In the 138 years since the first private pension plan in the United States was established by American Express Co., few retirement vehicles have been as polarizing as the 401(k) plan.
Established by section 401(k) of the Revenue Act of 1978, this new breed of qualified deferred- compensation plan allowed employees to set aside part of their income on a tax-deferred basis for their retirement years.
Curiously enough, in the early years of 401(k)s, many employees still had traditional defined-benefit pension plans that guaranteed a monthly income. These new plans were viewed simply as a way to augment retirement income.
Now, some 35 years since their inception, 401(k) plans have been harshly criticized for failing to close what the Center for Retirement Research at Boston College estimates to be a $6.6 trillion difference between what people have saved and what they need to save for retirement.
Even Ted Benna, the so-called father of the 401(k), said he feels as if his creation has turned into a “monster.”
Add to that high fees, hidden fees and the inability of most plan participants to even begin to understand how much money they will need for retirement, and there is little wonder why 401(k)s have become the plans we love to hate.
No matter where one stands, the inescapable conclusion is that the overwhelming majority of participants in defined-contribution plans are neither professional money managers nor especially investment-savvy, putting them at a severe disadvantage when it comes to deciding how they will invest for their retirement years.
ADVISERS' OBLIGATION
But does this make 401(k)s a bad idea? Or should much of the obligation for making these plans rest on the shoulders of the financial advisers who sell these plans to corporate America?
Below are five “rules of the road” to help advisers and plan participants change their behavior in ways that make the most of the 401(k) experience.
Teach them well and let them lead the way. Chances are, we wouldn't let first-graders design and implement their own academic curriculum. They clearly don't have the skill, knowledge or life experience necessary to make those types of decisions. Similarly, most 401(k) participants have never managed a 401(k). It may be a participant-directed plan, but the adviser is the expert and the teacher. Therefore, the adviser must be the one directing the process and providing the discipline necessary to achieve success. If the adviser is an effective teacher, participants will learn and eventually be able to manage the process themselves.
Autopilot isn't just for airplanes. It can work just as effectively in 401(k) plans. The best way to maximize participation is to implement a process that is outcome-focused. Setting up a plan that has automatic enrollment, re-enrollment, auto increases and a qualified default investment alternative helps the adviser control the curriculum and the process, and shape the outcome.
Model behavior. Most participants unfortunately have mastered the ability to buy high and sell low, behooving us to get as far away as possible from a menu of individual funds being the primary choice for a plan. Independent studies have demonstrated that participants who use target date funds or risk-based model portfolios generally have significantly better outcomes.
Run marathons, avoid sprinting. Like many people who invest, plan participants tend to focus on the short term. They track gains and losses instead of thinking about the bigger picture: the long-term accumulation of wealth. Advisers need to constantly remind participants that investing for retirement is akin to running a marathon. Patience and the ability to stay in the race for the entire duration are the two critical components for compounding wealth.
Navigating to a successful retirement requires a road map. Most people wouldn't drive to an unknown, perhaps perilous, destination without the benefit of a map or GPS. Similarly, plan participants should arm themselves with the tools that they need to make the journey to retirement culminate in a successful conclusion. Advisers should provide them with retirement calculators and other planning resources and, above all, demonstrate what they are and how they should be used. Demand that they take responsibility for their future. No question, 401(k)s are a good idea, but they require accountability and prudence. Plan advisers can bring both to the table.
William P. Simon Jr. is managing director of retirement plan services at Brinker Capital, a registered investment adviser.
