Barry’s Pickings: The Role of the Employer in the 401(k) System

Art by Joe Ciardiello

There are three issues I would like to write about: the flood of 401(k) plan fee litigation being brought against plan sponsors; whether we should require that all employers maintain some sort of automatic enrollment retirement savings program; and whether we should require that all 401(k) plan sponsors disclose annually the “lifetime income value” of participants’ 401(k) account balances.

But, it seems to me, all of these issues implicate two even bigger issues: Do we need employer-sponsored retirement savings programs, and why? And if we do, what should we expect employers/plan sponsors to do?

In this column I’m just going to consider the first of those two bigger issues—why we need an employer-based retirement savings system. And I want to begin discussing that issue by contrasting the current 401(k) plan system with the one that it replaced (or at least is replacing), the traditional defined benefit (DB) plan system.

In the (traditional) DB system, all important retirement savings decisions were made by the employer:

• The employer decided which employees would be covered by the plan. And participants who were covered didn’t have the option to “opt out.”
• The employer set the level of benefits the plan provided.
• There was no (or very limited) choice as to how the benefit would be paid, generally (in one form or another) as a life annuity.
• Finally, short of bankruptcy, the employer bore all the risk of financing benefits.

In the 401(k) system, all of those key decisions are made by the employee: whether to participate; at what level to save; and what to do with the distribution. And the financial results are all, for better or worse, owned by the participant.

This greater participant-level flexibility, together with the transfer of financial responsibility from the sponsor to the participant, explains to a large extent why 401(k) plans have replaced DB plans.

Consequently, in the 401(k) system the employer is much less involved. And less committed. Indeed, if you took a poll of a random group of 401(k) plan sponsors and asked them whether they would prefer if someone else ran their plan, a lot of them would say, emphatically, yes, please.

As I see it, in the 401(k) system the employer is essentially providing a retirement savings-utility: an easy and efficient way for employees to save.

In this regard, I would identify four important functions the employer supplies: collecting retirement savings at the “point of origin”—when wages are earned, via payroll deduction; “capturing” the 401(k) tax benefit, which entails, via Tax Code nondiscrimination rules, making sure (through automatic enrollment, matching contributions and qualified non-elective contributions (QNECs)) that the plan benefits low paid (and low-tax paying) employees and not just highly paid (and high-tax paying) employees; at larger employers (at least), using buying power to reduce the cost of saving; and leveraging its relationship with employees to educate them about the need to save for retirement and how best to do it.

All of these functions could be accomplished outside the employer-employee system. There are proposals to revise the tax rules to provide a more direct benefit to low paid employees, e.g., a tax credit. These have generally been Democratic-led efforts, and no one has raised the possibility of getting rid of nondiscrimination testing in connection with them. But it’s the obvious tradeoff.

The issue of cost-of-investment is, in the view of many, as much an issue of participant choice as it is of exploiting employer buying power. Moreover, while many employers exploit scale effectively, many don’t and many smaller employers don’t really have scale to exploit.

Obviously, there are other ways to get information about whether and how to save for retirement than a letter from the employer.

One can even imagine a solution to payroll deduction that does not involve the employer implementing a retirement savings program. The federal government could collect a default amount of savings—something like a FICA-plus “tax,” with the option to opt out, sort of like Medicare Part B.

But these “solutions” to the employer problem unmask what for me is the most important problem with subtracting the employer from the current system.

I actually don’t think most American workers would mind a single payer retirement savings system that provided them with an easy, efficient way to save and a competitive return on their savings. With whatever tax benefits our two political parties determine is “fair”—in effect, whacking up the tax expenditure on retirement savings between tax deductions/exclusions and tax credits.

But, what do you do with the money? The idea that a government agency, or some group of money managers appointed by a government agency, would determine how to invest more than $5 trillion in assets is, to me, terrifying. How long would it take before decisions about how to invest this money would be politicized? Before the process of securing this business became corrupted by political contributions, political posturing, and rent-seeking at its most egregious.

And that, it seems to me, is the most important function that employers play in the current system—diversifying the way retirement savings are invested. Under our current system, every employer, for good or ill, makes an independent decision about what funds to include its 401(k) plan fund menu. That feature of the current system may in fact add to its cost, as a result of inefficient decisions by some employers as to which funds to offer. But it is clearly worth it. Our diversity is our strength, as they say.

That leads us right into the next issue I want address (and will address in my next column): 401(k) plan fiduciary litigation and the need for some clear and rational guidance on when we are prepared to punish a sponsor for the decisions it has made on that most critical issue—the selection of funds to be included in the fund menu.

Michael Barry is president of the Plan Advisory Services Group, a consulting group that helps financial services­ corporations with the regulatory issues facing their plan sponsor clients. He has 40 years’ experience in the benefits field, in law and consulting firms, and blogs regularly http://moneyvstime.com/ about retirement plan and policy issues.