More than 62 million Americans now participate in DC plans, according to the PSCA -- close to half the total workforce -- and there seems to be a growing public acknowledgement that the 401(k) plan is the major retirement vehicle for many people. With this change in officialdom, plus the rapid pace of change in the provider and plan sponsor sides of 401 (k), the implications of fiduciary responsibility seem to be changing as well. This puts me in a legalistic state of mind.
Consider the subject of "default" plan decisions, such as automatic enrollment, assignment of a default investment vehicle, even automatic savings rate adjustments. Not too long ago these things were viewed with caution by plan sponsors, and by their lawyers. Now they're becoming common practice. Nothing in the law has changed, (although new regulations to make automatic enrollment easier are in the works.) But the interpretation of that law has evolved.
As Fred Reish points out in the latest issue of Reish, Luftman, Reicher & Cohen's ERISA Report for Plan Sponsors, "From a legal perspective, there is no such thing as a default account. That is, ERISA says that, where participants do not give directions, the plan fiduciaries must prudently invest the money on their behalf." In other words, doing nothing may be just as bad as doing the wrong thing.
The real world already works this way. What if your mechanic wouldn't change the oil in your car unless you specified when to do it, what brand, and what type? Unless you're a gearhead yourself, you'd consider this unhelpful at best, unethical at worst. After all, a mechanic is the expert who's supposed to look after your car's best interests. Right?
This reasoning makes sense just about everywhere except in a retirement plan. But good sense may soon prevail. According to Reish, "In my opinion, we are about to experience a seismic shift in the popular perspective of prudent default accounts. Of course, the law has always required that default money be invested prudently for retirement purposes. So, in a sense, the popular perspective is simply shifting to match the legal requirements." And not a moment too soon.
I've always believed that this logic applies to providing some kind of investment advice as well. Consider our unhelpful mechanic. What if you asked him directly how and when to change the oil, and he still wouldn't tell you? Sure, it's your car, but it's sitting in his garage! I feel a retirement plan presents the same situation: It's ultimately your money, but because it sits in your employer's plan for many years, your employer should provide much more than just a parking space.
Note that the word "prudent" keeps coming up. In practice prudence is notoriously open to interpretation, but in principle it means (more or less) "the way a well-informed and well-intentioned hypothetical person could be expected to act." To my mind that's not the same as "put the whole thing in cash and leave it there." Yet that's what plan sponsors have traditionally done.
It's ironic that while we often bemoan the too- conservative choices of participants, plan sponsors are even more risk-averse. Their usual rationale, avoiding legal exposure, makes the irony even worse. As Reish explains, ERISA requires that, "as with any decision for a retirement plan, fiduciaries must invest for the exclusive purpose of providing retirement benefits (as opposed to investing for the purpose of minimizing criticism or risk.)" Once again, doing nothing is not an option.
All this points to a redefinition of what fiduciary responsibility really means. The good news is that employers will be free to do much more for the long- term welfare of their employees, such as strong default investments, advice services, and the like. The only bad news, for some fearful employers, is that they'll be required to do so.
When I'm Sixty-Four
Moving beyond default account choices, this trend is visible in other areas, such as in-plan annuities. Many experts recognize that spending retirement money wisely is just as important as accumulating it, and that annuities provide a powerful tool for post- retirement financial security. However, few participants know much about the usefulness of annuities, and very few request them.
According to BNA's Daily Labor Report for July 12, this low demand plus a confusing standard for liability adds up to a chronic fear of annuities on the part of plan sponsors. But ERISA's Working Group on Retirement Plan Distributions is now paying attention to the problem. Meanwhile, plan providers are starting work on ways to integrate annuity options with other plan services. I see this as a step in the right direction, toward a concept of responsibility that includes proactive measures for employees well-being -- even after they retire.
Finally, a recent Vanguard Group report recommends managed accounts, among other possibilities, as a more appropriate default plan option. In their opinion, these are "more consistent with the legal standard of prudent investment decision-making," which I think means the new, improved standard I've been talking about. The authors point out that "In the end, some type of balanced investment program as a default fund is likely to generate higher retirement assets over the long term, which is certainly the main objective of offering a retirement savings plan in the first place."
So it seems the world of 401(k) may be coming to its senses after all. Now if only we could do something about those 40-page SPDs!