New Rules on Deferrals
Over the years, numerous employers, both large and small, have been caught misusing employee contributions, i.e. 401k deferrals, for their own purposes or for company purposes. Such misuse is illegal and a breach of fiduciary duty. Blatantly stealing retirement plan assets is a relatively easy matter for the Department of Labor or legal authorities to prosecute and win. A more challenging task has been, however, determining when an employer has misused retirement plan assets prior to them actually getting into the plan.
Aren’t My Deferrals Always Plan Assets?
Prior to 401k plans, the only contributions, for the most part, that went into retirement plans were employer contributions. Before the contributions were made, the assets were part of the general assets of the employer to be used however he saw fit to grow the business. Certain timelines were in place for when contributions needed to be made for tax deduction purposes, but in general the employer had a large amount of time to decide when to put the monies into the plan.
Once employees started contributing their own monies into the plans via 401k deferrals, there became greater scrutiny on making sure the deferrals made it into the plan in a timely manner. Otherwise, the employer might very well misuse those assets. So the question becomes, how long after the time of deferral at payroll does an employer have to remit your contributions into the plan? The answer to this question is critical because if the employer keeps the assets in his general account too long, he is breaking the law.
Safe Harbor Rules and Implications
If you work for a larger employer, the rules surrounding this issue of when an employer needs to remit your salary contributions to the plan have been pretty well settled for a while. In larger plans, plans with more than 100 employees, the employer must remit the contributions as soon as administratively feasible, which has been understood to mean a couple of days. With respect to smaller plans, we just received guidance this week that as long as an employer remits your contributions within 7 business days, he will not be deemed to have violated any laws.
Such guidance is extremely important for you as an employee if you work for a company with less than 100 employees. For the first time, we have a clear rule that says if an employer withholds your 401k deferrals for more than 7 days after payroll is cut, he is breaking the law.
So what does this mean to you? If the employer violates these timelines, he will owe penalties and interest. Moreover, he will likely be required to pay you additional interest on your deferrals as if they had been timely deposited. Fortunately, the vast majority of employers want to do the right thing and in general do. These new rules will help give guidance to the good ones, and serve as a warning to the bad ones.
Family Investing Advice
As we all wind down from work and get ready for a week of holiday celebrations, most of us will be spending a rather concentrated amount of time with our families. To be sure, these are the times where our fondest memories are made and we get a chance to once again experience both the very best, and sometimes the worst, of “family.” The topics around the dinner table will be many, and undoubtedly the discussion will turn to your 401k plan and how it did at some point. As you get ready for these conversations, I write today to provide a cautionary tale.
Lots of Advice, Little Experience
Some new research out from Sun Life shows that a surprising number of Americans overweight the value of the investment advice they get from their family members. In fact, on average, 43% of us consider family members as the primary source for investment advice, followed by friends at 39%, and financial advisors at 36%. Now let’s think about this for minute. How much more experience do family members and friends have over financial advisors in the area of investing that we should overweight their advice?
I don’t mean to suggest that family members and friends don’t ever do the right thing with respect to investing, but following their advice in general seems misplaced to me. For example, just because your dad was able to fix a squeaky door around the house, would you follow his advice on how to build a house? Or just because a friend was able to change a flat tire on his car does not mean you should follow his advice in performing your own engine tune-up. My point is that anyone might have a good idea or two or might get lucky with an investment or two, but such “one-offs” is not the way to build a financial foundation.
We Learn as We Age
The Sun Life study showed that as people age, they rely less on friends and family and more on the experts – financial planners. Indeed, those aged 60-69, relied the most on financial planners – 45%. Could we not use their example as a guide in our youth and recognize that experience teaches us that the best place to get advice is from experts, maybe we should affiliate ourselves with experts sooner rather than later?
I know many younger people probably feel intimidated seeking the advice of a financial advisor, or quite possibly do not have many assets to invest. However, there are still things you can do. If your parents are using a financial advisor, he might be willing to meet with you to get you started. Also, there are several advisors at discount brokerages that can also provide guidance, as well as numerous on-line tools developed by financial firms to assist the “do-it-yourselfer.” The point is that while holiday conversation is great, don’t let it determine your future.
401k Enrollment Meetings
Tis that time of year again when employers who engage in a proactive employee education program with respect to their benefits will typically conduct employee enrollment/education meetings. Let me start by saying that I applaud any employer who gets behind such meetings and takes the initiative to communicate to employees not only how their benefit plans work, but also the value of these plans. These meetings are a win-win for all involved. However, with respect to the 401k enrollment/education aspect, employees would be well advised to review the materials distributed with some degree of skepticism.
I Can Earn How Much in 10 Years?!
Any 401k enrollment materials with which I am familiar involve 2 separate sections – education and investments. The investments section is devoted to the available options inside the plan, contains historical performance data, and has multiple disclosures. Sound familiar?
The other section – education – is a bit more broad. It can discuss the merits of joining the 401k plan, it may talk about retirement in general or how the plan works specifically. The other thing it generally contains is hypothetical data showing you how much your money will grow to under certain presumed time frames and rates of return. My main point of writing this blog today is to warn you not to put too much faith in those projections!
What Do You Mean I’m Back Where I Started?
If you have reviewed your 401k account lately and compared it to 10 years ago, you will see that it has grown. However, growth can be deceiving. I would guess that much of the growth in your 401k account is attributable more toward your contributions, and any employer matching contributions, than to actual earnings. In fact, the investment data shows that over the last 10 years, the equity markets, in aggregate, are essentially in the same place. That nice 8% return that we all expected in 2000? Forget it. We essentially got nothing.
So should we dismiss those 401k education materials that illustrate the growth of a dollar over various time frames? Of course not. Compound interest/rates of return are still wonders of the world. Moreover, markets do grow over time, and it is realistic to expect that in 2019 we will be able to look back on a decade just past and say that we saw positive growth in the equity markets. However, this last decade has been sobering for many and at the very least should serve as a warning that just because your enrollment materials show how much your account might be worth in 10 years at an 8% return, this does not mean you will actually be there.
Fixed Income and Your 401k
As investors have fled the equity markets over the last year, they have increasingly turned to stashing their money into fixed income investments – bonds, money money markets, stable value funds. Often in a 401k plan, you will have your choice between one money market, maybe one stable value fund, and surprisingly only one or two bond funds. Most investors tend to view all of these in similar ways – fixed, boring, generic. Although this might be the case for the first two, it is most certainly not the case for bonds.
Fixed Income is as Exciting as Equities?
Well, yes. Fixed income investments, particularly when you focus on bonds, can be every bit as exciting as equities. From an analytical standpoint, understanding the capital structure, markets, strengths and weaknesses of the firms in which you invest is every bit as sophisticated as investing in equities. Surprised? Isn’t all you need to know is the interest rate being paid? Not exactly.
The bond market is as varied as equities, and this is where most 401k plans make their mistake. By only having one or two bond offerings, participants are given the false impression that a “bond is a bond.” Moreover, most people believe that bond funds return similar results regardless of which bond fund is chosen. Again a dangerous generalization.
As of October 31st this year, investors had poured $312.8bb into bond mutual funds, the most in 25 years. Yet Hewitt Associates notes that 57% of 401k plans only have 1 bond investment option. If bond fund investing is going to remain with us for a while as the place to put our 401k dollars, we clearly need more options than one.
Types of Bond Funds
So just how varied is this market? Let’s take a quick look. One common bond fund includes US Treasuries. The safest of all bond funds, and typically the lowest return. There are US corporate bond funds and they will invest in “investment grade” bonds all the way to “junk” bonds, which will carry the highest interest rates. Foreign bonds? You bet. Just like foreign and global equities, you have foreign and global bond funds.
So what’s the point of this? Well, if bond mutual funds are gaining in popularity with 401k investors and you are in one of the 57% of all plans that only have 1 bond mutual fund investment option, you need more options! It’s time for your company to pay a bit more attention to this asset category and beef up the options. Having only one option is not what anyone would consider to be adequate “diversification.”
Youthful Habits
Levi’s Jeans currently has an ad campaign running that highlights the poetry of one of America’s great poets – Walt Whitman. These ads inspire hope for all generations that youth has the energy, strength, and maybe most importantly, the time to make changes in the world; positive changes. They are excellent commercials and I suspect that if I were still of that age demographic, I too would be inspired to do better. Although the ads suggest youth has the opportunity to “go forth” in all areas, I wonder if they are learning any lessons with respect to saving for retirement and leveraging their 401k plans?
Reason for Hope and Concern
A new Fidelity study out looks at the attitudes and behaviors in regards to financial matters of more than 1,000 employed Americans ages 22-33 years old. The survey was not focused solely on retirement trends, but as with all financial matters, it’s important to understand the whole situation to be able to develop a context.
So what were some of the positive findings? Nearly half of all respondents indicate that the recession has made them more conservative with respect to making financial decisions. Indeed, 64% check their bank balances online before making a purchase of $300 or more. Interestingly, 62% say that the quality of the overall benefits package influences their choice of employer and 64% say it impacts job loyalty. Hear that employers?
With respect to retirement issues, the findings are a mixed bag. 47% say that managing everyday finances is more important than saving for retirement. (The alternatively positive way to look at this, however, is that 53% do say saving for retirement is important). Indeed, 18% of respondents say saving for retirement is the MOST “crucial goal.” Wow.
Go Forth O’ Pioneers
The youth have always had a challenge making ends meet and the Gen-Yers (that’s what this group is called) are no different. When faced with challenges like starting a career, striking out on one’s own, managing bills, including college debt, it is not surprising that many struggle. In fact, 20% indicate that they maintain credit card debt above $10,000. Ouch.
Neverthless, this group is at least as responsible as those that have gone before. 1 in 4 even say that they expect to remain with their current employer until retirement, and 57% say that a retirement plan at work is a “must-have”. They will figure it out, by-in-large like we all do, and the good news is that they have time on their side. With a little planning and diligence, I suspect this group will be very well prepared for retirement in 40 years. (Did I just say 40 years!)
Watching Out for the 401k Investor
So how ya feelin’ at the end of 2009? A little better than when we started the year I would bet, assuming you are still employed. However, with regard to your 401k plan, I suspect you are feeling better regardless. We started the year with great uncertainty and a market still in a downward spiral. Most 401k investors were frozen and their investments were shrinking. How different things seem at the end of 2009.
Has Much Changed Since the End of 2008?
Certainly, much has changed economically since the end of 2008, but has much changed in how we manage our investments? Remember all the rhetoric and concern expressed in Washington the early part of this year about how poorly 401k investments had performed and how much more at risk Americans were of having a comfortable retirement? Remember people pointing at Target Date Funds saying “something needs to be done?” Well, I do. Has anything happened? Not really.
Investments go up and investments go down. This is a fact of life. Protecting investors against such vicissitudes of the market is impossible. If you want certainty, go with a fixed income account. However, Target Date Funds and other life-style funds are unique in the investing world. Unlike a fixed investment class, such funds actually reallocate your money amongst various assets classes. In other words, the managers of these types of funds have discretion over your money. Typically, when people have discretion over your money inside of a 401k plan, they owe you some type of fiduciary duty to look out for your best interest. Interestingly enough, this is not the case with Target Date Funds.
Things Are (Might Be) A Changin’
Some folks in Congress have become concerned about how Target Date Funds operate. On the one hand, they are the fastest growing investment option in 401k plans, they are continuing to receive more and more money, and they provide your company with a “free pass” with respect to fiduciary responsibility if the company defaults employees into these type of funds. On the other hand, however, the investment managers of these funds have virtually no responsibility beyond what the prospectus says to manage the funds in the best interest of employees.
Senator Herb Kohl from Wisconsin does not like this one sided equation and is expected to introduce legislation that would require fund managers to assume some type of fiduciary responsibility for the Target Date Funds that they manage. Such legislation is warranted in his opinion to better protect the interests of 401k participants who more often than not are simply defaulted into these investment options. Will such legislation, if passed, protect investors from another 2008? It is difficult to say, but at least they would have someone on their side.
Thinking About Your 401k Match
As we close out 2009, there is much upon which to reflect. The near collapse of the US financial system, the recession, unemployment, Tiger Woods, to name a few. Today, I thought we might spend a moment or two thinking about your 401k match, because my feeling is that many matches are going to be messed up this year.
Understand the Formula
2009 has seen an unprecedented number of companies discontinue or reduce their company match. Moreover, many of these companies have since reinstated their match at the old formula or some reduced amount. With all these moving pieces, my sense is that employees would do well to understand how their matching formula has worked at various times of the year and make sure they are getting their rightful share.
Throughout the recession we have seen statistics showing how steady employee deferrals have been. Assuming you have been able to keep your job, the odds are very strong that you have maintained your same level of deferrals. However, employer matching contributions have been all over the board. To make sure that you have received your right amount, a review of how matches work might be in order.
Matches – Discretionary or Mandatory
There is no law that requires employers to match 401k deferrals. However, when they do, certain things need to be done. Many smaller plans have a purely discretionary matching formula that is determined by the company on an annual basis. Under this scenario, the employer may match every payroll, at the end of the year, or do nothing at all.
Another type of match which is far more common is one where the employer commits in writing what the match will be. In this situation, the employer will draft a formula into the plan document, which will be reflected in your Summary Plan Description. Absent a plan amendment, the employer is obligated to follow the formula as laid out in the document. Obviously, the document can be amended, but merely stating at a company meeting that the match will be discontinued is insufficient to affect such a change.
If the employer changed your match during the year, you should have received something in writing, often termed a Notice of Material Modification, indicating what the change is and how you are affected. If you did not, then the change is probably not valid. Additionally, some matching formulas will match based on your deferrals in a particular payroll. Others will match based on overall compensation. An example of the latter is a formula that says “50 cents match on the first 6% of income deferred. Under this scenario, you might have significant matching contributions owed to you depending on whether or not the changes were properly made. The point is, now is the time to understand your formula and what is owed to you.
Target Date Funds – Confusion for Everyone
We have discussed before the impressive adoption rates of Target Date Funds (“TDFs”). These funds, virtually non-existent until 2006, have taken the 401k investing world by storm. They are now used by the majority of companies as the default investment option of choice for the Qualified Default Investment Alternative (“QDIA”). Moreover, some surveys show that as much as 60%+ of all 401k deferrals are now streaming into TDFs. Although clearly popular, TDFs are not without challenges. Last year, many TDFs delivered below sub-par performance in what should have been conservative investment portfolios. New research is just out showing just how much employees misunderstand these funds.
I Thought It Was Good To Diversify?
The basic concept around TDFs is that all an employee needs to do is identify a particular TDF which has a Target Date coinciding with or near to the employee’s own retirement date and then put all his money into that fund. The TDF will pick the right asset allocation and shift the participants assets from aggressive to conservative over time. The fund provides all the investment diversification that is needed.
A new study out by the Employee Benefit Research Institute (“EBRI”) shows how confused employees are with the supposedly simple concept of TDFs. Looking at an investing population of over 750,000 participants, the EBRI shows that over 70% of all employees are not using TDFs as designed! The ways in which employees messing up this simple investment concept appears many fold.
First, approximately 13% of all employees invest in two or more TDFs. You only need one! When asked about why they are invested in two or more funds, the most common answer appears to be that employees can’t decide on their retirement date, so they pick two or more funds that look like they might be close. Another way employees are using TDFs is in conjunction with other investments offered in the plan. Fully 60%+ of all employee who use TDFs also invest in at least one other investment offering. Evidently, they are concerned about putting all their eggs in one basket.
More Education Needed
Congress and money managers are spending a great deal of time examining how TDFs are constructed, the fees they charge, and how they are represented to employees. You can be sure that come 2010 there will be many changes on the horizon for these funds. However, in research like the EBRI it is clear that fixing real or perceived problems with TDFs is only part of the solution if the goal is to better assist employees save for retirement. Equally important is that investment managers, service providers, and companies need to work together to bette explain how these funds work and how to maximize the benefits of them.
The Ugly Business of 401k Fee Reporting
Retirement plans, including 401k plans, which are so simple in concept (provide a means for employees to save for their retirement) are incredibly complex in practice. There are hundreds of moving parts to a typical 401k plan and they need to all be working properly all the time. Additionally, given all these moving pieces, there is normally a fee associated with each one. Congress has rightly been concerned about fees that are charged to employees that reduce what would otherwise be earnings, and as a consequence has held numerous hearings over the last year or so to better understand the fees inside 401k plans.
The Department of Labor – Here to Help
To understand the fees associated with 401k plans, we must first figure out a way of identifying the fees and then devise a way to uniformly present those fees so that comparisons can be made. Additionally, the collection and the reporting responsibilities need to be clear so that companies, investment managers, and 401k service providers can fulfill their responsibilities. The responsibility for developing clear communications and reporting requirements has fallen on the Department of Labor (“DOL”). Care to take a guess at how they have done?
The General Accountability Office (“GAO”) just released a report on how it thinks the DOL is doing in fulfilling its responsibilities and the outcome is not that good. I think I know part of the reason why. On page 16 of the report the GAO notes that the DOL has no specific plans for the data they are now requiring companies to report and that they will wait to see what they want to do with it after they get it!! Are you kidding me?!!
Rule #1 – Know Why You Want Something Before Requiring Others to Provide It
The DOL has redone the annual retirement plan filing – Form 5500 – to require a multitude of new information. Not only is the Form confusing, according to the GAO, with respect to what required, we now learn that the DOL doesn’t even know what it wants to do with the information once received. Moreover, one of the key items – explicit mutual fund fees – that you would think would be fundamental to the new reporting, is not even getting captured in the new form.
So where does all this leave a 401k participant like yourself in trying to better understand the fees associated with your account so that you can better manage your retirement account? Well, unfortunately, you are no better off in the short run. I think changes will be made long term, and in fact the DOL is specifically working on getting new fee disclosure regulations out to help you. But if the work done thus far on Form 5500 is an indication of the type of work we can expect on future guidance, I would start researching fees on my own if I were you.
Get Wealthy, Get Help
Worried about the future? Who isn’t, right? Survey after survey keeps coming out reflecting this worry, and a new one showing that Americans are increasingly less confident about their economic future does not seem like cutting edge research to me. However, a new survey out by the Hartford Financial Services Group shows just how dramatically optimism over the future has changed for most Americans as a result of the deep recession and volatile equity markets. And although much of the data is disturbing there were some findings to inspire hope.
Cover the Basics First
When people are concerned about life’s basic necessities, it is difficult for them to imagine or plan for what to them would be considered a luxury. After all, when you are worried about where your next meal will come from, you are probably not spending time planning a European vacation. And so it is with those Americans who are contemplating retirement. 65.2% of Americans say that their #1 financial concern in retirement is simply meeting the basic expenses of life – food, shelter, etc. This number is up from 24.5% in 2007, a dramatic increase to say the least.
Is such a dramatic shift justified? Has the economy and the recession really caused such a large number of Americans to really drop so far, economically speaking, that they will actually be just above the poverty level in retirement? Probably not. And this is where the interesting findings of the survey present themselves.
Be a Planner; Work with an Advisor
I suspect that the vast majority of concern over retirement is knee jerk. People are over-reacting to a short term crisis. A large crisis to be sure, but one that will be overcome by most folks. So why all the concern? Because most people do not have a clear understanding of their current situation, do not know what they need in the future, and have no idea how to get from where they are to where they need to be.
Is this the case for all people? No. As the Hartford Survey reveals, individuals who take the time to plan for retirement are 3x more likely to be confident that they will have sufficient income in retirement as compared to those that do not plan. Nearly 60% of what Hartford is calling the “planners” feel they are on target to retire.
What is also very interesting is that “planners” are 3x more likely to work with an advisor than non-planners. This makes sense. People who plan realize where they need help and most Americans need help making investment decisions. The moral of this research? Retirement is not out of reach. Rather, it takes careful planning and the assistance of an expert when you feel you are beyond your comfort level.
