Whether you love or hate your job, the freedom to retire is inescapably appealing. In fact, it’s the American Dream – work hard in order to attain the requisite financial freedom to retire to a comfy home with a white picket fence, pursue your interests irrespective of earning potential, and provide for your family. Unfortunately, the changing dynamics of retirement accounts, Social Security, and the economy at large may be making this dream harder to realize, if not turning it into a nightmare for many folks.
Not only does the aging American populous put Social Security in jeopardy, but the increasing reliance on 401(k)s instead of pension plans has also made many Americans’ safety nets less reliable, especially since a lot of people do not fully understand these plans or their true effectiveness.
The Problem with 401(k)s
This isn’t necessarily your fault, though. Contributing as much as possible to one’s 401(k) has become the golden rule for retirement planning, but the truth is that a lot of our plans charge exorbitant fees, leverage underperforming or risky investments, and truly serve the interests of the companies that offer them rather than you and me.
Most employers don’t have the requisite investment knowledge to make shrewd account decisions, so it’s common for them to hire outside firms that offer comprehensive 401(k) management, from choosing investments to record keeping, while managing to contractually avoid assuming the employer’s fiduciary liability.
And while these bundled plans are “free” for employers, the hidden cost comes from the high built-in fees charged to employees and the business the providers get for their cronies. In short, 401(k)s have become breeding grounds for conflicts of interest, such as providers only offering access to funds in which they have a financial interest, charging consumers fees that amount to 3-7% of their account balance annually, or instituting crazy termination fees to prevent employers from doing business with another company.
Studies show that such practices are costing retirees as much as 30% of their eventual nest egg.
Unscrupulous 401(k) management firms have gotten away with this for years. The lack of clear disclosure requirements made it difficult for employers to compare services in order to find the best deals for their employees. In addition, employees were not given the information they needed to effectively choose their investments or realize that the best options were not actually at their disposal. It’s not like employers didn’t want the best for their workers or the workers the best for their wallets, but a lack of information combined with a desire not to be bothered made this difficult to come by.
Is Help On the Way?
I used past tense in that last paragraph because the Department of Labor recently issued the following two final rules designed to promote 401(k) transparency and effective consumer management:
- Reg. 404(a): Requires plan administrators to provide participants with information regarding their rights and investment options, including fees and expenses, on a regular or periodic basis. It also necessitates that administrators advise consumers of their investment options outside those designated by their respective plan and provide clear statements laying out the fees being charged, the performance of investments, industry benchmarks for comparison purposes, and a glossary of important terms to foster increased consumer understanding of how 401(k)s work.
- Reg. 408(b)(2): Necessitates that 401(k) providers disclose their total compensation as well as possible conflicts of interest.
Benefits to the You, Me & the Economy
These new rules will obviously prove beneficial on the personal level, but we mustn’t forget the positive effect they’ll have on the overall economy as well. First of all, the Employee Benefits Security Administration (EBSA) estimates that Reg. 404 (a) will carry $2.7 billion in administrative costs over the next 10 years, but will provide $14.9 billion in benefits for consumers, largely due to time saved. Reg. 408 (b)(2) is expected to cost $43 million per year and offer a significant monetary benefit given that fiduciaries will find it easier to compare 401(k) plans.
Improvements to the way 401(k) plans are managed will also help consumers maximize the savings that eventually become their retirement income. It’s long been a worry that the volatility of 401(k) investments and the difficulty of strategic management in old age will make it hard for retirees to budget and ultimately put a strain on the economy when taxpayers are inevitably asked to bail them out. The new rules simply lessen the cause for concern.
Ultimately, while we should still be careful about relying too heavily on risky investment vehicles that require vigilant management into old age, at least regulators are taking the necessary steps to curtail impropriety in the retirement investment industry.