A recent review of financial industry practices conducted by the GAO has been making headlines with reports of disturbing and misleading practices among 401(k) service providers pushing terminating participants into IRAs. The report even included undercover “sting” calls in which investigators posed as participants. The information provided was confusing, contradictory, and at times simply wrong – for example, claiming that employer-sponsored plans aren’t allowed to offer investment help. What they had in common was a strong sales pitch for their own IRA products versus rolling over into a new employer’s plan.
Path of Least Resistance
We were amazed and disheartened by this news. It’s especially on our minds because we’ve recently put some effort into our own procedures and standards for investor communication. We couldn’t agree more with the GAOs demand for “complete and timely information.” But the problem goes deeper than a few bad call-center scripts.
How did our industry get into this mess? It’s well known that some plan sponsors tend to discourage departing employees from leaving money in their plans. Unfortunately the rules governing plan-to-plan rollovers are complex and often poorly understood. Rollover into an IRA with the same firm who manages the 401(k) plan is simply the path of least resistance. The trend has accelerated in recent years as IRA providers have gained greater access to this market: the GAO also found that 90% of new IRA assets are rolled over from qualified plans.
The report goes on to make a number of recommendations. Most of them involve removing barriers to plan-to-plan rollovers so that assets can flow more easily into new 401(k) plans. This is reasonable and certainly appropriate. After all, most of those barriers are government-imposed, whether indirectly through lack of guidance to plan sponsors, or more directly through IRS regulations regarding distributions.
However, we take issue with the GAO’s reasoning that 401(k)s “are generally considered better than IRAs when it comes to fees, access to advice, and fiduciary oversight.” With regard to fees, size matters. Fees in larger plans tend to be lower than in comparable IRAs, but fees in smaller plans are actually often higher. In fact, reducing fees was one of the only valid arguments for an IRA that we heard in those sales pitches!
Advice is still generally less expensive and more available in 401(k). That’s changing rapidly, though. It may change even faster if employers are required to offer automatic IRA enrollment as proposed in the President’s 2014 budget. And we couldn’t agree more about the lack of fiduciary oversight being a major weakness of (most) IRAs.
Overall, the choice between opening an IRA and leaving the money in the 401(k) environment is a multi-dimensional issue for an individual. Fees, educational and advisory services, and fiduciary responsibility (including Investment Committee oversight) are all important. But in a volatile economy an unlimited range of asset classes, access to the money, and real-time trading may trump other concerns to drive people to IRA’s.
The IRA of the Future?
As some observers address in detail, and the report itself notes, the heart of the issue is really fiduciary responsibility, not procedural details. If you tell a participant in a qualified plan where to invest their entire account balance, is that not a fiduciary activity? At a minimum, providers who assist participants with the rollover decision should be required to act clearly, impartially, and transparently, with the best interest of the investor in mind.
That’s the minimum. We’d like to push the fiduciary role farther – all the way into the realm of the IRA. There’s no reason IRA providers can’t take a more active role as fiduciaries – from simply pledging to look after the long-term wellbeing of investors, to providing prudent advice and professional management services.
Expanding the scope and capabilities of IRAs makes a lot of sense considering the changing nature of the American workplace. If it happens on a large scale, the preface to every one of the GAOs recommendations does not have to be “keeping retirement savings in the 401(k) plan environment.” And the intricacies of plan-to-plan rollover are no longer a barrier to maximizing investor outcomes.
On the surface this might seem like just another argument to expand government regulation. But philosophically such an approach is really very back-to-basics: if you’re minding someone’s retirement money, especially if you just took it out of a qualified plan, your responsibility should amount to more than just sending an annual statement.
As is often the case, the language people use may say as much as their actual statements. Somewhere along the line we’ve seen a change in the vocabulary of the retirement conversation. We used to refer to working Americans as “employees” or “investors” participating in “the retirement system.” These days we’re increasingly labeling them as “consumers” buying products in “the marketplace.”
We happen to believe that a free market is the best way to meet the needs of customers and firms alike – in the aggregate. But in the particulars, mistakes and problems are bound to happen. Because management of your life savings is more important than your choice of a new phone, and because a long history of fiduciary responsibility already surrounds such decisions, we call for a higher standard to be applied as broadly as possible. At GuidedChoice we’ve always maintained a strong commitment to transparency. Transparency helps investors make better choices, and keeps the engine of the free market running smoothly.