US 401(k) plans after the crisis

 

Raquel Pichardo-Allison: What has been the biggest impact of the financial downturn on 401(k) plans? 

 

David Wray: I think it has resulted in people being somewhat more conservative in their approach to investing. You see participants have, to some degree, changed their future allocations to a more conservative allocation. We’ve gone from probably a 70/30 overall in equity versus fixed to maybe 60/40. 

And certainly, plan sponsors are reviewing the plans’ investment programmes more often and more intensively. There had been a trend towards quarterly reviews, but I would say this has cemented that into common practice. 

For participants, what has been remarkable is their resilience, partially because of a significant communications effort by the 401(k) community. Participants overwhelmingly continue to participate. People are saving more, and 401(k) is the most trusted method of saving and investing. 

 

Raquel Pichardo-Allison: Is the increased savings rate an emotional response to the economic climate, or something that will permanently take hold? 

 

David Wray: The savings rate has always reflected, to some degree, demographics. Younger people don’t save as much. They’re setting up households and they make less money. Older people save more. Now, retirement is a real event in their lives, and they have more money. When baby boomers were young, it skewed the savings rate. The rate was lower. As the baby boomers age, they are now entering a peak savings period. So I anticipate that the savings rate will continue to increase. 

So you add this demographic reality... plus, I think there has been an emotional experience and people have been reducing their debt significantly, you’re going to see the savings rate elevate and stay elevated. 

 

Raquel Pichardo-Allison: What kind of changes is your organisation advocating regarding 401(k) plans? 

 

David Wray: We hope to support significant employer commitment to the programmes. We absolutely believe there is a correlation between employer commitment and success of the programmes. Our mission, for the past 60 years, has been to help employers be successful at that. 

Another mission is to promote a regulatory environment that is conducive to growth in the system. The system needs to be trustworthy, so having some kind of fee disclosure is positive. Not because fees are too low. In fact, fees in 401(k) plans are lower than when people pay on their own, but that’s not recognised because we don’t have fee disclosure. 

Right now we’re focused a lot on the preservation of the current structure. 

 

Raquel Pichardo-Allison: On the federal level there had been talk of mandating automatic-enrolment, but that was dropped. Why?

 

David Wray: We argued that this is a voluntary retirement system and the reason that automatic enrolment works is not because of passivity alone. It requires the participant to trust the employer and to believe automatic enrolment makes sense for them. Imposing a generic program (would cause) a lot of employers to step away from the extra support that makes it work. It’s critical that the employers be a part of the system, and once you make something mandatory, that changes. 

Also, once you start mandating the plan design, then what’s next? Pretty soon the system loses its flexibility. The US is a huge, very complex, diversified country. If you want a voluntary system to work, you have to have the flexibility for employers to design programs that work best for their employees and their companies. The government has over-regulated the defined benefit system out of existence and we do not want that to happen to the defined contribution plans. 

 

Raquel Pichardo-Allison: How wide spread is automatic enrolment now? 

 

David Wray: In the large companies, over half have automatic enrolment. That means a large portion of the workforce now is being automatically enrolled. It’s less in small companies. Probably a third of all companies have it. 

 

Raquel Pichardo-Allison: Do you think there’s room in the US for something similar to the Australian system where pension contributions are mandatory?

 

David Wray: The Australian system does not have social security. Right now the American worker is already paying over 12% into social security. It is unrealistic to believe that we can force American workers to pay additional money into some mandated program. 

 

Raquel Pichardo-Allison: Some would argue that social security won’t be around for much longer. 

 

David Wray: That is not true. In its worst projection, social security would provide 75% of promised benefits. There will always be social security revenue generated by current workers. That revenue will flow to current retirees. 

Whether or not that revenue in the future is sufficient to fund the benefit levels currently structured is certainly a topic of discussion, but to think there will be no benefit is just not true. Any review of social security demonstrates that social security will be providing substantial benefits to retirees. 

 

Raquel Pichardo-Allison: How much of a role should the employer have in doling out financial advice? 

 

David Wray: What makes our system different than any other, is that there has to be someone making fundamental decisions for participants. Now, you can turn that over to the participants themselves. There are clearly people that would suggest everyone should have their own plan. The other extreme is that the government should manage this. 

Our view is that the most effective fiduciary process is to have the employer (act as fiduciary). The employer’s interest is aligned with the employees. They don’t make money managing plans. What they do get, if the plans are well run, are loyal, committed workers. This alignment of interest gives participants the very best outcomes. (We recognise) that employers are not experts, but then neither are employees, or government bureaucrats. 

The critical issue is that the plan sponsors are the decision makers, and that’s why the plans are so successful. They have legal, moral, and business reasons to do this right.  

The other alignment is the fact that the decision makers are aligned with the rest of the workforce…because they are the participants with the most money in the programme. 

 

Raquel Pichardo-Allison: What do you think of how target date funds have performed over the past year and how they’ve been set up?

 

David Wray: Conceptually, target date funds are a very valuable approach to managing money for 401(k) participants. They result in diversification. They are automatically rebalanced, and they recognise the time horizon of the participant. So conceptually, they are very good. 

We are at the threshold of the target date era... very smart people came up with an approach that resulted in fairly short target date funds having significant equities. The result of that was that the returns in those plans were startling to those participants. I think we need to do a better job at explaining the underlying philosophy of the target date funds we use in our plans. 

There is quite a discussion on glide-path construction. One group suggests that you ought to think of the glide path as terminating at age 90. Some of the funds that are based on this philosophy had some of the biggest losses. The target date is not age 65, it’s really 90. 

There’s another philosophy that the termination date should be the date of the end of employment, and you should be significantly more conservative as you approach that period. 

There’s still a question of how much equities we should see at the end. This area is going to be discussed a lot, and there will be a lot of changes over time. 

 

Raquel Pichardo-Allison: Coming into the beginning of this year, there had been a lot of questions about whether or not the 401(k) plan will continue to exist. Are those questions still being asked? 

 

David Wray: There’s recognition that to the extent that there will be a programme beyond social security, it will most likely be a defined contribution programme. When you look at the proposals and the conversations... there’s no-one who believes the 401(k) system will be replaced by a traditional pension arrangement. The broad based defined benefit arrangement we have in the US is social security. 

The conversation is about what kind of defined contribution system we will have. 

 

Raquel Pichardo-Allison: Looking ahead five years from now, how would you answer that question? 

 

David Wray: The system we currently have will remain in place. There will probably be some changes, because there are changes constantly to the system, but the fundamentals will be relatively the same. 

For example, I think the system will remain voluntary. The social security tax is significant, and the benefit is quite significant, so I just don’t believe that American workers will accept another mandatory program that takes money from their paychecks. 

 

Raquel Pichardo-Allison: What are some of the biggest changes you’ve seen over your 22 years at the organisation? 

 

David Wray: The biggest change has been the enormous growth in the system. The amounts of money are huge now. On the other hand, I’ve seen the system go from what I would call a paternalistic approach, where the company made most of the decisions for participants, to a system where participants had to make virtually all of the decisions, to the present approach which is more balanced and in which participants if they wish can let their employers make the decisions for them. 

One attribute of the system in its current form is that it is highly flexible. It has been able to evolve and change in reaction to current situations and to take advantage of new best practice ideas. That’s one of the reasons we resist government mandated plan design.