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Benefits Business
Changes in the air
Employers are reassessing 401(k) and other employer/employee plans
By Len Strazewski
It sounded like such a simple and powerful idea: Employees contribute to retirement accounts on a tax-free basis, and their own contributions are matched to a limited degree by their employers.
The employees then choose their own investments from a group offered by the sponsoring employer but remain responsible for their own retirement security. The employer is off the hook for specific or defined retirement benefits and employees build attractive and portable accounts of real, measurable dollars.
Everyone recognizes the 401(k) plan which was an extremely popular retirement benefit—until the equities market collapse reduced those cash accounts by more than one-third and revealed a host of other weaknesses in the defined contribution retirement plan design.
Agencies with employee benefit divisions that helped design and administer these plans for their clients now have a new challenge. As the plans have come under attack from frustrated participants and baffled employers, agents and brokers will have to be prepared to advise and administer changes in plan funding, design and communication.
First among likely changes is the nature of an employer match. Last year, as the economic downturn mushroomed and corporate earnings shrunk, many employers suspended their matching programs for at least one year.
Most employers plan to reinstate a match in 2010 says Ginny Olson, principal in the Atlanta office of Towers Perrin, an international consulting company. However, they may not want to return to the same old plan design.
Olson says employers could choose to follow different paths or philosophies with allocated match funds—and not all of the funds may wind up in a retirement account.
Moving beyond retirement funds
Some employers may choose a reactive match—linking the 401(k) plan contribution to profitability. Until this year, a typical employer match was 50% of employee contribution up to a cap—usually about 6% of salary; but employers could reduce their standard match to only 25% and link the remainder to corporate profitability.
Profit-sharing plans are time-tested designs, she notes, and some employers have already built profit-sharing into their overall retirement benefit designs. Linking the match to profitability is a small but significant change that could be a powerful tool in improving profitability.
Employers may also want to shift some of their match to what Olson calls “total retirement adequacy.” Post-retirement medical expenses are among the greatest concerns for retirees, but most employers have been moving away from offering retiree medical benefits.
Employers could use match dollars to help retirees save for medical expenses by contributing to Health Savings Accounts (HSAs) that can be reserved for retirement.
Finally, Olson notes that some employers may want to remove the match allocations entirely from the retirement benefit design and focus the spending on employee training and development—two areas that suffered during the downturn.
Investment in employee development could improve overall job security, leading to better income and career longevity, she says.
Funds and capital management may be in for big changes, too. Prior to the recession, the most marketed innovation in defined contribution investment was target funds—mutual funds designed to maximize returns toward a specific time period—five, 10 or 20 years to retirement.
The idea sounded great and built in a changing mix of equity and fixed income investments to protect projected gains as fund participants approached their target retirement date. However, the market collapse undermined the principles of the target funds—the early high returns from equity investments.
The failure of the funds to meet target goals led to U.S. Department of Labor and Securities & Exchange Commission hearings on potential regulations.
Chuck Epstein is a Sacramento, California-based independent financial marketing consultant and mutual fund design expert. He blogs on mutual fund and consumer investment issues at http://www.mutualfundreform.com.
Epstein says plan administrators need to become more diligent in supervising costs, expenses, and the fund offerings themselves. “It’s clear that the faddish target-date funds failed to perform. These funds are great from the mutual fund company perspective because they often bundle mediocre funds into a target date program with a ‘glide path’ or asset allocation exposure which is very flexible and untested.
“While target dates have an appeal, they did not work in the current recession. If they did, there is no reason for them to be down 25% to 30%.”
Seeking security
Epstein says that in light of the recession, plan sponsors and plan participants will be seeking greater security in plan design and investments. “People want the security of a pension. It is also very clear that people cannot manage their own funds themselves, which accounts for the lower returns. 401(k)s are great for the mutual fund business, but they are not making great strides towards helping for a more secure financial future.” Epstein recommends that employers and the agents who represent them become more diligent and adopt a fiduciary standard approach to their providers and critically evaluate target-date funds.
Epstein also recommends that agents choose carefully from among the fund companies they represent and be prepared to question their plan designs and expenses. “Be critical of insurance companies which offer mutual funds as an adjunct to their plan administration business. Often these are mediocre funds that are offered as loss leaders to get the business,” he says.
“And revisit the idea of pension funds or group annuities as a way of rebuilding employee-company loyalty.”
Employers may also want help in improving plan participation after they find a better funding formula. According to a study of 3 million plan participants conducted by Hewitt Associates in Lincolnshire, Illinois, and Ariel Investments in Chicago, employee participation in 401(k) plans is not balanced in regard to race and ethnicity. And as a result, the plans benefit some employees more than others and leave large groups of employees with less retirement security.
The study, released this summer, found that regardless of age and income, Hispanic and African-American employees have lower participation rates and contribute less overall than White or Asian employees, leaving them with generally lower account balances and significantly less retirement security.
Only about two-thirds of African-American and Hispanic employees participate in their employers’ 401(k) plans, compared to 77% of White and 76% of Asian employees. On average, African-American employees contributed 6.3% and Hispanic employees about 6%, compared to 7.9% for White employees and about 9.4% for Asian employees.
African-American employees and Hispanic employees were also more likely to reduce the value of their accounts by taking loans or hardship withdrawals. Nearly 40% of African-Americans and about 33% of Hispanics borrow from their accounts, compared with about 20% of Whites.
“These statistics are troubling because loans and withdrawals jeopardize long-term financial security to satisfy immediate needs. The impact is heightened during an economic downturn when unemployment rises and withdrawals and loan defaults increase,” noted Hewitt Associates principal Barbara Hogg in an analysis of the study.
As agents and brokers increasingly take the lead in preparing benefit statements and benefit communications materials, they may need to take hard looks at employee demographics and diversity issues in plan design and administration.
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