Is Financial Wellness Missing the Point?
By George White, CEBS
Financial wellness is the latest retirement topic du jour, with numerous programs marketed and panelists devoting coveted time at industry conferences. What’s not to like about helping people budget and reduce stress? If there is predictive power in a name, financial wellness may be here to stay. But is the enthusiasm coming at a cost?
Some in the industry believe retirement plan sponsors should take stock of their plans’ effectiveness before devoting time and energy on broader programs. Many plans seem to lack a focus on retirement security, and it’s worth asking why. Perhaps employers feel that providing access to a qualified plan with assets in a trust is enough. But retirement security is more than having assets in a safe place; it’s about achieving sufficient lifetime income.
An undue focus on “financial wellness” may overlook four common threats to a successful retirement: not contributing enough; high fees; poor investment selection; and premature job loss.
Four common threats to achieving a successful retirement
1. Not contributing enough
While contributing to a plan is an employee decision, you can’t blame people for procrastinating at first. Saving for retirement can fall pretty far down the list until people are more established in their careers. Other priorities feel more urgent.
What Employers Can Do
Educate employees. Employees need education on two important basics: saving early, and joining the plan at a high enough rate to qualify for any available employer match.
Many experts consider saving 10-15 percent each year to be ideal. Perhaps not realistic for all, but contributing just six percent of the median U.S. salary with a three percent match would allow most people to retire comfortably if they average six percent annual investment returns during their career.
Auto-enrollment/auto-increase features. Many employers help workers get started through features that automatically enroll them into a plan unless they opt out. Other employers take it a step further, increasing deferral rates each year to a pre-set level (increases are often 1% per year until the employee contributes enough to maximize a match). While contributing is the employee’s responsibility, plan sponsors have the tools available to help nudge workers. Where auto-enrollment is not a fit, employers can inquire about “simplified enrollment.”
2. High fees
Retirement plan fees continue to be in the news. Class action lawsuits have uncovered plans with funds charging 50 percent or more than other similar funds – costing employees in large plans millions of dollars in retirement savings.
Much of this discrepancy is related to the use of active portfolio management – where investment professionals are paid to select securities for a portfolio – when similar passively managed products are available. Passive investments are designed to track market indexes, not outperform them, and are often available at a fraction of the cost. With expenses the only factor an investor can control, and the fact that passive funds have outperformed actively managed equity funds over every recent measurable time period1, the benefit becomes clear. It’s no surprise these index trackers continue to gain in popularity on many plan menus.
What Employers Can Do
Fiduciaries are obligated to administer the plan in the best interests of participants. Employers should offer a highly-rated investment menu with index funds tracking U.S. equity markets, international equity markets, fixed income, a range of lifestyle or target date funds, and a money market or cash alternative. Additionally, employers can supplement this core menu with a brokerage account window for more sophisticated participants.
3. Poor investment selection
Putting low cost investments in the plan is not enough; some plans subject to recent lawsuits offered them. In one recent example involving a financial company, nearly all the assets were invested in the plan sponsor’s own investment offerings.
How should your employees select among the low-cost investments your plan offers? Or allocate correctly across different asset classes? There is much debate about whether we can reasonably expect employees lacking financial expertise to appropriately allocate their savings among different investment options. This is no small matter. Studies have shown that more than 90 percent of investment returns correlate to the underlying asset class.2
Here, Target Date Funds (TDFs) offer an excellent option. TDFs are “funds of funds”, typically made up of underlying plan investments and offered as a suite of investments participants can select based on the year they plan to retire. TDFs, which automatically diversify across asset classes and grow more conservative as retirement approaches, have become a critical addition to plan menus and the fastest growing investment in qualified plans.
Once implemented, however, plan sponsors have to regularly review fund performance and overall expense structure to ensure the right fit for participants.3
What Employers Can Do
Auto-invest in Target Date Funds (TDFs). By designing a plan to automatically default investment contributions into TDFs (based on a limited number of passive investment options), an employer can help workers get off to a good start. The combination of passive options and more conservative investments over time solves for both fee and investment selection issues.
4. Premature job loss causing loan defaults
Premature job loss might be the most overlooked threat to retirement security. Why? Although 401(k)s are portable and can move with employees to their next job, any outstanding loans have to be repaid. If the job loss was involuntary, employees typically lack the income to repay the loan.
Studies show when retirement loan borrowers lose their jobs, they default on their loans 86 percent of the time. An industry paper put this figure at six billion dollars in 2014 alone.4 Compounding the problem, when faced with hefty taxes and penalties, the vast majority of participants turn to their only savings — that very same retirement account — and cash out their remaining balance. That jeopardizes their retirement and wastes years of potential growth; time they cannot get back.
What Employers Can Do
Offer loan default insurance. To protect employees’ retirement savings, employers can add retirement loan insurance to their plans. This insurance prevents loan defaults; it pays off the borrower’s outstanding loan balance after they lose their job but before the loan defaults.
Retirement is too important not to protect. We routinely insure our homes. Why not insure our 401(k) loans? Eliminating them is not the answer; participants value loans. The ability to access retirement funds for certain circumstances (avoiding foreclosure, etc.) gives many the confidence to participate in retirement plans. Fully 20 percent of Americans with access to plan loans borrow money — with the number rising to 40 percent over five years. 4
Group loan insurance is a simple way to safeguard a participant’s account balance, preserve future earnings potential, and keep them on track to reach the successful retirement they deserve.
Feels like financial wellness, doesn’t it?
George White is a financial services industry executive who has spent his career managing and advising employee retirement benefit plans. Contact the author at email@example.com or follow his company on LinkedIn.
In the year ended June 30, 85% of large-cap stock funds, 88% of mid-cap funds and 89% of small-cap funds failed to match the major stock indexes they track. Numbers for five and ten years were slightly worse, S&P Dow Jones
Determinants of Portfolio Performance, Financial Analysts Journal, Brinson, Singer, Beebower, 1991
Note: the inclusion of target date funds is not enough. Employers have to know what underlying funds the target date products are using for their allocation models. See Johnson et.al. v. Fujitsu Technology and Business of America, Inc.
Borrowing from the Future: 401(k) Plan Loans and Loan Defaults, 2014 Vanguard Wharton