The Controversial Trend Toward Employee Investment Freedom
Just how much investment freedom and responsibility should an employer-sponsored retirement plan give to employees? This is the subject of a heated and critical debate that will probably grow in coming years.
In recent times, of course, the trend has been toward greater employee control and accountability. In the U.S., 47% of surveyed companies report offering defined benefit plans, compared with 72% offering defined contribution (DC) plans, according to a study by the Society for Human Resource Management. (Some firms provide both types of plans.) DC plans have also become more popular in a variety of other nations, especially Canada and Australia, where they account for 80% of all employer-sponsored retirement plans, according to consulting firm William M. Mercer. Mercer forecasts increases in DC plans in a variety of other countries, including Mexico, the UK and France.
But, of course, not all DCs are alike, with some moving further than others toward employee investment empowerment. On one extreme edge are a small but growing number of employer-sponsored plans that provide self-directed brokerage accounts. These accounts allow “employees to invest their retirement money in almost anything,” reports the Boston Globe.
There are at least two major points of controversy here. First, greater choice means there’s a greater risk that employees will make bad investment decisions. “With the huge growth of assets invested in DC, particularly self-directed plans, there has been a dramatic shift in the risk that is being borne by the individual. But what we have not seen is a transfer of expertise, so that individuals are being asked to make the same decisions as professional managers in defined-benefit plans,” says Chris Jones, vice-president for strategy and financial research at Financial Engines, in Global Finance magazine.
Second, if employees do make bad investment choices, who is liable? This remains a gray area, so even some of the boldest firms are hedging their bets. Southwest Airlines, for example, allows participants to transfer just 25% of their 401(k) out of core mutual funds and into Schwab’s Personal Choice Retirement Account. Employee education may also be key in making such accounts less risky, perhaps reducing employer accountability for bad decisions. But no company, experts note, should adopt such accounts unless it has a thorough understanding of its potential liability.
Some observers foresee a time when most DC plan investments are no longer the responsibility of employers. “Things are going to change dramatically for defined contribution plans,” Ted Benna is reported as saying in Financial Planning. Benna, president of the 401(k) Association, adds, “The employer is going to cease to be the gatekeeper of where the money is going to be invested.” In the future, he states, employers will still deposit matching funds but employees will be in total control of the account.
The Urban Institute has even written a white paper in which Pamela Perun and C. Eugene Steuerle outline a future scenario where DC plans eventually disappear in the U.S. The financial services industry will, they think, provide nearly all the services required by DC plans. That is, the current system will be replaced by a “retail system.” However, they and others note, the government would need to make some substantial legislative changes before such a system is possible.
In the nearer term, some experts expect innovative DC plans to be developed in other parts of the world. Various other nations “are in the enviable position of being able to take the best practices prevailing today, couple these with state-of-the-art technology and build a defined-contribution market in an innovative system,” says Rich Malconian, managing director of defined contribution in the U.S. for Barclays Global Investors.
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For more info:
See Gregory Bresiger's The Future 401(k) or
See Doff Meyer's 401(k) Roulette or
See the Urban Institute's ERISA at 50: A New Model for the Private Pension System
Although not online, another interesting article is Charles W. Thurston's "Defined Contributions Swell with Choice." Global Finance, May 2000, pp. 75-76.
In recent times, of course, the trend has been toward greater employee control and accountability. In the U.S., 47% of surveyed companies report offering defined benefit plans, compared with 72% offering defined contribution (DC) plans, according to a study by the Society for Human Resource Management. (Some firms provide both types of plans.) DC plans have also become more popular in a variety of other nations, especially Canada and Australia, where they account for 80% of all employer-sponsored retirement plans, according to consulting firm William M. Mercer. Mercer forecasts increases in DC plans in a variety of other countries, including Mexico, the UK and France.
But, of course, not all DCs are alike, with some moving further than others toward employee investment empowerment. On one extreme edge are a small but growing number of employer-sponsored plans that provide self-directed brokerage accounts. These accounts allow “employees to invest their retirement money in almost anything,” reports the Boston Globe.
There are at least two major points of controversy here. First, greater choice means there’s a greater risk that employees will make bad investment decisions. “With the huge growth of assets invested in DC, particularly self-directed plans, there has been a dramatic shift in the risk that is being borne by the individual. But what we have not seen is a transfer of expertise, so that individuals are being asked to make the same decisions as professional managers in defined-benefit plans,” says Chris Jones, vice-president for strategy and financial research at Financial Engines, in Global Finance magazine.
Second, if employees do make bad investment choices, who is liable? This remains a gray area, so even some of the boldest firms are hedging their bets. Southwest Airlines, for example, allows participants to transfer just 25% of their 401(k) out of core mutual funds and into Schwab’s Personal Choice Retirement Account. Employee education may also be key in making such accounts less risky, perhaps reducing employer accountability for bad decisions. But no company, experts note, should adopt such accounts unless it has a thorough understanding of its potential liability.
Some observers foresee a time when most DC plan investments are no longer the responsibility of employers. “Things are going to change dramatically for defined contribution plans,” Ted Benna is reported as saying in Financial Planning. Benna, president of the 401(k) Association, adds, “The employer is going to cease to be the gatekeeper of where the money is going to be invested.” In the future, he states, employers will still deposit matching funds but employees will be in total control of the account.
The Urban Institute has even written a white paper in which Pamela Perun and C. Eugene Steuerle outline a future scenario where DC plans eventually disappear in the U.S. The financial services industry will, they think, provide nearly all the services required by DC plans. That is, the current system will be replaced by a “retail system.” However, they and others note, the government would need to make some substantial legislative changes before such a system is possible.
In the nearer term, some experts expect innovative DC plans to be developed in other parts of the world. Various other nations “are in the enviable position of being able to take the best practices prevailing today, couple these with state-of-the-art technology and build a defined-contribution market in an innovative system,” says Rich Malconian, managing director of defined contribution in the U.S. for Barclays Global Investors.
====================================================
For more info:
See Gregory Bresiger's The Future 401(k) or
See Doff Meyer's 401(k) Roulette or
See the Urban Institute's ERISA at 50: A New Model for the Private Pension System
Although not online, another interesting article is Charles W. Thurston's "Defined Contributions Swell with Choice." Global Finance, May 2000, pp. 75-76.