I had a chance recently to watch the piece about 401(k) plans by Martin Smith on the PBS program Frontline, “The Retirement Gamble”. The piece takes a critical look at the 401(k) plan as the central retirement savings vehicle for most Americans. Smith covers a brief history of the 401(k), the market turmoil that has shaken confidence in it, and the various points of confusion and conflicts of interest that can occur in the 401(k) marketplace. In short, it paints a worrisome picture of the retirement industry.

In general, this is good information for 401(k) participants to have. Lack of participant engagement is a dominant force in the retirement readiness arena that we retirement plan professionals work hard to counteract. Smith’s work to stoke the ire of 401(k) plan participants may inspire some of them to actually open and read the statements and fee disclosure notices we diligently send them. Cautionary tales about not dipping into your plan are important at a time when many people are doing just that.

However, Smith’s piece only paints part of the picture—saving for retirement doesn’t have to be such a gamble. He says next to nothing about what people can or should actually do to improve their retirement accounts besides keep working, and dream of winning the lottery. The advice to participants to request formal acknowledgment from their financial advisors of their status as a “fiduciary” is dubious at best (for one problem, it’s unlikely the average participant could draft a meaningful fiduciary contract). Smith’s piece does not reflect the recent legislative and litigation efforts—enhanced fee disclosure, increased fiduciary responsibilities—which, while slow to develop and long overdue, are nonetheless beginning to address the very problems Smith laments.

So, for participants who were left wondering, and for plan sponsors who are fielding questions, what can each of us do to improve our odds at a secure retirement?

1) Start saving! If you haven’t started already, or perhaps stopped as a result of recent economic turmoil, it’s critically important to set aside money for savings on a regular basis. How much? Typical recommendations range from 6% to 20% depending on age, investment style, current savings, and other factors. Many employers contribute regularly to 401(k) plans, as well, to help participants reach that target savings rate. A retirement income calculator such as Milliman’s PlanAhead for Retirement® tool is a great way to hone in on an amount to save.

2) Choose a diversified investment strategy. This doesn’t have to be hard. Selecting a target date fund counts as a diversification strategy.

3) Understand your plan’s investment and transaction fees (and the impact thereof) by reading the annual disclosure notice and the fees section of account statements. An HR representative can help with most questions. Employers are required to act as fiduciaries and should have additional resources for any questions they can’t answer themselves. Use this information to fine-tune #1 and #2 above.

As part of the proposed federal fiscal year 2014 budget, President Obama included a cap on the amount of retirement savings an individual could accumulate in tax-deferred retirement plans. The total accumulation amount for an individual includes all qualified tax-deferred savings plans such as traditional defined benefit (DB), cash balance, money purchase, profit sharing, 401(k), and 403(b) plans, as well as funded governmental 457(b) arrangements and Individual Retirement Accounts (IRAs), both traditional and Roth.

The proposal is most likely a result of the presidential campaign last year, during which it was reported that Governor Mitt Romney had qualified accounts in excess of $100 million. However, the Administration’s budget proposal would not tax accumulated accounts in excess of the cap. If the accumulated accounts exceed the cap, the individual would not be allowed to make future deferrals or receive any future employer contributions under any retirement plan.

The proposal would essentially cap tax-advantaged retirement plans to an amount necessary to provide the maximum annuity permitted under a defined benefit plan. The current limit is $205,000 payable annually at age 62. The annual annuity amount would be increased by a cost of living adjustment.

After converting the annuity to a present value using current interest rates, the total accumulation amount is approximately $3.0 million to $3.4 million. Because of the current low interest rate environment, that total accumulation amount is inflated. If interest rates return to a historical level, the maximum accumulated amount could be as low as $2.2 million to $2.4 million for an individual age 62.

No real details are available on how account values would be reported or how the cap would be calculated. There is a concern small business owners could eliminate their retirement plans if they were at the accumulated cap, because they would not receive the benefit of tax-deferred treatment. As a result, retirement savings vehicles for many rank and file employees could be eliminated. As an alternative, consideration could be taken to limit only employee deferrals under the proposal or a portion of employer provided contributions, allowing small business owners some incentive to keep their retirement plans.

Under the proposal, it is estimated that the accumulation cap would result in approximately $9 billion in additional federal tax revenue over the next 10 years beginning October 1, 2013. On the flip side, it has not been determined how much tax revenue would be lost in future years as a result of smaller account balances for these taxpayers. All distributions from qualified retirement plans (other than Roth accounts) are taxed at distribution.

It will be interesting to see if this proposal will gain traction with lawmakers.

This blog summarizes a presentation given by Genny Sedgwick at the Mid-Sized Retirement & Healthcare Plan Management Conference in San Francisco.

We’ve talked a lot about fees in defined contribution (DC) retirement plans lately: the disclosure regulations effective in 2012 have caused quite a stir, and for good reason. For plan fiduciaries, ensuring that retirement plan fees are reasonable and fair is a fiduciary duty, and understanding plan fees can have a significant impact on retirement savings for participants.

For example, if a participant’s retirement investments or account is overpriced by one-quarter of 1% (25 basis points), and the participant has $5,250 in total contributions annually for 40 years, then that participant will have overpaid $40,056 in fees!

But simply knowing the base amount or formula stated by the recordkeeper is often not sufficient to truly understand the impact of fees in a retirement plan. It’s also essential for plan sponsors to consider the different types of fees that occur in retirement plans: plan-level service fees, participant-level service fees, and investment fees. These fees interplay in ways that can have dramatically differing effects from participant to participant.

In order to understand retirement plan fees, it’s important to understand investment expenses and the concept of revenue sharing. Each investment option has an expense ratio, which may contain two major fee components: an investment management fee that varies based on the attributes of the fund or its manager, and a shareholder service fee, which is often paid indirectly to the plan’s service provider(s) in a process called revenue sharing. Expense ratios can vary substantially from fund to fund within a plan, so participants pay different amounts of investment expenses based on their allocations among those funds. Revenue sharing further complicates the matter because not all investment options have a shareholder service component, and those that do have different rates and policies.

Revenue sharing can be normalized among participant accounts in the plan through a process called fee leveling, wherein revenue sharing is allocated back to participant accounts on a per capita or pro rata basis, or back to the participants who held the funds that generated the revenue sharing. However, not all recordkeepers can administer all of these options.

Another issue to consider is who should pay the plan fees that exceed the amount of revenue sharing generated by the plan. Some employers choose to pay these fees, while some assess them to participant accounts, in which case they must decide whether to allocate those “hard” costs pro rata or per capita. Pro rata cost allocations protect smaller account balances, while per capita allocations protect larger account balances.

What’s right for your plan? As the plan sponsor, it’s your choice, but given the implications for fiduciaries and the impact on the retirement readiness of participants, it’s important to understand the options, consider what’s best for your plan, and document your decision.

Most individuals are beginning the process of preparing their income tax returns this time of year—paying taxes later is not an option that presents itself. However, an item in the American Taxpayer Relief Act of 2012 has added the flexibility for retirement plans to allow individuals to choose to pay income taxes on their retirement accounts now, so that it won’t be necessary when they retire and begin to draw the money out.

That is the primary attraction of a Roth account. If your 401(k) plan currently has a Roth option, the good news is that you may be eligible for this conversion. However, it will require some research to determine if it’s the right decision for you.

At face value, the trade-off is simple. If you convert pretax dollars to a Roth account within your plan you are essentially taking a distribution, within the plan, and opting to pay taxes in the year of conversion at your current income tax rate. This, of course, leads to an increase in taxes that are due for that year, and may even increase the tax bracket you are in. Once done, the new Roth dollars and any future earnings will grow tax-free as long as you hold the account for at least five years and are at least age 59 and a half years old before you withdraw it from the plan. A word of caution: the conversion is irreversible and therefore requires some forethought and analysis.

The types of individuals that may benefit most from this include people who anticipate making a significantly higher income as they near retirement, or believe they will be in a higher tax bracket in retirement. Individuals who believe this will find that a Roth account may fill a need in their estate planning. It’s important to project how these changes will affect individual tax situations and to make sure the available resources outside of the plan are there to pay for the taxes now. Specific details on the new Roth conversion are still being researched and guidance is needed before most retirement plans will consider adding this provision.

As an employee you can consult your summary plan description or talk to your employer’s benefits department to find out if your plan currently allows Roth accounts and whether the plan will add the feature to allow you to convert your pretax dollars. It’s great to have options when it comes to saving for retirement because it’s within those options that you’re able to develop an effective strategy to meet your retirement goals.

Effective January 1, 2013, the recently negotiated and signed American Taxpayer Relief Act of 2012 includes provisions for in-plan Roth conversions. The new provision is akin to the in-plan Roth rollover, with the difference being that the provision is applicable for amounts that are not currently eligible for distribution. The legislation benefits plan sponsors and participants but it also provides a revenue stream for the federal government.

Roth contributions to a qualified 401(k) or 403(b) plan or to a governmental 457(b) plan are made on an after-tax basis. This means participants pay taxes on contributions now, not later. Before the new rules, if a plan permitted an in-plan Roth “rollover,” then a participant could move money from a non-Roth plan account (pretax salary deferrals, employer match, employer nonelective contributions) to the Roth account within the same plan. Participants were only allowed to do this if they had distributable events (i.e., distribution at age 59½, severance from employment) and the amount was eligible for rollover. Under the new law, if a plan permits an in-plan Roth “conversion,” then a participant may move money from a non-Roth plan account to the Roth account within the same plan, without having a distributable event.

If participants decide to take advantage of an in-plan Roth conversion, they will pay income taxes at their current tax rates. The conversion is not subject to mandatory or optional withholding, nor to the early 10% penalty tax, although a recapture rule may apply a 10% penalty if in-plan Roth amounts are distributed within a five-year period. This means the participant needs to think about the following: Is my tax bracket at retirement going to be higher than it is now and do I have the money outside of my plan assets to cover the taxes?

If participants expect to remain in the same tax bracket for the remainder of their working careers, there is no advantage to paying the tax now. However, for participants who believe they will be in higher brackets as they go through their working careers and in retirement, and have other money available to cover the income tax, then conversion of a non-Roth account may be beneficial. The converted amount would be considered tax-free, as are the future earnings on it, if certain requirements are met, including a five-year holding period. If the participant will cross multiple tax brackets, it may be beneficial to spread the Roth conversions over multiple years. This helps the participant accumulate resources to pay the taxes and makes the conversion more affordable.

There are additional questions and considerations the participant needs to address, such as when to retire, whether to work after retirement, how much money will be needed in retirement, whether estate taxes must be paid, and how much Social Security provides. These are not easy questions to answer, but taxes and taxable income may impact the answers. Most participants want to maintain a standard of living in retirement that is not less than what they currently have. Considering after-tax investment vehicles, such as a Roth account, may help participants achieve their financial retirement goals.

When discussing indirect compensation in relation to defined contribution plans, “float income” typically receives minimal coverage. However, litigation risk persists in a post-408(b)(2) world with regards to float. Diligent plan fiduciaries should be aware of this trickle of income and its implications.

“Float” or “Float income” represents interest that may be earned on cash held for investment or distribution. For most institutional trustees, the omnibus nature of these cash accounts makes it difficult to track and allocate the appropriate amounts at the participant level; thus the float is typically absorbed by the trustee or custodial firm.

While these earnings constitute eligible indirect compensation for Schedule C purposes, they could potentially be considered a prohibited transaction under ERISA if not properly disclosed. For that reason plan fiduciaries should make sure that float income is addressed within the service agreement between the plan and the applicable service provider and that it is properly disclosed on the form 5500 Schedule C. In order to avoid a prohibited transaction of fiduciary self-dealing, the service agreement must clearly state that the trustee may retain float income as additional compensation and provide a formula to estimate the dollar amount of compensation. Float income must be included in a discussion of the reasonableness of the service provider’s fees. It would be wise of plan fiduciaries to review the possibility of float income with their service providers, make sure it is reasonable, and, if possible, request certain fee offsets if the accumulation of float is significant enough.

With interest rates currently low, it would seem reasonable that most service providers are not earning a significant amount of float income; however, as interest rates increase, this could become a large source of income for a service provider. Plan fiduciaries may be able to manage float by:

• Having clear policies in place for timing of contributions being invested (i.e., a limit of how many days after funding until contributions are invested)
• Reviewing outstanding checks that have not been cashed in a timely fashion and the procedures in place to locate and have participants cash stale-dated checks.

When a plan fiduciary does their annual plan “checkup”—normally around 5500 time—it would be a good time to discuss float with the service provider and make sure all the necessary disclosures are being done, including Schedule C of the 5500 and service agreements.

There are some things about your 401(k) you should know. In her new article, Jinnie Regli provides 10 items that can help you maximize your 401(k) retirement plan. Here is an excerpt:

1. Average 401(k) account balances are up but that average account still won’t support the average person’s retirement. During November, Fidelity Investments published research that said that the average account balance as of the end of the third quarter of 2012 was the highest they’ve seen since they began tracking account data in 2000, at $75,900. Although this is a significant increase from 2009, when the average account balance was $46,200, the fact is that $75,900 may not be enough to support the average American’s retirement.

2. You should utilize tools to calculate your retirement readiness and adjust your savings strategy. In a 2011 retirement confidence survey conducted by the Employee Benefit Research Institute, 42% said they determined their retirement savings needs by guessing. The fact is this percentage is much higher than it needs to be. Recordkeepers and administrators have made enormous strides in creating calculators that work to align your retirement saving strategy to your estimated required retirement savings need. Of those surveyed who have utilized a calculator to estimate required retirement savings, 59% reported saving or investing more as a result. Please take the time now to utilize these calculators so you won’t find yourself unprepared when nearing retirement.

3. It’s important that you understand the fees you pay to participate in your 401(k) plan. Fee transparency is important on a participant level because the fees assessed to your account will impact your account growth.

Your employer is required to deliver fee information to you in two ways. Your quarterly statement must include an itemized listing of fees, if any, that were assessed to your account over the quarter. The second requirement is an annual notice that discloses fund performance, fund expense ratios, benchmarks, information about designated investment managers, the use of revenue sharing to offset plan expenses (if applicable), and any fees that you may incur if you initiate transactions from your account. Even if you’re not currently contributing to your employer’s 401(k plan, you should expect to receive a copy of this notice every year. This document is full of useful information and shouldn’t be discarded.

While these disclosures are important to you as a participant, it’s also vital to note that an individual retirement account (IRA) may sometimes be more costly to maintain than a 401(k) plan through your employer. Fees for investment advisors or administration are often split between all of the active participant accounts in a 401(k) plan while with an IRA you may be standing alone in funding those fees. Please take the time to stay informed about the fees associated with your accounts.

To read the entire article and see all ten considerations, click here.

As plan sponsors look to 2013, they might consider setting aside some of their retirement plan budgets to benchmark various aspects of their plan designs, vendors, and processes in order to ensure that their plans are competitive, compliant, and providing value to each company and its employees.

Many industry experts recommend benchmarking defined contribution (DC) plans every three years to ensure they are receiving the same pricing and product offerings that any new client would receive. Do you have a dated legacy product? If so, this could be a good time to benchmark your plan.

Remember, ERISA imposes high standards—“the highest known to law”—upon fiduciaries. Section 404(a) of ERISA provides that fiduciaries must elicit information necessary to assess not only the reasonableness of the fees to be paid for services, but also the qualifications of the service providers and the quality of the services that will be provided. Benchmarking your plan can help ensure that the fees you and your participants are paying are reasonable and commensurate with the services received, and will help to protect against public embarrassment and legal hassles.

But benchmarking is not just about fiduciary protection. Fees and plan design features have a huge impact on retirement savings for participants, contributing not only to the success or failure of their retirement readiness, but also to the value of a company’s retirement plan as an employee recruitment and retention tool.

Benchmarking a plan can be performed in many different ways, including issuing a request for proposal (RFP). Conducting an RFP can result in a thorough review of plan(s) and service providers, with the search consultant providing added value by educating plan sponsors on how to be smart consumers in the retirement plan marketplace. However, this can be an expensive and time-consuming process requiring internal resources, typically senior staff.

As a first step, you might consider having a recordkeeper or investment advisor run a benchmarking report from an independent benchmarking company such as Fiduciary Benchmarks, Inc., BrightScope, Plan Tools, or Advisor Labs Retirement Plan Diagnostic. Each of these companies can produce a nice executive summary diagnostic report, which can be very useful in evaluating plans and negotiating with vendors.

Whichever tactic you choose, it’s important to consider the following in order to maximize the benefits of benchmarking your plan:

• Use up-to-date, accurate, and consistent plan data. Apply this rule to collect and examine the plan fees in the benchmark group as well.
• Compare the plan in a relevant context: Plans of similar size, type, design, location, and industry.
• Don’t forget to consider the value provided! It can be reasonable to pay higher fees if a plan is receiving more or higher-quality services or is attaining higher participant success measures than similar plans.

Regular benchmarking of retirement plan costs and performance can go a long way to protect a plan’s fiduciaries and participants.

The 2012 PLANSPONSOR Defined Contribution Survey lists Milliman among the best 401(k) providers “based on evaluations from more than 6,000 companies.” The firm won the most Best in Class “cups” across all client size categories for each designated service targeting plan sponsors and participants.

For more 401(k) perspective from Milliman, click here. Addition information on Milliman’s DC services can be found here.

As the last wave of new fee disclosures is readied for inclusion with quarterly statements this month, the big question remains: What impact, if any, will the barrage of fee disclosures have on the retirement plan marketplace in general, and, more specifically, on retirement readiness for participants?

While the pricing landscape for retirement plan recordkeepers is, in many cases, still a confusing combination of basis points, rebates, formulas, and wraps, we have seen a marked uptick in sales activity as an increasing number of plan sponsors endeavor to measure the reasonableness of their vendors’ fees, services, and value. The service provider disclosure requirements of 408(b)2 should have a positive effect on the retirement plan marketplace, allowing sponsors a better understanding of the underlying fee components and fee assessment methodologies, and making them better prepared to compare their fees with market rates. Increasingly prevalent and accurate benchmarks should lead to lower and more equitable fees, lower-cost investment options, and improved retirement savings for many participants.

But this month, the focus is on the 404(a)5 disclosures for participants. Yes, it’s important that participants understand that their retirement plans are not free, and that their investment decisions affect the expenses charged to their retirement savings accounts. But will that really be accomplished by sending information that vast segments of the participant population won’t properly study—and when even those who do will not have any context to gauge the “new” fees that appear therein? Only a third of participants spent more than five minutes looking at the annual disclosures they received last quarter, and only a fraction of a percent actually called to ask questions of their plan sponsors and service providers. How many participants will notice the additional fee detail on their statements this quarter? And for those who do, will they have the knowledge to appropriately interpret the information they’ve been provided?

Recordkeepers and plan sponsors should not rely on participants to process these disclosures into actionable decisions on their own. The required disclosures, while a step in the right direction, are far from sufficient. If we want participants to understand and take appropriate action in their accounts, service providers and plan sponsors need to proactively engage with participants, using communication strategies targeted to each specific population segment that will deliver the appropriate tools for effective decision making.