Designing 401(k)s that really work

When “Frontline” aired “The Retirement Gamble,” its controversial feature on retirement investing, it caused a firestorm of reaction from financial advisers, plan sponsors, plan providers and investors.

Although it provided a good start to a discussion about America’s retirement crisis, “Frontline” fell short of presenting a complete picture of the issues. Lost in the hour-long documentary — and the subsequent reactions of anger, despair and ruffled feathers — were many of the positive developments and solutions that are driving change in the 401(k) industry.

One such trend is the recognition from a growing number of retirement professionals that 401(k)s can incorporate the best traits of a defined-benefit plan. Although originally designed as a supplement to pensions and Social Security, 401(k)s will have to play a greater role in the lives of retired Americans if we are to overcome the retirement crisis.

Here are some steps that government and the industry can take to make 401(k)s more effective:

Mandatory enrollment for all employees: Automatic enrollment is increasingly being incorporated into 401(k) plans, particularly by larger employers. The American Benefits Institute surveyed plan sponsors this year and found that 56% of the respondents include an auto-enrollment feature in their 401(k) plans. Although that’s encouraging news, many employers still don’t offer such programs, particularly in the small-plan market. Federal mandates requiring employers, including small businesses, to offer a plan and automatically enroll employees would help jump-start retirement savings.

Mandatory employer contributions: The recent rise in the stock market has helped nudge the average 401(k) retirement balance past $80,000, according to Fidelity Investments. But participants are still falling short in retirement savings, and that is why employer contributions are crucial. Like health plans, retirement contributions should be considered a cost of doing business.

Professional management and allocation of plan assets: Advisers typically focus on the plan sponsor when it comes to investment advice. Unfortunately, this advice typically doesn’t extend to participants. Because many have little investing experience, they make poor investment decisions, especially regarding asset allocation.

Asset allocation is critical to successful long-term investing, as it explains more than 90% of the variation in a portfolio’s return.

Automatically enrolling participants in a professionally managed investment vehicle that includes quality investments with proper asset allocation would simplify the investment process.

By educating plan sponsors about the benefits of risk-based, cost-sensitive, professionally managed models, retirement plan advisers would help sponsors take guidance and due diligence to the participant level, where it is needed most.

The need for fee transparency: The second half of the “Frontline” program focused on the problem of high fees and hidden expenses in retirement plans. The Labor Department’s 401(k) fee disclosure rules are a good first step to an overhaul, but much more needs to be done. Service providers need to offer benchmarking comparisons for fees and expenses, and they should provide both employers and employees with a meaningful all-in number to help them understand the true cost of their retirement plan.

Employers and participants need to focus on investment costs in plans, which represent 84% of a plan’s fees. Unnecessarily high fees will eat away at the value of retirement savings over time.

A focus on participant success: My firm recently overhauled its 401(k) plan, defaulting all employees into low-cost, risk-based models that are professionally managed. We also added auto enrollment and auto escalation of employee contributions, and increased our employer match. The program is already showing results, as employees are better allocated and more aware of their investing program.

A simpler, transparent and low-cost plan that is professionally managed is an approach that gets back to the roots of the defined-contribution plan. Ted Benna, the “father of the 401(k),” said that his original goal was to create plans that were as easy for employees to manage as pensions.

Thirty-five years later, many 401(k)s are riddled with complexity, overwhelming numbers of investment options and a service mentality that puts investment companies’ profits ahead of participants’ needs. As an industry, we can do better.

Tom Gonnella is executive vice president of Lincoln Trust Co., a provider of 401(k) plans.

Related Topics: Retirement Watch