Financial security in retirement is one of our nation's cornerstone principles when it comes to the way of life we have come to envision after a lifetime of hard work, dedication and sacrifice. Originally, the underpinning of that retirement security for those in the private sector was to come from Social Security enhanced by private pensions and personal savings. Unfortunately, for many of us, the demise of most employer-funded primary pension plans and inadequate personal savings has shifted the role of Social Security from being a safety net of supplemental income to being the primary, and sometimes only, source of retirement cash flow.
Retirement plans can't continue to do business as usual. The current approach is failing to provide the type of retirement security that people need from their primary private income source. Going forward there has to be a realization that 401(k) and 403(b) plans have to move away from being viewed as simply retirement savings plans. Instead, they have to be built and managed to deliver meaningful and measurable progress toward successful outcomes. Successful outcomes have to be defined as the generation of sufficient income to fund comfortable and dignified retirements.
Unfortunately, plan sponsors face the same challenges that participants face - apathy and procrastination. Both need to pay more attention to their retirement plan, but they're too busy with other aspects of their business and lives.
Regardless, plan sponsors are mandated to take their responsibilities seriously. They are placed in a position of trust and held accountable, regardless of their expertise in such matters. As such, most plan sponsors, or their internally designated fiduciary representatives, would be well-advised to seek counsel from experts or service providers who can and are willing to help shoulder, or even accept transfer of, the majority of their fiduciary and operational responsibilities. This process can be done with an existing stand-alone plan design or, as many plan sponsors today are exploring, by adopting a multiple employer plan. A MEP is a single, qualified retirement plan sponsored by a lead employer housing multiple different adopting employers with common retirement plan objectives. This unique type of plan construct offers numerous advantages when compared to a typical stand-alone plan sponsored by a single employer. Some of those advantages are:
1. Cost reductions through plan aggregation, creating volume discounting.
2. Fiduciary risk transfer to the MEP sponsor and its named fiduciary.
3. Elimination of document maintenance by adopting employers.
4. Elimination of Form 5500 filings by adopting employers.
5. For larger adopting employers, elimination of expensive individual ERISA audits.
The current level of retirement insecurity is pervasive and disturbing. According to The Employee Benefits Research Institute's 2010 Retirement Readiness Rating, 47.2% of older baby boomers (aged 56-62) are simulated to be "at risk" of not having sufficient retirement resources to pay for basic retirement expenditures and uninsured health care costs (estimated to exceed $250,000). Younger baby boomers (aged 46-55) were slightly better off with "only" 43.7% simulated to be at risk. High-income earners are not exempt from this issue, with 23.3% of the highest-income subgroup deemed to be at risk.
There are a multitude of reasons for this lack of retirement readiness triggered by an inadequate accumulation of personal savings and investments. Some of the reasons are basic, such as a lack of commitment to deferring current income to create future capital for retirement or simply starting too late to allow sufficient compounding time to create the desired outcomes.
Others are more complex, such as the impact of investment losses during the recent recession that have not been recovered, an extremely low current interest rate environment, the deterioration of real estate values and flat-to-even declining incomes, all of which have combined to negatively impact the net worth of even the most prudent.
For many, the first response to addressing the issue is to delay retirement. According to the May 2009 issue of The McKinsey Quarterly, almost 25% of all U.S. consumers were already planning to delay retirement beyond a targeted age of 64.
The 1% difference
Costs are a key component of an employer-sponsored retirement plan and, in most cases, the most measurable and controllable aspect of fiduciary oversight. In recognition of how important fees are to the financial security of an estimated 72 million retirement plan participants, the Department of Labor has passed new fee disclosure rules that go into effect in 2012. One set of rules set forth under ERISA 408(b)(2) mandates the plan's service providers to deliver uniform disclosure of all fees in excess of $1,000, as well as any conflicts of interest that might exist. The second set of rules, as set forth under ERISA 404(a)(5), finally mandate clear and understandable disclosure directly to plan participants of any fees that impact individual accounts.
The following example demonstrates how fees and expenses can affect an account. Assume that you have an employee with 35 years until retirement and a current 401(k) account balance of $25,000. If returns on investments in his/her account over the next 35 years average 7%, and fees and expenses reduce his/her average returns by 0.5%, the account balance will grow to $227,000 at retirement, even if there are no further contributions to the account. If fees and expenses are 1.5%, however, the account balance will grow to only $163,000. The 1% difference in fees and expenses would reduce your employee's account balance at retirement by 28%.
Even a small difference can have a huge impact on future values. If one service provider's fees "all-in" are 1%, and a competitor's are "only" a half percentage point more expensive at 1.5% - with no discernible difference in services rendered - why would you pay 50% more for the same thing, regardless of the product or service in question? Keep in mind that, as a plan sponsor, you have a fiduciary responsibility to make sure that fees paid for services rendered are fair and reasonable when compared to similar alternatives, or fiduciary liability can be triggered.
Plan sponsors should be prepared to defend their plan's fee structure or take steps toward change if it's determined that better or more reasonable alternatives exist. It's better that the process is proactively initiated by the plan sponsor than initiated in reaction to participants armed with newly available information and using it to demand accountability from the plan's decision-makers.
Investors make mistakes
Many studies have been done comparing the investment returns of individual investors to those of institutional investors. One analysis found that over the 20-year period from 1988 to 2007, the average individual equity investor realized a return of 4.48%, while the average institutional equity investor realized a return in excess of 10%. Inflation over that same period was measured at 2.99%.
According to another study, the four most detrimental mistakes made by individual investors that lead to this underperformance are: not paying enough attention to asset allocation, trying to time the market, having too much money in one investment and holding onto poor investments too long. In many cases, these mistakes exacerbated the investment losses experienced by many investors during the two savage bear markets of 2000-2002 and 2008.
While future performance can never be guaranteed, within a well-constructed 401(k) or 403(b) plan, these investment pitfalls can be addressed and overcome by:
1. Using an open architecture investment platform from an independent custodian offering unrestricted access to highly rated investment options in the desired asset classes, many times at pricing only available to large institutions.
2. Engaging an ERISA 3(21) or 3(38) investment fiduciary that will accept the responsibility and associated liability of monitoring and managing the plan's investment menu. Taking this approach dramatically reduces the fiduciary liability exposure to the plan sponsor and its designated representatives.
3. Offering lifecycle or target-date funds and/or multifamily asset allocation models as investment options to simplify the participants' decision-making process and provide access to institutional-caliber investment management processes.
4. Providing access to vetted investment professionals legally bound by a fiduciary standard of care and loyalty to provide personalized advice and guidance that is in the best interest of the plan participants.
Retirement plans and planning are at a crossroads. To create the financial security for the private sector that we've all come to expect, we have to reset our priorities, commit to higher standards, take our responsibilities seriously and then provide flawless execution. The solution must be a collective one, where plan sponsors, government regulatory bodies, the retirement plan industry and participants come together in a cohesive effort.
If that cooperation can take place, financial security after a lifetime of hard work, dedication and sacrifice is still very much possible, and employer-sponsored 401(k) and 403(b) plans will be at the heart of the effort.
Jeffery A. Acheson, QPFC, is a partner with Schneider Downs Wealth Management Advisors, LP, and the managing director of its retirement plan solutions division. SDWMA has offices in Pittsburgh, Pa., and Columbus, Ohio.
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