they’re paying significantly higher fees than they need to, and not getting added value for doing so.

EBN: Do you have any parting messages for sponsors and advisers?

Benna: Many of them need to be more sensitive to the fact that the law says you need to make decisions solely in the best interest of the participants. And when you don’t do that, you are assuming some risk, pure and simple. Historically decisions often have been made by employers that factor in things other than the sole benefit of the participants, and some of those employers have been paying a major price for that. On the adviser side, many need to wake up to the fact that they’re getting paid outlandishly for the services they’re providing. That shouldn't continue.

EBN: Isn’t that ultimately for sponsors to police and decide what’s unreasonable?

Benna: Yes, employers need to be concerned about what advisers are being paid. Their challenge is that the benchmarks that are used to indicate whether fees are too high or within a normal range are based on norms that are too high to begin with. I think advisers’ compensation should shift to fee for service, like accountants and lawyers, rather than assets under management. An AUM-based fee structure doesn’t determine the level of service you’re getting, only what you’re paying.

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