There's a lot of talk in Washington these days about the deficiencies of the 401(k) system. While the voluntary defined contribution system has allowed millions of Americans to accumulate trillions of dollars in retirement savings, it leaves about half of all workers out in the cold because they don't have access to a retirement plan at work.
But there's a logical solution to the problem of expanding access to workplace-based retirement savings plans and financial advisers could reap the benefits of potential changes.
I sat down with Jamie Kalamarides, senior vice president of institutional investment solutions at Prudential, to discuss the legislative outlook for 401(k) reform and the impact on the financial adviser community. While neither of us was willing to put money on the outcome of the presidential election, Kalamarides thinks there is already sufficient agreement on Capitol Hill—regardless of who wins the White House or who controls the House and Senate—to approve legislation that would allow small businesses to join newly created multi-employer retirement plans. So far, legislation has been introduced on both sides of Capitol Hill to make this concept a reality.
The plans would be built on the demonstrated best practices of auto-401(k) features authorized by the Pension Protection Act of 2006. That means participants would be automatically enrolled in a 401(k) plan (although they could opt out); they would have a fixed percentage of their salary earmarked for 401(k) contributions initially; and their salary deferrals would automatically increase by a certain amount each year. The auto enrollment feature would satisfy safe-harbor requirements and investments would include a qualified default option such as a target-date fund.
Auto enrollment and escalation features have become commonplace in many existing 401(k) plans in recent years and have successfully increased enrollment. But critics charge that the standard 3% initial deferral rate is too low to provide sufficient savings in retirement and the annual increase, which is typically 1% a year, is too paltry. Kalamarides suggested that defaults of 6% initially and 2% annual increases would be more appropriate to build a meaningful nest egg.
Although 90% or more of large employers offer 401(k) plans, only about a third of small employers do. And the fact is most Americans work for small businesses. So the key to expanding 401(k) participation is to make it more attractive to small businesses to offer a retirement savings plan. The biggest stumbling blocks are cost, administrative hassles and fiduciary responsibility—hurdles that many small businesses can't overcome.
But think what would happen if groups of small businesses could band together in a model 401(k) plan that is already approved by the IRS, one that offers low-cost, professional investment management and shifts the fiduciary responsibility from the plan sponsor to the plan administrator. Bingo! Suddenly more small businesses may find it more attractive and cost effective to offer a retirement plan to their employees.
And imagine what that could mean for financial advisers who manage the investments and serve as the fiduciaries for such plans. Rather than trying to create and service a dozen or so individual small plans, you could administer a multiple-employer plan, streamlining the investment options, lowering start-up costs and relieving plan sponsors of fiduciary duties. And when some of those plans grow big enough to justify a more customized plan of their own, they'll know who to turn to for advice. “That is why the prospect of streamlined, multiple-employer 401(k) plans for small businesses could be great for financial advisers,” Kalamarides said.
Of course there are still sticking points to be resolved, particularly whether such plans would be voluntary or mandatory and whether employer would be required to offer matching contributions. But with bipartisan support for the broader concept of providing an easier way for small businesses to offer retirement plans to their workers, those kinds of obstacles can be overcome.