Necessity, they say, is the mother of invention. That would explain the flurry of new changes taking place in the retirement planning industry.
Indeed, unstable stock market conditions in recent years have not only motivated legislators to fix some of the flaws in the system, but also inspired plan sponsors (meaning employers) to create better tools to help their workers meet long-term savings goals.
“There’s been a philosophical shift going on for several years from a ‘if you build it they will come’ mentality to a more paternalistic approach to offering (retirement) plans,” says David Wray, president of the Profit Sharing/401k Council of America in Chicago. “After 2002, participants in 401(k) plans, who once believed they could outperform the market on their own, started looking for help. Employers are now coming up with solutions and you see that in a lot of the automated features now available.”
Take automatic enrollment, for instance. This program enables employees to automatically enroll in their company’s 401(k) — unless they elect otherwise.
Their take-home pay is reduced by a certain percentage — generally 3 percent — which is contributed to the 401(k) plan, though the employee can elect to save more.
Contributions are made on a pretax basis, invested in a manner designed by the plan, and nothing is taxed until distributions are taken.
Some employers are also using the auto escalation feature, which gradually increases their workers’ contribution every year.
Currently, the number of companies offering automatic enrollment is holding steady at about 30 percent, but as market conditions improve, that figure could climb to 50 percent, says Nevin Adams, editor in chief of Plansponsor.com, an adviser for the retirement planning industry.
In 401(k) plans, automatic enrollment has tended to increase participation rates to more than nine out of 10 eligible employees, the Treasury Department reports.
Plans that offer automatic enrollment helped fuel the popularity of target-date funds. That’s because the federal government approved these investment vehicles under the Pension Protection Act of 2006 as a default option of 401(k) plans.
Also known as life cycle or age-based funds, target-date portfolios are designed to simplify long-term investing by automatically shifting their allocation (or glide path) of stocks and bonds to become more conservative as the retirement date edges closer.
Target-date funds come in two broad categories.
The “to retirement” variety selects a glide path that is often more conservative, anticipating investors will cash out of the fund once they reach retirement and move their money into an annuity.
The “through retirement” target-date funds, meanwhile, presume the investor will gradually draw down their fund during retirement. Because it assumes a longer time horizon, it tends to be more heavily weighted in stocks.
Some target-date funds suffered mightily during the recent bear market, with losses ranging from 15 percent to more than 40 percent in 2008.
Because some investors claim they didn’t understand the risks, the White House recently announced plans to review target-date funds to ensure that employers that offer them as part of their 401(k) plans can better evaluate their suitability for their work force and to require that workers receive clear disclosures about the risk of loss.
Many of the 78 million Americans who don’t have access to workplace retirement plans today may soon find themselves enrolled in an automatic Individual Retirement Account.
The proposal from the Obama administration, which has been introduced before but not yet implemented, would require small employers with more than 10 employees that do not currently offer a retirement plan to automatically enroll their employees into an IRA.
Workers would have a portion of every paycheck withheld and directly deposited into their IRA — unless they opt out.
Employers would not be required to make matching contributions to the accounts.
Automatic IRA deposits would qualify for the saver’s tax credit, which provides a government match for workers’ contributions to retirement savings plans.
Under the White House’s latest proposal, revealed in the annual report on the Middle Class Task Force, the saver’s tax credit would be simplified and expanded.
The expanded credit would match 50 percent of the first $1,000 of contributions ($500 for individuals) to retirement plans by families earning up to $65,000, and provide a partial credit to families earning up to $85,000, rendering more middle-class families eligible.
The proposal also would make the credit fully refundable, allowing lower-income savers to take advantage of the credit for the first time.
“The question is whether the administration will have the time to focus on (automatic IRAs) and make it happen,” says Adams, who believes “this may not be the right year to do that.”
If the proposal does get the green light, he notes, it likely won’t be implemented before 2012.
Enhanced saving features
The White House also proposed making it easier for workers to save their federal tax refunds by allowing them to receive it in the form of a savings bond that can be deposited into their IRAs or bank accounts.
It announced a proposal to allow workers to put payments for unused vacation time and sick days into their retirement plans as well, an option not currently available to most workers.
401(k) fee disclosure
Another hot item on the legislative agenda is 401(k) fee disclosure.
At present, employees are given precious little information about the fees and expenses associated with their retirement plans. Fees make a big impact on overall investment returns.
After countless failed attempts to implement reform, a bill that would increase the transparency of 401(k) fees for employees is widely expected to pass by the end of the year, says Wray.
But guidance from the Labor Department on how employers should provide that information to plan participants could come sooner than that — as early as this spring.
The White House recently announced its commitment to making the 401(k) system more reliable and transparent, and to give American workers and plan sponsors the information they need to get “investment, record-keeping and other services at a fair price.”
One reason participation in employer-sponsored 401(k) plans remains low is that retirement savers can’t make sense of their investment options and aren’t willing to track down (or pay for) a financial adviser for help.
Making matters worse, employers who wanted to help by providing independent investment advice often shied away because they were required to have third-party advice reviewed by the Department of Labor to ensure the plan provider didn’t benefit. That cost time and money.
The Pension Protection Act of 2006 created an exemption by which companies were once again free to offer third-party investment advice to workers if certain criteria were met to ensure the advice was objective.
The Labor Department was set to release guidelines early last year, but the Obama administration felt it did not go far enough to protect the interests of employees and sent regulators back to the drawing table.
In late February, the Labor Department proposed new regulation that will expand the availability of quality advice. It can be dispensed in one of two ways: through the use of an unbiased computer model or through an adviser who is compensated on a “level fee” basis, meaning the fees do not vary from one investment to another. The regulation contains safeguards to ensure information is unbiased.
There’s no question, the recent bear markets hit retirement savers hard, forcing millions to continue working and many others to return to the workforce after having left.
Yet, the carnage on Wall Street also inspired a litany of new products and policies that are likely to help working Americans feather their nest egg for generations to come.