The fact that 401k plans are replacing pension plans is old news.
But there's still a lot of work to be done when it comes to providing employees with free, independent advice on how to handle this huge responsibility. Many workers still aren't saving enough in their 401k plans to ensure a comfortable retirement. And, even when employees are participating in their company plans, they're often investing improperly.
Sure, 401k plans have improved. Many employers have installed automatic enrollment plans that sign up workers for retirement savings programs when they join the payroll. They're also offering products like target-date retirement funds, also known as lifecycle funds, where all investors need to do is pick the fund with a date that is closest to the year they expect to retire. The fund, which invests in several other funds, grows more conservative as the retirement draws draws near.
But here's my problem: we're not focused enough on finding ways to empower workers with personalized independent advice.
"It's becoming clear that employees aren't doing very well making decisions on their own," notes Olena Berg Lacy, the former assistant secretary of labor and head of the Pension and Welfare Benefits Administration. She's also a board member at Financial Engines, the financial advisory firm founded by Nobel-Prize wining economist William Sharpe.
Automatic enrollment programs and diversified funds are part of a solution that "make 401ks look like traditional pension plans so employees can show up at work and it's all set up for them," she says.
Still, it's an incomplete solution at best. Of those employers using automatic enrollment, the median default deferral rate is a paltry 3%, according to our cousins at the Wall Street Journal. Meanwhile, the majority of plans usually apply automatic enrollment only to new employees, not existing ones. Some target date funds are also flawed: some carry extra fees, while others are larded with a manager's less popular funds. Not to mention that every employee's financial situation is unique.
For me, the most troubling part of this solution is that it ignores the employees that want to create and manage personalized plans but don't know where to start. All these people need is a little help. And, well, let's be honest. They don't want to pay for it.
Who can blame them? Employees are already paying for the fees related to their investments (pension plans used to cover these expenses). Meanwhile, it's less expensive for a company to provide a 401k plan than to manage a pension plan, according to David Wray, the President of the Profit Sharing 401(k) Council of America. Employers seem to be benefiting from the change.
The 401k system would be a lot more effective if employees had all of the tools they need to make informed investment decisions. Independent advisors can help them with that: not only can they can draft personalized long-term investment plans, they also teach clients how to think about asset classes, managers, and fees.
So why don't more employers step up and pay for independent investment advice for employees who want it?
Some employers may fear that they'll be liable for a third party's bad advice. But policy makers have pushed through laws that make it safer for employers to provide employees opportunities for investment advice.
The Profit Sharing 401(k) Council of America's recent survey of 1,000 401(k) plans reported that about 45% of plans offered independent financial advice services to employees. However, not all of these employers picked up the tab for these services.
This advice doesn't have to be expensive. Financial Engines has automated the process with online technology. By doing this, they've managed to keep costs down: they charge $10 to $12 per employee a year, says Chief Investment Officer Chris Jones.
Aren't we worth it?
| Type | Today | Week Ago |
|---|---|---|
| 15 Year Fixed | 4.62%  |
4.67% |
| 30 Year Fixed | 5.15% | 5.15% |
| 1 Year ARM | 3.48% |
3.51% |
| 5/1 Year ARM | 3.62% |
3.68% |
| Type | Today | Week Ago |
|---|---|---|
| Line of Credit | 4.89%  |
4.88% |
| 10 Year Loan | 7.47% | 7.47% |
| 15 Year Loan | 7.61% |
7.60% |
| Type | Today | Week Ago |
|---|---|---|
| Interest Checking | 0.28% | 0.28% |
| Money Market/Savings | 0.38% | 0.38% |
| 12 Month CD | 1.13%  |
1.15% |
| 60 Month IRA CD | 2.40% |
2.41% |
| Type | Today | Week Ago |
|---|---|---|
| Cash Back Cards | 12.66% |
12.68% |
| No Annual Fee Cards | 12.08% |
11.97% |
| Reward Cards | 12.75% |
12.61% |
| Small Business Cards | 11.01% |
10.94% |
| Student Cards | 13.77% |
13.49% |
| Platinum Cards | 12.26% |
12.11% |
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Great focus.
It is debatable whether or not automatic enrollment is worth the cost to employers; and even whether it results in employees saving more for retirement.*
But employers and plan fiduciaries alike have an interest in giving participants viable paths to optimized portfolios. Putting together a portfolio of assets that provide the least risk for any level of expected return -- or the greatest expected return for a given level of risk -- is the only free lunch in the investment world. Outside of the use of efficient portfolios it is all a trade off: risk vs return.
And while managed accounts are but one path to efficient portfolios, they are clearly an important path. And yes, some employers do incorporate advice into the set of services offered to participants without any additional cost.
*Most of the savings that gets into the plan earlier as a result of automatic enrollment is taken out in loans or early withdrawals -- if it is not forfeited or distributed when an employee terminates after a few years employees.
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This is a very interesting take on the ongoing 401k debate. I agree that some of the investment vehicles and programs created to ease the hassle of investing your retirement plan are flawed, however I think at some point it is our responsibilty as employees to take our investments into our own hands. Employers can only do so much to help their employees set up and invest in their retirement plans.
You mentioned that the most troubling part of simplified solutions, such as TD funds and automatic enrollment, is that it ignores the employees who wish to take a more active role in managing their plans. I don't think these services were set up with this employee in mind. At some point I think the responsibility of actively managing your own investments lies with the individual. There are an infinite amount of resources available to the public these days to give individuals the information they need to make informed investment decisions. If one doesn't hold themselves accountable to learn about investing on their own, then maybe the Target Date Funds is their best option for retirement. Why place this additional responsibility on the employer?
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Hi Herb -
Thanks for your thoughtful comments. I agree that we employees need to find our way into "optimized" retirement portfolios - meaning that we capture as much return as possible for the amount of risk we take on in our portfolios. The question is: how do we get there? Advice, education and managed accounts all seem to be part of the answer.
Kristen
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I currently work for a company that enrolls employees automatically in the company's 401K plan -- and a lot of the newer employees are indeed clueless as to how to save up enough for retirement. I agree that individuals are ultimately responsible for funding their own retirement; however, I also agree that companies could do more to educate their employees!
I don't believe in half-way measures; just as employers ought to fully explain benefit options -- such as how to choose between different health insurance plans -- they could do a little more to help employees learn about retirement options.
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Hi Becca -
Thanks for your comment!
I think you're right that target date funds and automatic enrollment are designed for employees that don't want to play an active role designing their retirement portfolios. And employers and plan providers are working hard to get this group of non-motivated savers into effective retirement plans. I just wish more employers would also spend a little more time and money on the group of employees who do want to play an active role managing their retirement investments.
Yes, there are resources out there. But it takes time and expertise to weed through these resources. I think that the best investment advice comes from third-party independent financial advisers who offer unbiased insight on managers, asset allocation and fees. It would be nice if more employers helped employees get this advice.
Kristen
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@Dwight: agreed!
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Thanks for the link that employers can give to employees for advice to 401k
investing. Maybe the investment firms should be developing "employee service packages" that they can sell to companies that would includes seminars and a certain number of one on one meetings with an investment consultant. There is a market for this type of thing!
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Seems like there's a strong efficiency argument to be made for the employer handling more of the 401k issues. It's redundant to have multiple employees researching the same thing when the employer can get all the information once and then distribute it. This can save time and add to the productivity of the company and financial well-being of the workers. Also, the employer, representing the collection of employees, should be able to get better group rates on plans and tools.
While i agree with Becca that employees need to take responsibility for their finances, there are many workers who don't have a handle on even the basics of financial planning. It's amazing how many institutions of higher education graduate their students without any training in personal finance, let alone economics. For these people, some rudimentary guidance in 401k's and saving could go a long way. For the financially savvier employees out there, employers can just provide the tools to help them better plan for their futures.
It's also great to see financial writing done in such a readable, colorful, and informative fashion. Keep it coming.
Theo
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Great article
Now I'll be standing by to read the next installment on the answer to your ending question "Are they worth it?"
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