The 401(k) faces some serious challenges.
The President, Washington lawmakers and state legislators are all trying to chip away at the backbone of employee retirement benefits. While the near-term future of the $4.5 trillion defined contribution plan is secure, moves to alter the 401(k) tax structure, cap plan contributions and create retirement benefit alternatives could significantly affect the 401(k)s 88-plus million current participants.
For benefits managers, who have worked diligently to rebuild participant confidence in the value and security of the 401(k) as Americas go-to workplace savings tool, any talk of undermining or reconfiguring the system mid-stream could be a disincentive.
Elimination of the tax deferral benefits of 401(k)s would upend the value of the entire system, argues John Kalamarides, senior vice president of institutional investment solutions with Prudential Retirement. It doesnt just impact higher-compensated individuals; 80% of employers say tax deferral is essential in order to offer a plan at all, and two-thirds of households say they would think twice about contributing at all, he notes. In a country where retirement planning is as poor as it is, its troubling to think that they might take away the leverage for Americans to save.
While the 401(k) has long been targeted as a quick source of tax money the 1986 Tax Reform bill effectively cut 401(k) contributions by nearly 400%, as lawmakers targeted the plans deferral benefits as leakage to current tax coffers the most recent threat to 401(k) comes as a quiet provision of President Obamas 2015 budget.
A proposal to limit plan participants combined balances among their tax-advantaged accounts, 401(k)s, IRAs and pensions combined, would set a cap, based on the participants age, with interest rates and inflation factored in. Exceed the balance one year and youd be unable to make contributions the next year. A cap on the value of deductions for retirement savings is also in the works.
Its not just a Democrat-led strategy: Congressman Dave Camp, the Republican chairman of the House Ways and Means committee, floated his own tax reform plan earlier this year that would directly chop the tax deduction for high-income 401(k) participants, as well as eliminate the tax shelter of investments in municipal bonds.
On top of the cap and tax plans, there are a number of 401(k) alternatives being proposed by the President, members of Congress and even 16 individual states, to establish retirement planning alternatives. The myRA plan unveiled by during the Presidents State of the Union address would allow those without workplace savings plans to deduct money from their paychecks and invest them in a Treasury-backed retirement savings fund but pre-taxed like a Roth IRA. California, Connecticut, Maryland, Oregon, Wisconsin and other states are also looking to create retirement savings plans, ranging from full-fledged re-creations of defined benefit plans to state-run IRA plans, again largely aimed at workers currently unable to save through employer-sponsored systems.
Critics, such as the Securities Industry and Financial Markets Association, note that any entirely new retirement systems represent a whole new level of bureaucratic management and increase costs for cash-strapped states, as well as a potential tug-of-war between the states and the Department of Labor on ERISA rules and functionality and that state-level savers might not have the same level of rights and protections enjoyed by federally administrated programs.
At the same time, two other Washington notables, Republican Senator Orrin Hatch from Utah, ranking member of the Senate Finance Committee, and Democratic Senator Tom Harkin of Iowa, chairman of the Health, Education, Labor and Pensions Committee, have both floated their own proposals to create an alternative to the existing 401(k) system. Harkins USA Retirement Funds Act would establish a federally controlled, pooled retirement fund with universal coverage and a 6% standard savings rate; Hatchs Secure Annuities for Employee Retirement Act gets states to transfer their pension funds into annuities run by private insurers, as well as adding a low-cost starter 401(k) program to encourage small businesses to take part.
Industry analysts say that while the bulk of the proposals do offer some previously unavailable benefits to lower-income workers who have been underserved by the 401(k)s advantages or employed with companies too small to sponsor their own 401(k) plans the appearance of a confusing range of alternatives could further sidetrack the focus on savings. This would be especially true for employees still unsold on the 401(k)s benefits; for those with 401(k) access, a better path might be the ongoing emphasis on automatic features to help employees not overthink the savings process.
I think that auto-enrollment and auto-escalation have made incredible strides, notes Jeanne Thompson, VP of thought leadership with Fidelity. Its a way to effortlessly put people on a path, when they dont have the impetus to make those decisions and its a way of using inertia as an asset. Combined with a robust employee education program, the results can be encouraging, even for those who have doubts about the 401(k)s overall efficacy.
Will proposals like Hatch or Harkins (or even the presidents myRA) open the floodgates for plan sponsors to move their participants into simpler, lower-cost solutions, or find a way to get around their concerns over 401(k) fees?
Barring anything short of a complete overhaul of the entire system, most experts concede that the 401(k) will remain the vehicle of choice for most American workers an imperfect model, yes, but a system thats helping to reinforce a better-than-basic hope for retirement, especially as Social Security coffers are projected to be insufficient, even by the end of this decade.
Still, benefit managers worry that outside political pressure will continue to threaten the 401(k)s stability, as well as a larger potential agenda calling for the entire retirement system to become a nationalized system.
The ideological battle
For years, the temptation to raid the 401(k) piggy bank more recently couched in an ideological argument that the 401(k) is just a frivolous tax benefit for middle- and upper-class workers, a sentiment mentioned directly by the President himself in this years State of the Union address have caused ripples of worries about the defined benefit retirement plan.
However, proposals to tinker with the existing employee savings plan system are creating a new level of anxiety for plan sponsors and benefits decision-makers. Not to mention setting off alarms with those who watched as debt-stricken European nations, such as Cyprus, absorbed their own citizens retirement funds, the worst case scenario for those who fear further federalization of the American retirement system.
Others simply suggest that the 401(k)s in-built weaknesses substantial exposure to market risk, plus employees temptations to take loans and hardship withdrawals of their own money serve to illustrate that the system never should have become the go-to choice for savers.
I would say that the 401(k) has mostly been a failure, an experiment gone wrong for that middle group of employees, who are not putting enough into it, says Teresa Ghilarducci, an ardent detractor of the 401(k) model. Ghilarducci, chair of the economics department at the New School for Social Research in New York, argues that a public mandate through automatic IRAs, requiring employees to save a portion of their income for retirement, is a far better solution, given the leakage inherent in the system.
Mandate, however, is a dangerous word in this post-ACA climate, and insiders advise caution.
I dont think the country is ready for a mandated retirement system you saw that in the health care debate, says Doug Fisher, senior vice president of policy development with Fidelity Investments.
We need, as an industry, to work with plan sponsors to continue to innovate and drive participation in the current system. I know it still feels complicated to many participants, but its incumbent upon us to make sense of this, to help people better approach their savings goals.
Brian Graff, CEO of the American Society of Pension Professionals and Actuaries, and executive director of the National Association of Plan Advisors, says the political climate does seem especially charged at the moment, as the increasingly polarized nature of debate in Washington has led to more new, out-of-the box retirement proposals, and more eyes on all of that much desired defined contribution tax revenue.
Retirement has become the new health care and it looks like the states are all addressing the same concerns, with the same rhetoric, kind of a grassroots legislative movement, he says, noting state efforts to create state-run, large-pool, automatic-IRA-infused retirement savings funds, ostensibly aimed at lower-paid workers not currently served by workplace 401(k)s. Most likely a state or two will do this and then suddenly the feds will take a serious look. But youre probably going to need a soft mandate in order to move the [retirement savings] needle considerably.
A call to action
Graffs organization has long worked on behalf of the retirement industry to help reinforce the benefits of the existing 401(k) structure, going so far as launching the Save My 401(k) campaign in 2012. He notes that the Presidents opinions on the social imbalances in the 401(k)s benefits reflect a continued disconnect over the entire retirement conversation in America, itself part of a larger conversation about financial equality.
Marcy Supovitz, immediate past president of the National Association of Plan Advisors, said benefits managers who feel like getting engaged in the political process can get involved with advocacy groups such as hers, as well as the ongoing educational outreach of organizations including the American Benefits Council and the Plan Sponsor Council of America, as well as the American Business Council and the U.S. Chamber of Commerce.
Were all committed to enhancing and improving the retirement prospects for Americas workers and often that means educating lawmakers to really understand that tax deferral does not mean that the taxes disappear forever, unlike things such as mortgage interest deductions, she notes.
[Politicians] also need to be aware that there are non-discrimination rules in place so the tax benefits arent necessarily applied disproportionally, she adds. Weve sent an awful lot of letters to Congress, and that will pick up as new retirement proposals are introduced. And if programs are developed at the state level, thats not necessarily a bad thing, as long as they allow for plans that are already available. New proposals, unfortunately, just tend to add confusion to the system.
And beyond taking direct lobbying action, industry insiders suggest that becoming a stronger advocate for the 401(k)s benefits as well as implementing a modicum of plan design to push participation might help add weight to the value of the existing system. Financial education, in particular, could be the best way to empower participants.
For plan sponsors such as Chris Jann, CEO of Medicus Solutions, Inc, a health care IT company in Alpharetta, Ga., the most positive path for his heavily vested and enthusiastic 401(k) participants in these uncertain circumstances is to stay the course and to help educate other small employers about the value of sponsoring and encouraging employees to save. The average deferral rate at Janns firm is 10%, and automatic enrollment, auto-escalation and an annual discretionary match have all helped keep participation at a very strong level.
Employers [themselves] must be incentivized to educate their associates and help provide guidance to them; some will do it out of the goodness of their hearts, but the average owner will not, he says. Its a matter of caring and providing education to employees so that they understand the benefit. Its not that most dont want to do it, they [just] dont see the real benefit and dont understand how the money can truly work for them.
Dan Harding, director of compensation and benefits at MVP Health Care in Schenectady, N.Y., has also taken his form of advocacy in a very strong educational push for not only new but existing workers among his 1,500-person employee base. Thats helped move MVP to a 94% overall participation rate; hes doing his very best to keep employees focused and involved.
The biggest thing for us is financial wellness in general, and a 401(k) is just a part of it, but its a key engagement tool, he says. Were always looking at refining our plan design to better engage the participants. The 401(k) is not a tool that just sits there, its something that has to be looked at over and over again.
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