Dear 401(k) Participant -- An Open Letter

Dear 401(k) Plan Participant,

I hope you are doing well. I really do, but I am concerned about you. No, if you are one of those wealthy participants, I'm sure you'll be okay. It's the rest of you I'm worried about.

You got your statements around the end of last year and the markets were at near record highs. But, the Dow is down somewhere around 20% since then and the NASDAQ nearly double that. The fixed income part of your portfolio that most of you don't understand isn't doing very well either. Have you looked at those statements recently?

Let's look into the future. Do you plan to retire someday? Do you expect a source of regular lifetime income? You do? How much can that 401(k) buy you? Have you factored in the insurance company margins? How about the fees you're being charged by the recordkeeper for the plan and the fund manager? You haven't? Perhaps you should?

How about that lifetime income? Social Security is there, but it might not be the same program when you get to retirement age. 

What's that you say: you have a friend with a defined benefit (DB) plan? I know; you told them it was foolish to factor that into their choice of an employer, but they're still not upset with their choice, are they?

I understand that a year ago, you were contributing 10% of your pay to your 401(k) plan. That's great. But with inflation, you don't seem to be able to do that anymore? Oh, you maxed out your credit cards so that you could contribute to your 401(k) and now you can't pay them down? And, you can't afford to go out, but you can't afford groceries, and you can't handle your credit card debt? Where did you say that lifetime income was coming from?

How about that friend who took the job you recommended against? You know; that job with a pension. That's a pension her employer pays for. You say your friend has been contributing a steady 5% of pay to their 401(k) and feels absolutely fine about retiring someday? Your friend isn't worried about lifetime income just because they have a good DB plan? 

Amazing!

And that house you just overpaid for? But, you got a great teaser rate on your Adjustable Rate Mortgage. Oh, what was that? The rate resets after one year and it doesn't look good. But you told me it was okay because you read you can tap into your 401(k). Something that I think you called a hardship withdrawal?

So, the markets are depleting your 401(k), you're depleting it, and you can't afford to contribute to it anymore? Doesn't that bother you? Why isn't your friend with the DB plan losing sleep at night like you are?

What's that you said? You're going to be parents? The medical costs for childbirth are going to eat away at your HSA balance? And, then there are diapers and you're afraid you'll have to buy formula? Those are all expensive, aren't they?

How are you doing with those lifetime income projections?

Don't you wish you had a DB plan?

How are you doing with your credit card debt? Your mortgage? Your weekly food bills? Your discretionary income for fun? You mean you had to give up saving for retirement?

Don't you wish you had a DB plan?

Regretfully, but I told you so,

John

Inflation and the Labor Market in Revenue-Controlled Industries

For many of us, we're seeing inflation today that we've never experienced before. I'm old enough to not be part of that "many of us," but it's been a long time. In fact, by the time I was in the profession I am in today, inflation was seriously on its way down -- a downward path that has largely remained until just recently. Still, I vividly remember the late 70s and early 80s.

When inflation spikes, it seems to come upon us somewhat suddenly -- unexpected, yet expected. The 2022 vintage of this phenomenon fits that pattern quite well. There has been rampant government spending and therefore printing of greenbacks for the last couple of years and large amounts of those dollars have gone into the hands of consumers. In the case of most people, when they suddenly have more cash than they are used to, they look for ways to spend it.

The current period is no exception. With all of the various government programs from which Americans have received compensation for being unemployed, underemployed, low-income, middle-income, high-income if you can cook up the right circumstances, and more, even people deeply in debt having the choice of paying down that debt or spending the hot dollars in their hands on goods have opted more often than not for the goods.

Let's think about this in economic terms. People want to spend more. Said differently, demand is up. Production of goods, particularly in the US is not up at the same rate with the reasons purported to be largely supply chain-based (not my expertise and I don't want to argue whether these reports are true and not inflated). And, with global tensions, imports of products from many typical supplying countries are way dawn. Translated: supply is down and demand is up.

Let me repeat: supply is down, demand is up. That means people will pay more for goods and services resulting in inflation. Frankly, I've been expecting it for years as have very likely most of you, but I would argue that the Fed has taken steps to somewhat artificially keep it in check. 

Now let's turn to what I suggested was the core topic of this post. We'll consider the labor market first.

Employee turnover is at historically high levels. People are taking time off or simply job-hopping. In many cases, they do it for the instant gratification of additional cash in hand. Generally speaking, they do it because there is something better about the employment deal at New Employer than their was at Former Employer. It might be purely pay. It might be a great boss. It might be the ability to work from home whenever you feel like it. 

Whatever the reason, employers are finding that unless they are offering something special -- higher pay, some wonderful benefits, or whatever the fad of May 26 is -- they are losing employees and having to spend money to recruit new ones at higher pay. Said differently, labor costs could easily be 20% higher in 2022 than some Finance executives anticipated (they might not be, but I think it is certainly a possibility).

How about the employer? Most of us think better in round numbers, so for illustrative purposes, I am going to start with one. Suppose Employer X had budgeted $100 million for total labor costs (whatever that means to them) for 2022, but now finds that in order to run its business, it now finds its labor costs for 2022 up 20% to $120 million. 

The immediate response is simple: they should raise their prices. Since consumers are used to paying more, they'll pay more for these goods or services as well, right?

They might, but it's not that simple.

Consider Hospital H. Hospital H is paying more for supplies, more for utilities, and as we noted, 20% more for labor. But in the 2022 environment, H really has no way to bump up its prices. 

Why? Hospital H gets the very large majority of its revenue by being an "in-network" facility for pretty much every major health plan in its area. It negotiated 2022 reimbursements a while back. And, the health plans/insurers are not about to be charitable and renegotiate them. Hospital H's revenues are largely locked in. It's stuck with its expenses. Whoops!

This is where the creative minds will win out. How can Hospital H cut its expenses for the second half of 2022 without harming patient outcomes or patient experiences? Are there ways to do that without jeopardizing 2023 and beyond?

Some organizations will have that flexibility. Others will not. But I think there are solutions ... at least partially.

A Tale of Two Businesses

 It was a thriving business, it was a sinking business. It was a wise idea, it was a foolish idea. It was a time of profit, it was a time of loss. It was the season of growth, it was the season of closure. 

The story is true, or at least almost true. The names have been changed to protect the innocent and the not as innocent.

As we all know, both London and Paris lived to flourish, but I'm not as sure about the two businesses although time is yet to tell. You see, these were two business in the same industry and in the same geography. They competed with each other. One's market share drew from the others. When one offered a better product or service than the other, it thrived and the other suffered. When one treated its employees better, their customers were also treated better while the one with a less welcoming environment lost customers because they were treated poorly.

This nearly true story is a tale of two businesses.

You see, both of these businesses were dealing with the effects of COVID. Both were dealing with the so-called Great Resignation -- a term that I despise just as an aside, but in these days of short catchy names and the 24-hour news cycle, great is a word that goes with lots of things. And, each of the two were viewed as sector leaders in their common geography, but each was struggling to have enough employees to produce what was needed to serve their customers.

The leadership team at one of the organization -- let's call them Paris because for them it turned out to be the worst of times -- had some not so innovative ideas. Their strategy was focused on cash and on instant gratification -- something that a leaked internal email said would satisfy the younger generation. So, Paris through cash into the marketplace. Come work for us. Paris is great. If you come work for Paris, we'll give you a big signing bonus. And, what we're not going to tell you or anyone else except when the law forces us to is that we are going to pay for those signing bonuses by reducing other parts of the rewards package. We'll tweak your health benefits in ways that you hopefully won't notice. We'll eliminate your pension because we know you don't care about pensions. We'll reconfigure the matching contribution we give your retirement amount because a match is a match. And, in doing all this, we'll get great new employees and dominate our market.

Not so fast Paris. What is it they say about loose lips. We're in 2022. Nothing is a secret. Paris forgot that experienced employees would find out about this. They asked where their bonuses were, but were told there was no money left. They asked why their health benefits and their pensions were cut. That was to pay for all these expensive signing bonuses. 

So, the experienced workers did what any smart yet underappreciated Parisian would do; they left for London.

London's leadership also had a strategy. Their strategy was to provide a great working environment and to spend money uniformly on their employees both old and new. They kept their generous health benefits. They kept their pension. They benchmarked and looked for tactical opportunities to be above the median where their employees would appreciate it. 

What London has noticed is that their business is thriving. Their turnover is extremely low for their industry and surveys that an external vendor does of their customer base show them that London is best in class. At the same time, Paris seems to be burning.

Instant gratification is what it is. You can get people in the door with it, but at this point, neither London nor Paris would tell you that you can keep them that way.

Revisiting 5 Years Ago -- The Talent Problem Isn't New, But More Apparent

I haven't written here for quite a while. There are a number of reasons, some of them probably not so good, but I'm not going to go into them today. But, let's get started.

It was almost five years ago that I wrote about the talent crunch with a focus on hospitals. Little did I know that that was just the beginning. For a while, if you asked a hospital CHRO or VP-HR what their biggest challenge was, they would far more likely than not have told you it was talent -- recruiting and retaining talent. 

Today, however, you don't have to keep it to hospitals or to the Human Resources side of the house. Go to almost any industry and find a CFO -- that's right, a Finance Chief -- and it's very likely that even that side of the house will tell you that along with cybersecurity and supply chain, recruiting and retention is a top issue.

If you haven't studied talent management a whole lot, this probably comes as a great surprise. So, let me toss out some data and rather than linking to a whole bunch of sources, let me say that what I am about to state is based on an amalgam of recent studies. The cost to replace unwanted skilled talent (below the level of high management is estimated anywhere from about 1.25 to 2.25 times cash compensation. For top management, up to and including the CEO, those same studies say that the cost varies anywhere from about 2.5 to 4 times cash compensation. 

Impossible? No.

Those numbers include recruiting costs, transition costs, transition of knowledge costs, potential other turnover, costs of having to hire more than one person when the first one doesn't work out and many more items. In fact, when you lose a well-liked, high-performing CEO without an obvious successor, the disruption caused by that loss might be as big as the numbers cited in even the studies that indicate such loss is more expensive.

How do you keep these people? Sometimes you just can't. Sometimes somebody throws money or some perquisite at them that you just can't compete with. It could be that the allure of Hawaii is just too much. 

But, let's assume that it wasn't anything like that. Let's assume you just didn't have anything to keep them. Then, we might say the loss was avoidable. But, sometimes proverbial handcuffs work.

Often times, long-term compensation with long vesting periods is enough to keep people around, but long-term compensation is usually limited to pretty high up people. And, a company that really wants that person might buy out the non-vested portion anyway.

The trickier part is pensions. Pensions are a form of deferred compensation. The deferral period is often long and the time at which the benefit pays out is often far in the future. In fact, it pays out during the period of time -- retirement -- during which that person might not be able to replace it. 

For a time, that wasn't a big deal. But, in 2022, other surveys indicate that there are a tremendous number of workers who say they will never be able to retire. Of course, those are not workers with pensions. Those are workers who are not sure where their lifetime income is coming from.

This is not to say that pensions are somehow nirvana. But, they do serve as recruiting and retention device when communicated properly that very little else does. Someone can always pay you more currently. But, are they willing to pay you more after you have left their company? The companies that will certainly seem to be having a little less trouble recruiting and retaining.

Why Would We Ever Create a New Plan to Do Exactly What an Existing Plan Already Does?

I think my title is self-explanatory. Suppose you have a perfectly good employee benefit plan, in this case, a retirement plan, why would you seek to change another type of plan to make it look like the perfectly good plan?

I think that is a great question, but lots of people seem to disagree. Congress. Think tanks. People with something to gain from rejiggering the plan they indirectly benefit from to replace something that solves all the same problems and is already in place.

I'm sure you're wondering where I am going with this. If you want a deep dive, I wrote one for Human Resource Executive. It got a fair amount of good feedback including that from one finance executive who described it as "true thought leadership."

So, what's the problem? The problem is that participants are worried about their retirement. They are worried about outliving their savings. They are worried about a lack of lifetime income protection. They are worried about the fate of their retirement hinging on their Social Security and their 401(k).

Of course, Congress has an excellent response. Let's take the 401(k) and twist it and turn it until it looks more like a pretzel or worse yet a Mobius Strip or Klein Bottle. Let's make sure that it gets annual disclosures. And let's make sure that those disclosures estimate (poorly, I might add) the amount of lifetime income that plan can buy for you. And, let's see what we can do to mandate that lifetime income options be available from those plans, albeit ensuring that there is room for insurers and fund managers, and investment managers to profit from it which, of course, means that the lifetime income you are getting as a participant is not really a fair amount. 

This makes no sense. Not to me. And, it shouldn't to you. 

You know we already have a perfectly good plan type that provides lifetime income as a default. It provides security and that is what the public is looking for. It's called a defined benefit (DB) plan and despite what our legislators in Washington seem to think, those people who have them do not want to give them up. Under any circumstances. In fact, I could point you to swaths of people who once they have such a plan will not leave the organization that provides it unless their new organization gives them something similar. Yes, both will offer a 401(k), but only one provides the security of lifetime income. Necessarily, if the participant wants it.

If you took the 8 minutes (that's what Google tells me it takes) to read my article in the link above, you'll understand that this is workable. It might not be the DB plan that your parents had 30+ years ago, but it's still a DB plan. What makes it better is that your employer will like it too. You can understand it and they can understand it. And, as you noticed, when you retire, you can choose how much you want as a lump sum, within some reasonable limits, and how much you want in the way of lifetime income protection.

That, my friends, is what the American populace is screaming for. Yet, Congress, having a perfectly wonderful solution staring them in the face, is looking for a way to make the 401(k) plan look like that perfectly good solution, albeit with your money leaking to every constituency out there.

That makes no sense, does it?

Create your plan of the future using the tools we already have in that neat little box called DB.

If CFOs Are Worried About Benefit Costs, Why Are They Leaving Avoidable Pension Costs on the Table?

This morning's lead article in the Wall Street Journal's CFO Journal says that CFOs are concerned about benefit costs. This was not at all surprising to me. What is surprising though is how much they are leaving on the table relative to defined benefit pension plans, often frozen legacy plans.

Let's start out with some background. 40 years ago, most large companies in the US provided defined benefit (DB) pensions for large parts of their workforce. This was, of course, before the 401(k) gave us the perhaps misguided self-sufficiency explosion. Over time, many of those employers froze those DB plans (meaning no new participants and those in the plan get no further accruals) and some terminated them. But, there remain a lot of frozen DB plans that remain in what some call hibernation. I call it lingering death.

That lingering death seems to go on interminably. And, there are reasons that happens. Freeze the plan and it becomes out of sight, out of mind. Not to overdo the cliches, but they go into a set it and forget it mode.

But, set it and forget it with a legacy pension may not work so well. Research by October Three has shown that many of these plans have what might be termed overhead or frictional costs exceeding 1% of plan assets. That means that for a not atypical frozen plan that the long-term cost of that plan -- unless the sponsor is willing to fund it sufficiently to terminate it may be 10-15% higher than if those frictional costs were entirely eliminated. (Understand that it is impossible to eliminate all of those frictional costs, but most can often be eliminated.)

How does this happen? Nobody is paying attention. There's nobody on staff focused on efficiency in that frozen plan. The last person doing that went away a few months after the plan was frozen. So, now, a typical company with a, for example, $50 million frozen plan may be spending more than half a million dollars per year on that plan unnecessarily. 

Suppose the company assigned one professional to that plan. Suppose they made that plan half of that person's responsibility, at least until the plan is terminated. And, suppose they pay that person $200,000 per year. Let's add in another 25% for additional employment costs and we're up to $250,000. Then, this company is eliminating more costs than it is incurring and in doing so, they are getting rid of perhaps an unnecessary headache.

The last obstacle is figuring out what this person should focus on. And, since they probably have not been focused on pensions, they may not know. However, there is a good chance that they are paying a lot of money for consulting that is not focused on their needs. Or, the consulting might be excellent, but the company's lack of focus causes them to ignore it.

Either way, this is something to consider and if they're not sure, I know someone who can guide them down the right path.

Coronavirus Crisis as Catalyst: Change the Way You Look at Your Rewards Structure

I saw these words this morning: "Your brain isn't resistant to change; it is lazy." Can we extend that? Is your corporate rewards program -- the way that you reward your employees for working for you -- resistant to change? Or is that change somehow always on the back burner?

You've looked at the survey data. You've heard the cries for help from employees. But, your rewards program remains right down the middle.

Perhaps you've tried some innovative ways to become an employer of choice. You put the ping pong table and beer keg in the break room. Alas, it didn't reduce turnover. It didn't make your employees happier (except when they hit the beer keg too often). It didn't reduce their real stresses even if it did mask them for a few minutes.

But, the crisis caused by the coronavirus pandemic has forced you to change the entire compact between you and your employees. They've forgotten their office space. The fancy espresso maker you provided them sits idly as they become reaccustomed to the coffee they make quickly in their own home. At the same time, they've likely created their own custom background for their Zoom calls. All of this, they have managed. In fact, if you've kept them employed and had to cut their pay a little bit, most of them have probably managed how to live on a little less.

What they haven't learned though is how to feel secure. They haven't figured out how they are going to deal with a health catastrophe or disability, but maybe the federal government will come to the rescue. Where the federal government has not promised to come to the resuce, even in the most grandiose of campaign speeches is in helping your employees to retire.

You remember retirement. It's what your parents did. Either or both of them worked for a company for a long time. They retired with a pension. Supplemented by Social Security and perhaps some savings, somewhere in their early to mid-60s, they stopped the daily grind and pursued all the hobbies that had been given short shrift while they were working. It was part of the "American Dream."

Not for you? You can't even dream of it?

Look back at what I said a few paragraphs ago. Most of them have probably managed to live on a little less.

Let's do some oversimplified math to figure out how we are going to use this to become an employer of choice again. Consider Taylor, a good employee.

Pre-coronavirus, your basic costs for Taylor included:

• Base pay: 100,000
• Health benefits: 25,000
• Other non-retirement benefits: 5,000
• Retirement benefits: 4,000
• Total: 134,000

With coronavirus, you've had to cut Taylor's pay by $10,000. So, the equation now looks like this:

• Base pay: 90,000
• Health benefits: 25,000
• Other non-retirement benefits: 4,800 (a couple of benefits had a pay-related component)
• Retirement benefits: 3,600
• Total: 123,400

At some point, this crisis will end. And, during the crisis, Taylor may have learned to live on $90,000 instead of $100,000. She would love to get that full $10,000 back, but since she has learned to live on it, that's not what's keeping her up at night. 

During her new social distancing life, Taylor has taken to ever family search website she can find: 23 and Me, Ancestry, MyHeritage, and more. She's learned that going back four generations, the women in her family are long-lived. That's great news for Taylor, right?

Not really. As the she saw the stock market fall and her bank decrease the interest rate on her savings account to 0.01%, Taylor wondered how she can ever afford to retire. After all, she guesses, based on her genealogical research that she will probably live to be about 95. And, after she retires at age 62 (she learned she can start collecting Social Security then), that leaves her with a 33-year retirement. She's going to have to pay for it somehow.

As her employer, you can be the solution to her problem and be an employer of choice. After all, you don't want to lose a great employee like Taylor. And, you've committed that you are willing to spend $134,000 on her total rewards.

Before we do that, let's think about what Taylor is not good at. Like many in her age group and yours and mine and everybody else's, she's not good at financial planning. What you can do to help is to create a nest egg for her. And, don't do it so that some day, she gets a pot of cash from the company, give her lifetime income.

So, let's reconfigure the $134,000.

• Base pay: 95,000 (she learned to live on 90,000)
• Health benfits: 25,000
• Other non-retirement benefits: 4,900
• 401(k): 3,800
• Subtotal: 128,700

You have $5,300 left to spend. That's 5.5% of pay. 

I don't care what you call it, but now is the time to call it something. Take that 5.5% of pay and allocate it to Taylor's lifetime income. Sell it to your employees until you can't sell it anymore. Tell them you are giving them this plan because you want them for their careers. And, tell them you are giving it to them because some day, you want them to be able to gracefully exit their careers and to do so without fear of outliving that little 401(k) nest egg that isn't worth what it was before coronavirus hit.

Once they get that benefit, your best employees won't leave.

Make the best of the coronavirus crisis. Let it be a catalyst for a great change.