Do We Have A Retirement Crisis? Of Course We Do.

Do we have retirement crisis in the US? Showing my age and with apologies to Messrs. Rowan and Martin, you bet your sweet bippy we do. Despite all the pundits citing data and telling us that we don't have that problem, I'm telling you we do.

I was inspired to write this by an excellent piece that I read in Investment News this morning. The theme was that Vanguard's data shows that the average combined savings rate (employee plus employer) has increased since 2004 from 10.4% of pay to 10.6% of pay. To understand this better, let's look at what else has happened during this period.

The Pension Protection Act (PPA) of 2006 became law. Many defined benefit (DB) pension plans were frozen and or terminated. The new in vogue terms in the 401(k) world all suddenly started with auto: auto-enrollment, auto-escalation, auto-pilot. At the same time, the new fear became that of outliving your savings.

That's right, people are living longer. People know that people are living longer. This frightens many. From a retirement perspective, they don't know how to deal with this. So, the old normal (2019) cannot continue to be the new normal (beyond 2019).

Why do I say that? What's wrong with the analysis from pundits?

Suppose I told you that 55% of Americans are "on track to retire," whatever that means (every recordkeeping firm who puts out data like that has their own basis for what that does mean). Is that good news or bad news? Most who think that the 401(k)-only system is as close to nirvana as one can get would tell you it's great news. They say so on social media. They go out of their way to bash those who disagree.

Well, I disagree and here is why. I'm going to reword what they are saying taking what they say as factual. Suppose I told you that 45% of Americans are not on track to retire. How would you react to that? My intuition says that you would think that is a horrible thing. Yet, it is exactly the same thing as 55% of Americans being on track to retire.

Further, the data being used often assumes that Americans will take their 401(k) balances and draw them down ratably and prudently. Which Americans are those? They're not the Americans of 2019. They're not the ones who want the latest gadget. They're not the ones that love their Amazon Prime accounts. They're not the ones from the instant gratification world of today.

For most Americans, being able to guarantee a level of lifetime income protection is of nearly paramount importance. It's not easy in a 401(k) world. In-plan annuity options are rare and expensive. Taking a distribution to buy an annuity is even more expensive and requires an education in an industry that few Americans have access to.

Look at the generation that retired over the 25 years or so from roughly 1980 to 2005. They often have lifetime income. They may also have account-based savings. They, because they did not live in a 401(k)-only world, were able to get it right.

DB plans of the past had problems. Smart people designed better solutions, but the really [not so] smart people conspired to make us think that 401(k) only is the best solution.

It's time to visit those better solutions.

• Cost stability and predictable cost for plan sponsors.
• Lifetime income availability at actuarially fair prices for participants.
• Account growth through professionally managed assets, but with a guaranteed return of principal.
• The ability to take your account with you.

And, you can still have your 401(k) on the side to supplement it.

Doesn't this feel closer to nirvana. Isn't this a way to truly move the needle and get us out of the retirement crisis?

Eliminating the Phone-A-Friend Retirement Plan

I read an article earlier this morning informing me that employees don't really understand 401(k) plans. News Flash: that's not news. In fact, looking at behavior of employees and overhearing casual conversations between otherwise intelligent 401(k) participants about the value of their 401 plans, their 201k (when they are underperforming expectations), their 501k (when they are overperforming expectations), and the ways that they choose investment options, this sounds like a statement from Captain Obvious.

How did 401(k) plans get this way? In their earlier incarnations, typical 401(k) plans gave employees an option to defer. In most plans, employees that did choose to defer got a match from their employers. Employees could then invest those assets within the plan in usually about five to eight options.

I recall a conversation back in the early 1990s with an individual who is now on every list of the great minds of the 401(k) world and the great innovators in the 401(k) world. This individual told me that no defined contribution plan needs more than six investment options ... ever .. and that any plan sponsor with more than six should be lined up with their adviser before a firing squad (the words are not precise, so no quotation marks, but they are pretty darned close). The same individual later became one of the leading proponents of a 'full menu' of options with at least one and often more than one from each asset class and each investment style within that asset class.

How exactly do employees benefit from such choices? They don't.

Suppose I choose three highly rated large cap funds from US News's report:

• T Rowe Price Institutional Large Cap Core Growth Fund
• Fidelity Blue Chip Growth Fund
• JP Morgan Intrepid Growth Fund

Let's imagine that they are all in my fund's lineup. How do I choose?

Intrepid sounds like a cool name. Maybe I should pick that. Blue Chip? My grandfather told me to invest in blue chips. I wonder if that's still true today. And, that long name? If it does all those things, it must be really good, too.

I could read the prospectuses. I could do research on performance history. I could look at investment styles and drift whatever all that means. I could phone a friend.

The simple fact is that for most of us, it's a crap shoot ... plain and simple. 

Because of that, despite all the forecasts in the world from 401(k) lovers, this should not ever be a primary plan for employees. As it was intended back in the late 70s and early 80s, this should be a supplemental savings plan -- an addition to what you get in your primary plan.

Your primary plan should be just that. It should be employer-provided. It should not be confusing. There should be no need for a phone a friend option. 

I don't care what kind it is although I have my biases. My bias is that the plan should provide for the ability for participants to take distributions in lump sums or wholesale-priced annuities (my term for annuities on a fair actuarial basis without middle men making profits at your expense). My bias is that the determination of your benefits in the plan should be simple. My bias is that assets should be professionally managed. 

I don't care what label you give to such a plan. I don't even care what label ERISA or the Internal Revenue Code gives to such a plan. What I do care about is that you not lose sleep over whether Intrepid is better than Blue Chip or conversely. What I do care about is that if you choose to annuitize your account balance that you get an annuity that is 100% of what you deserve not some number closer to 80%. 

And, for your supplemental savings, you can have your Phone-A-Friend ... oops, I meant 401(k) plan.

Imagining Retirement Plans Through the Eyes of a Child

Imagine retirement plans. Imagine retirement plans through the eyes of a child (gratuitous Moody Blues reference for readers in my age range).

I know, this sounds really strange. Of all the people who are not thinking about retirement, kids are at the top of that list. Bear with me though. I will bring you back.

Before I do, however, think back to when you were a child. You probably either lived in a house on a street where there were other kids or in an apartment where there were other kids around or went to school where there were other kids. One way or another, most of us found ourselves around other children.

Now, think about what really made you beam with pride and joy. There were lots of things -- good grades, winning a game or a race, and being the first kid on the block to have something that every kid wanted. It didn't have to be something big. But, if you had it first, every kid wanted to be you.

I promised that I would bring you back and I'm going to start now. Take yourself out of the mind of a child. At least do that a little bit, but we're going to be meandering back and forth a bit on this short journey.

Think about the employer-employee relationship. Some employees want a job; others want a career. Some employees want a paycheck; others want to be somewhere where they want to come to work. Some employers want to have employees who collect a paycheck and perhaps as small a paycheck as the employer can get away with; others want to be employers of choice.

From an excellent article in Fast Company, "[O]ne of the top factors most likely to keep professionals at their company for 5+ years ... is having strong workplace benefits ... ." The article continued, "[I]n comparison, the least enticing factor for keeping professionals at their current companies is having in-office perks such as food, game rooms, and gyms."

Employers that want to be employers of choice will care about this stuff. And, so will employees. And, many of these employees actually do remember being children. Just as I do, they remember things like spending a nickel on a stick of Topps bubble gum that came with five baseball cards and upon opening the pack seeing that they were the first kid they knew of to get a Mickey Mantle. You really do have something special then.

Often times, employers that want to be employers of choice want that because they know that the cost of unwanted employee turnover is so high. In fact, when companies are counting their beans, if they use 150% of one year's pay as a proxy for the cost of an unplanned and unwanted turnover of a professional employee, then 1) they are likely pretty close, and 2) they will realize that the cost of benefits probably pales in comparison to the cost of turnover.

One of those benefits that we mentioned is a retirement program (note that I talk about a program not an individual plan). Most companies, or certainly many if not most, have 401(k) plans. Their employees don't really know what they are, but everybody thinks they are important, and, in fact, they are. So, giving an employee a 401(k) plan doesn't make her feel special when she looks at it through her eyes of a child.

But, suppose I told her that I had a special plan for her. We don't have to give that plan a name. Suppose I told her that I, her employer, value my employees and that I was going to give her something like a match, but that it was better. Suppose I told her that I was going to auto-enroll her in our 401(k) plan because everybody says auto-enrollment is a best practice, but even if a year came where she had to stop deferring to the 401(k) plan, I was still going to contribute the same 5% of pay to her retirement account. And, by the way, those assets that accumulated from those over and over again five percents were going to grow based on professional investments. And, someday when she retires, she'll be able to take her benefit as a lump sum, or as an annuity, or as some combination of the two.

Imagine how a child thinks about that.

The child's eyes light up.

She is the first kid on her block to have this special benefit.

She is special.

Saving for Retirement in a President Trump World

I know this sounds like a politically charged topic, but it's not intended to be. I just want to pose the situation to let readers know a few things. While the Trump platform didn't particularly address retirement issues, how will retirement be affected?

In order to understand this, let's consider a few key non-retirement items that both the Republican-controlled Congress and President-Elect Trump have weighed in on to one extent or another:

• Repeal of the Affordable Care Act (ACA)
• Replace the ACA with a framework that is expected to feature competition across state lines, high-deductible health plans (HDHPs) with Health Savings Accounts (HSAs), and a la carte shopping for health plans (you insure what you want to insure to the extent that such coverage is available)
• Simplified (somewhat) Tax Code with lower marginal tax rates for most taxpayers
• Elimination of the Head of Household status for filing taxes

As I've remarked many times, our current retirement system for American workers is not what it was, for example, 30 years ago. It's no longer the norm to have the solid three-legged stool of

• the defined benefit (DB) pension plan from the company you spent most of your career with
• your personal savings in a high-return savings or money market account (you probably even had your choice of a free toaster or alarm clock when you opened the account)
• Social Security

Recall that 401(k) plans were in their infancy and even employees who had them didn't tend to make heavy use of them. 

Under the new [proposed] regime, personal responsibility will be king. Out of your higher after-tax income (not significantly higher for most Americans unless the economy booms to where employers are inclined to offer higher compensation to their employees), you'll need to save for retirement and make HSA deductions to accumulate a rainy-day fund just in case you have a high-cost medical expense. Is that practical?

Under the ACA, $10,000 annual health care deductibles are not all that uncommon. So, you'll want to build up your HSA account to ensure that you're not bankrupted by a large medical expense or even by one that you choose to not purchase coverage for. Let's say you choose to defer the family limit for 2017 -- $6,750. Further, since you've been reading about it online, you need to defer, say, 10% of your family income of $75,000 per year (or $6,250 per month) (well above the national median of about $52,000) or $7,500 to your 401(k). Let's add to that your $2,000 per month house payments (including escrow) and your $750 per month car payments (including insurance) and see where you are before basics like utilities, food, and clothing.

We start with $75,000 and let's pull out 22% of that for federal, state, and FICA taxes bringing you down to $58,500. Let's take out another $4,000 per year for health care through your employer (we'll assume they are subsidizing it) and you're down to $54,500. Now subtract your HSA, 401(k), house payments, and car payments and you're down to $7,750. That's $650 per month to pay for food, clothing, gasoline, and to build up a rainy day account, and you haven't even had a chance to buy anything because you just wanted it.

As they said in the movie, something's gotta give. What's it going to be? My guess is that the first thing you cut back on is your retirement savings. You'll worry about that in some future year. Or, will you? Recent history suggests you won't. 

People who retired 30 years ago tended to be much more prepared for retirement despite their lack of 401(k) plans. They were intended to be merely supplemental to employer-provided pension benefits. Is it possible that the Trump Administration should consider the benefits of incentives to get us back into a DB-biased world? Just asking.

Where Did We Go Awry With the 401(k)?

Section 401(k) was added to the Internal Revenue Code by the Revenue Act of 1978. It was such a significant part of that act that when I went to www.congress.gov to read the act summary, there was no mention of this new deferral opportunity. It was tossed into the legislation with little fanfare.

Why was that?

401(k) plans were never intended to be the primary retirement vehicle for the masses. In 1978, after the passage of the relatively new landmark law known as ERISA, defined benefit plans (DB) were all the rage and those companies that had chosen not to take the DB route frequently offered profit sharing plans, money purchase plans, or ESOPs, or because of the special tax treatment that they were given at the time, tax credit ESOPs, known back then as TRASOPs (bonus points for anyone who recalled TRASOPs before reading this).

Those were core retirement plans. Combined with Social Security, they were designed to be two legs of the so-called three-legged stool needed for retirement. The third leg was personal savings and the 401(k) plan was supposed to give people a more tax-efficient way to grow that third leg. Read that again; 401(k) plans were designed as savings plans, not as [core] retirement plans.

Somewhere, things went awry. I have written about this many times and blamed virtually everyone who had a voice. As our government and regulators made it more and more cumbersome to sponsor traditional retirement plans and the US economy took several turns for the worse, companies became less comfortable as sponsors of traditional retirement plans. They often placed the blame anywhere that they could. In fact, they placed it everywhere except where it belonged:

• Employees didn't appreciate the other plans (it turned out that the people who didn't have them sure thought their friends who had them had a good deal)
• They could be more competitive without them (don't you get higher productivity and better products and services from happy employees)
• The 401(k) would be enough (of course many of those same companies retained their executive retirement plans)

Now, in a workforce fraught with high turnover, low morale, and lots of part-time jobs, many of us expect employees to save for their own retirement. Projections done by proponents of those plans show that those who do will have a wonderful retirement. Those projections tend to leave out all of these complications:

• You can't defer when you are laid off and most of us seem to face one or more layoffs in our careers these days
• You will have periods in your career when you go through one hardship or another and can't afford to make the deferral you would like
• If you do have a hardship and have to pull money out, those penalties are severe
• You absolutely will not get the 7%-9% annual return on investment, net of expenses, that many of those projections would "promise"

But, companies persist in the belief that the 401(k) is the retirement plan of choice. Potential employees ask about the company's "401 plan." In the meantime, some people retire very early and many will be retiring well after the traditional retirement zone of ages 62 through 65 has passed them by. 

Isn't it time to bring back retirement plans and have more than just savings plans? Any of them can be designed today with the proper administration to show employees their account balance as of that day any day that they choose to look.

You can be an employer of choice.

Frightening Data on DC Plan Ownership

According to an article in this morning's News Dash from Plan Sponsor, fewer families had an individual account retirement plan (defined contribution or IRA) in 2013 than in 2010. However, on the bright side, average account balances have increased over the same period.

What do we learn from this? It's difficult to know for sure, but as is my wont on my blog, I'm going to take a shot at working it out.

Why are average account balances up? Well, the equity markets have performed pretty well over the last few years. Combine that with the fact that there has been time for additional contributions to those accounts and this makes sense. When we combine this, however, with my rationale for the prevalence of accounts decreasing, it may look troubling.

That the number of families with individual account retirement plans is decreasing suggests underlying issues with the economy. What I suspect is that many long-term unemployed or under-employed have had to liquidate accounts that they had a few years ago in order to survive. People laid off from jobs have taken distributions rather than rollovers to live on. I suspect that more often than not, these have been total distributions from smaller accounts. By eliminating some of the smaller account balances, the average and median accounts have grown in size.

That only about 50% of families have individual retirement accounts and only about 65% have any retirement plan at all is not good news for our future economy. How will the remaining 35% live? Moreover, among those 65%, will they have enough to survive in retirement?

The way it looks to me is that for people who are able to fully utilize their 401(k) or other retirement program for their entire working lifetimes, retirement may be comfortable. But this data suggests that this will be a substantial minority. For the rest, the retirement system is failing us.

30 years ago, defined benefit (DB) plans were the bulwark of the corporate retirement system. After years of Congressional meddling, many employers consider DB plans to be impractical. At the same time with further emphasis on individual responsibility, the burden of providing a retirement benefit has been shifted largely to employees.

If you are good at Googling or Binging, you can easily find projections from lots of smart people showing that a good 401(k) plan will be sufficient for responsible employees to retire on. In my opinion, most of these projections are deficient. You just don't see projections that consider leakage including:

• Unemployment for a meaningful period of time
• The necessity to take a job for a short or long time that does not have a savings plan
• Increased cost-shifting of all benefits to the employee which may reduce an employee's ability to save
• High-deductible health plans which force employees in many cases to pay significant amounts out-of-pocket for health care

This data is frightening. The retirement system is severely broken. Too many times, the public policy behind the retirement system has been abused by tax policy. We are left with retirement plans being a toy for Congress to make bills seemingly budget neutral. 

The ability to retire is part of the 21st century American Dream. This data suggests that the retirement part of the dream may be just that -- a dream.

Not pretty ...

Why 401(k) Plans May Not Be the Answer

Get a job. Find a new employer. Typical questions that get asked include compensation, health benefits, vacation, and do you have a 401(k) (or all too frequently, do you have a 401?)? Prospective employees usually don't ask about the 401(k) plan or about any other retirement plan, but simply want to know if there is a 401(k). Does it have a matching contribution? People don't ask.

According to a study from Aon Hewitt, 73% of those eligible are participating in 401(k) plans, but 40% of them are saving at a level below the full match level. Many of those plans have auto-enrollment, but that level of deferral is below the level required for a full matching contribution. Once people are enrolled at the automatic level, many tend not to defer enough to get a full match.

The Aon Hewitt study does not, as far as I could tell, explore why this may be. Is it a lack of employee education? Is it an inability to budget for a higher amount, especially in a time where costs of raising a family are increasing, but pay often is not? Is it a fear of the plan?

We can do the math. If a young worker (someone recently out of college, for example) participates in a 401(k) at a meaningful level throughout their career, and especially if there is a good matching contribution to go with it, those workers can eventually retire with a very good retirement income.

But, what about the ones who participate at a lower level, so that they get less than the full match? What about the ones who face temporary unemployment as so many of us do these days and may have to withdraw their 401(k) for funds to live on?

As Roth 401(k) plans have become the rage, this has become even more of a problem. While in a traditional 401(k), access to funds is essentially limited (large tax penalties) prior to age 59 1/2, in a Roth, that inaccessibility largely disappears after the employee money has been in the plan for 5 years. This means that practically speaking, Roths, for all their benefits, may be less retirement plans than their better known predecessors.

If these trends continue, 401(k)s in any form will not be the answer. In fact, for those people who are not using their plans to the fullest extent that they were intended, retirement may be nothing more than a pipe dream.

35 years ago, the answer was defined benefit plans. They provided retirement income pure and simple. But, do to Congress' ongoing efforts to protect pension plans, or so they would have you believe, that dinosaur is nearly extinct. But, 401(k)s will do the trick for only a small percentage of the workforce. For the rest, retirement planning is imperative. And, when they do the modeling, they may not like the future that they see.

Executives Need Retirement Education, Too

It's been a long time since I blogged. I needed a break. I needed some fresh ideas. I didn't feel like writing on anything technical. I didn't feel like offering my opinions. I just needed to stop writing for a little while.

This morning, however, I saw an article in the News Dash put out by Plan Sponsor. It stressed that plan sponsors feel that perhaps the biggest issue in nonqualified plans is participant education. Citing from the article, one in five said that education was a top challenge while 18% cited participation and appreciation. I think that they are essentially the same thing, so that makes 40% (rounded) and that's enough for me to conclude that this is a major issue.

Why is this? Executives generally make a lot of money (whatever a lot is). They are generally used to dealing with financial matters. They already have their qualified plans. What makes these plans so different?

There's a lot. Taxation is different. They usually don't have a real pool of assets that they can play with. They don't get the same level of disclosures. They don't understand Code Section 409A. And, they generally don't know if what they are getting is good compared to what their peers at other companies are getting or not.

What's the answer?

I suggest rewards education for executives. In my experience, it is rare that this can be done internally. Internal people are often considered to have a bias or an agenda. It comes better from the outside.

Who or what should that outsider be? It should be an independent person, one who has no horse in the race, so to speak. It should be a person who can speak to all facets of executive rewards -- cash compensation, deferred compensation, equity compensation, retirement compensation, change-in-control agreements, and the like. Unfortunately, there are not too many of them around.

Oh, wait, I can do all that!