ery often, 401(k) plans are referred to as nest eggs. For some plan participants,
however, they are more like sieves—money flows in, but then flows right out the
other end.
This issue was recently brought into the limelight with the
controversy over 401(k) plan debit cards. These cards provide participants with
easy access to 401(k) loans, and were dubbed a "gross distortion" of the intent
of 401(k) plans at a July 2008 hearing by the Senate Special Committee on Aging.
Although 401(k) plan debit cards are not widely used, they
do symbolize a valid concern: What is the point of increasing participation in 401(k)
plans through automatic enrollment, automatic escalation and the like if the monies
simply leak out?
As David John and Mark Iwry of the Retirement Security Project
put it at the hearing, "It won’t matter how tightly we lock the front door of the
barn if the horses are free to run out the back."
The reality is, though, when it comes to 401(k) plan leakage,
loans may be a relative trickle. A Transamerica Retirement Services survey finds
that loan utilization has increased in the past few years, but less than one in
five participants have loans outstanding. Almost all participants who take out loans
repay them. And according to Hewitt Associates, among those with loans, the average
outstanding loan balance is $7,800.
What causes that trickle to become more of a torrent is what
happens after employees leave their companies. Often, when this occurs, nearly half
of them simply take their 401(k) assets in the form of cash. The number is much
higher—66 percent—for younger employees, according to Hewitt Associates.
Now consider that figures from the Department of Labor put
the median job tenure for workers ages 25 to 34 at less than three years. This creates
the specter of many people reaching their 40s with little retirement savings—despite
perhaps having actually participated in their defined-contribution plans for a number
of years thanks to being automatically enrolled.
Among those who do preserve their retirement savings, many
participants roll their money into an individual retirement account versus leaving
their money in the 401(k) plan or rolling it over into another 401(k) plan.
Internal Revenue Service data shows that rollovers to IRAs
from employer-sponsored plans are the main source of new cash flowing into IRAs.
Yet the fees associated with retail mutual funds typically used within IRAs can
be significantly higher than that within 401(k) plans.
Consider a participant who has access to an institutionally
priced S&P 500 index fund within a 401(k) plan that costs as little as 2.5 basis
points per year. The average retail S&P 500 index fund’s expense ratio exceeds 60
basis points. Compounded over time, such a wide differential in fees can have a
tremendous impact on retirement accumulation.
Why should plan sponsors care? After all, is it really their
responsibility to ensure the retirement income security of people who are no longer
in their employ? Further, do they really wish to have fiduciary oversight over former
employees’ assets?
Some plan sponsors will care because the defined-contribution
plan is the only retirement-income vehicle that they provide to employees. The idea
of former employees marching toward old age without any employer-provided retirement
benefits may be very much at odds with employers’ goals in offering a defined-contribution
plan in the first place.
Other plan sponsors may recognize that it can be in the best
interest of both current and former employees to encourage terminated and retired
workers to stay in the plan. After all, increased plan assets mean greater economies
of scale that could translate into reduced plan fees, better access to institutional
money managers and even improved administrative services.
What can plan sponsors do to keep people in the 401(k) plan
once they are no longer with the company? One thing is to emphasize the benefits
of the 401(k) plan throughout the tenure of an employee’s career.
When employees leave or retire, plan sponsors may wish to
reinforce these messages, with a view to countering the barrage of propaganda from
IRA providers. Plan sponsors may even want to consider features that may make the
401(k) plan more attractive to former employees (and current employees as well).
For example, some online tools can simplify participants’
financial lives by providing an aggregate view of all of their investment accounts
(including outside brokerage accounts) through the defined-contribution plan’s Web
site.
Other tools include drawdown technology, which provides a
way for retirees to receive a "paycheck" from their defined-contribution account.
Periodic payments are made from the participants’ account to the participant on
a regular basis, based on employees’ needs in retirement, and the balance available
in their account—all of which the drawdown tool calculates.
Finally, if the plan simply allows partial distributions,
this in itself may broaden the plan’s appeal.
Even if plan sponsors do not wish to actively retain former
employees in the 401(k) plan, they can do much to help them avoid cashing out at
termination. This might include providing them with statements showing how much
they would have at retirement, even for the smallest of balances.
Plan sponsors could provide employees with calculations that
show the impact of taxes and penalties on withdrawn amounts. Further, more and more
record keepers support "one-click" rollovers by having the record-keeping system
connect directly with the systems of rollover providers. This can greatly streamline
the often onerous rollover process, which itself can be an obstacle to rolling over
plan balances. Again, any communication should start early, and should be reinforced
when an employee leaves the organization.
The weakened economy, higher oil prices and increasing foreclosures
mean that 401(k) plan assets are more vulnerable than ever to leakage. Although
there’s no widespread evidence that a run on 401(k) plan assets is occurring, certainly
there are pockets of real concern. This has clearly caught the attention of regulators,
who are already taking steps to plug up the holes.
When it comes to helping employees maintain assets for retirement,
what sounds like employer paternalism today may well turn out to be a requirement
in the future.
Workforce Management Online, September 2008 -- Register Now!
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