Thank serendipity, but don’t depend on it

Many Americans caught a lucky break when it came to retirement preparation, but they cannot afford to be complacent

Glenn Dial

The government official who drafted an obscure add-on to the Internal Revenue Tax Code back in the could have had no inkling regarding the consequences. Although it’s true that the one-page addition attracted little notice at the time, it ultimately kicked off the era of make-your-own retirement.

That addendum is, of course, the famous “k” tacked onto section 401 of the Revenue Act of. The irony is that lawmakers were trying to limit executives at some companies from having too much access to cash-deferred plans. Their attempts to rein in a perk created an opportunity that has since become a cornerstone of US private retirement provision.

The 401(k) is a positive unintended consequence that has enabled 52 million Americans to actively prepare for retirement. It was also an early experiment in behavioral finance. Faced with the choice of saving a portion of their wage in exchange for similar contributions from employers, workers clearly embraced this incentive and in the intervening decades have accumulated an estimated $4.4 trillion in assets (plus more than $5 trillion in IRAs, much of which comes from 401(k) rollovers), for their retirement, according to the Investment Company Institute.

The development of 401(k) is serendipity in action, a happy occurrence made by chance. Yet, my fear is that for all the good achieved with the 401(k), we are expecting one small loophole to carry a heavy burden. Much more needs to be undertaken to adequately prepare people for a dignified retirement.

COVERAGE FALLS WELL SHORT

Firstly, there is a coverage problem: many small firms do not offer 401(k)s. According to Government Accountability Office figures, only 14% of small companies with fewer than 100 employees sponsor a plan in which workers can save for retirement. The result is that 53% of the working population has no 401(k). As less than 10% of workers still have a regular pension, large segments of Americans will be left depending solely on Social Security when they retire.

Many of us got lucky when Ted Benna outlined the loophole’s potential, but we cannot assume that fortune will always be so kind when it comes to retirement planningThere are movements in states from California to Maine to extend pension plans for private-sector workers into small businesses. In all, 16 states have passed or are considering such plans. As an industry, we should support efforts to extend retirement preparation. However, these state-run proposals are unlikely to have much impact, because they do not require a Match (or Vesting schedule) and contribution limits are low. For the same reason, they will also be a poor tool for employers seeking to Attract, Retain, & Motivate (ARM) employees.

There are good reasons why small companies don’t offer 401(k)s, and cost is one of them. Small businesses are fighting to establish themselves, so often cannot afford such benefits until they are financially secure. Plans also add an unknown business risk, and many companies don’t want the unwanted hassle of yet more paperwork to administer.

CHEAPEST DOESN’T EQUAL BEST

What are driving fee costs? One factor often overlooked is government involvement. In discussions about the new small-business retirement plans, it is often said it would be better to include them in public-sector plans, which have lower costs. Now, I don’t accept the argument that cheapest means best when it comes to retirement planning, but leaving that aside, the question is, why do such plans have lower costs?

The reason 401(k) fees are high often has little to do with fund selection, more with government oversight. Public-sector plans are not subject to government-mandated regulations covering compliance, record-keeping and non-discrimination testing. Such regulations strive to serve a noble purpose of ensuring that highly compensated employees don’t have an unfair savings advantage. However, they have also had the unintended consequences of driving the cost of such plans out of reach for most small employers (fewer than 25 employees).

This in turn has left many Americans without access to a 401(k) plan. A simple fix would be to eliminate all government-mandated compliance testing and filings for employers with 25 or fewer employees and requiring them to offer a plan. A more competitive retirement plan model would streamline the number of bureaucrats involved. This would reduce fees for all plans and enable the private sector to compete with state systems for the benefit of savers.

Addressing fees is only one of many tasks ahead. People in the US still do not save enough and the 3% contribution rate is among the lowest in the advanced world. We also need to look at educating people about decumulation, how they spend their money in retirement to ensure they don’t outlive their savings, as well as transition risk. This overlooked danger can see investors transition from accumulation to income at an unfavorable point in time under unfavorable market conditions.

Many of us got lucky when Ted Benna, the man who identified the 401(k), outlined the loophole’s potential. But we as individuals cannot assume that fortune will always be so kind when it comes to retirement planning, nor can we as a nation expect the 401(k) in its current state to do all the heavy lifting to solve our growing retirement crisis.

Thank serendipity, but don’t depend on it

Many Americans caught a lucky break when it came to retirement preparation, but they cannot afford to be complacent

Glenn Dial

Thank serendipity, but don’t depend on it

Many Americans caught a lucky break when it came to retirement preparation, but they cannot afford to be complacent

Glenn Dial

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