Working together to improve individuals’ 401(k) plans

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In 401(k) plans, for many the only retirement vehicle, people have to be their own financial planners. Yet employers don’t provide enough advice, or the right kind of advice, so most are ill-equipped to manage the 401(k) effectively.

Many fail to contribute enough to take full advantage of employer matching money, when available. They also fail to choose a combination of investments that adequately manages risk, but many plans don’t offer enough options.

Workers’ investing errors typically include putting too much into money-market funds, which pay too little interest to grow enough assets for retirement; chasing past performance by choosing last year’s stellar mutual funds; and dividing assets equally among various options, a move that lacks strategy and usually doesn’t assure diversification.

Many employers have sought to solve the problem by opening their plan doors wide to target-date funds, mixed-asset investments that tout a “glide path” to the target retirement date by adjusting holdings as they age. The problem is that, like the money-market funds now holding a lot of 401(k) money by investors’ choice and by default, target-date funds tend to be heavily invested in bonds, especially in the final years. So these funds don’t tend to deliver the kind of returns that many people need to retire.

A more fundamental problem is that target-date funds can’t be individually configured. They’re a one-size-fits-all option for investors with varying goals, needs and risk tolerances. Uninformed employees can the mistake of choosing more than one target-date fund.

Thus, workers seeking to build the best possible nest egg are back to square one. They lack the knowledge and expertise to construct and manage a 401(k) account that works because they don’t get good advice. All too often, employers fail to provide enough help, especially small companies that lack financial professionals in-house. The root cause of this and other shortcomings of plan offerings is often a lack of investing knowledge among plan administrators. So workers and employers are basically in the same boat: They both need expert advice.

New federal rules are ratcheting up pressure on employers to assure better plans, with more objective advice and reasonable fees. As rules force employers to take a hard look at what they’re paying for their plans and what they’re getting in return, many will find that their employees have long been receiving precious little, if any, plan education or advice, despite high fees in many cases.

Though the new rules don’t tell employers what type of advisers to hire, they require employers to determine what type of adviser they’re using. They must find out whether the adviser is a fiduciary — a legal/regulatory term for advisers obligated to always put their clients’ interests ahead of their own, avoiding any appearance of conflict of interest. In a 401(k), this means advising employees in their best interests on investment choices from plan offerings. As 401(k) plan sponsors, employers themselves have fiduciary responsibilities.

The only financial professional advising many 401(k) plans is a broker. Yet most brokers avoid being classified as a fiduciary because of the regulatory burdens and increased legal liability.

Employees who don’t understand their plans should ask HR departments about getting objective advice in general education sessions or one-on-one. Though many employees feel employers don’t want to hear this, they should be aware that employers need worker input to improve plan education and the plans themselves. These discussions shouldn’t be adversarial; such improvements come at no cost to employers. Typically, most or all fees are paid by employees in plans; the money comes out of their accounts. And after all, company executives often participate in the same plans.

Improvements are more likely to happen if workers and employers work together to develop better 401(k) plans supported by better education and advice. For employers, success in this regard is creating a better benefit to attract and retain better workers. For employees, it’s a more effective plan that they can use to create a better-funded retirement.

Ted Schwartz and Jamie Cornehlsen are advisers with Capstone Investment Financial Group. Reach them at ted@capstoneinvest.com or jcornehlsen@capstoneinvest.com.