Today's employees are being asked to make financial decisions their predecessors 25 years ago were typically not required to make. In particular, decisions about appropriate retirement investments are considerably more complicated than they used to be. How far can and should employers go in playing the role of financial advisor?
Some short-sighted employers do not concern themselves with how their employees handle these issues. Indeed, part of the move from widespread use of defined-benefit to defined-contribution plans was to shift investment risk from employers to employees.
However, most companies realize that what impacts employees, impacts the employer. For instance, many studies have confirmed that workers concerned with their finances are more distracted at work, which can lead to attendance and productivity problems. In addition, many studies have linked financial problems to stress which, in turn, can impact things like employer healthcare costs.
While there is little most employers can do to address chronic financial mismanagement among employees, there are several basic things an employer can do within the context of its 401(k) plan to improve an employee's prospects for a healthy retirement.
The starting point in assessing ways to improve 401(k) plans is to determine the principle roadblocks that prevent employees from creating viable retirement accounts.
The biggest problem is simple: Too many employees never enroll in their 401(k) plans. However, the solution to this problem is equally simple -- make enrollment automatic for new employees.
While employees would have the right to opt out of these plans, studies have repeatedly shown that they tend to stick with plans once they discover the payroll deductions are not so onerous. Put simply, once employees are in retirement plans, they tend to stay.
Another basic problem is that many employees are poor investors. There are at least a couple of ways for 401(k) plans to address this.
For starters, when it comes to retirement investments, the argument could be made that less is more. In particular, many retirement plans provide employees with a bevy of mutual-fund options that employees are simply incapable of meaningfully assessing.
Investment gurus such as Warren Buffett have frequently recommended that unsophisticated investors consider broad-based index funds over specific mutual funds -- the basis for this position is that the majority of mutual funds routinely fail to beat the S&P 500 index, net of management fees.
A convincing case can be made that an ideal 401(k) would recognize this reality and offer a small number of broad-based index funds as opposed to a plethora of niche mutual funds. A multitude of investment offerings assumes a level of financial savvy that most employees simply do not have and the confusion regarding which investment vehicles to select probably leads employees to make poor investment decisions.
Perhaps the biggest investment error, however, is employees who invest too much in company stock. As Enron aptly illustrated, this is a mistake that can lead to retirement disaster.
According to Fidelity, about 14 percent of all 401(k) assets are in employer stock -- a percentage virtually all investment analysts suggest is too high. Why employees invest heavily in company stock varies (for instance, many employers match with company stock), but virtually everyone agrees that over-reliance on company stock in a portfolio is problematic.
Many contend that another component of an ideal 401(k) plan is the provision of employee investment education.
Some employers have been reluctant to offer employee education, fearing lawsuits if employees have poor investment results. However, federal law protects employers from liability so long as their investment education relies on accepted principles, such as the need to diversify among various types of holdings.
It should be noted that, while many employers offer general investment education to employees, at least one survey indicated that only 12 percent of plan sponsors said they were satisfied with their current programs. In other words, employers are spending resources to provide investment courses to employees; however, the vast majority of employers question the efficacy of such courses.
Perhaps these employers recognize what many commentators have noted -- what employees want and what they really need is specific investment advice. As one commentator has suggested, "Many employees just want to be told how to invest their retirement accounts. They don't want to invest time or money in a soup-to-nuts examination of their entire financial picture."
To some extent, this individualized investment advice is now allowed by the Employee Retirement Income Security Act. Specifically, in the Pension Protection Act of 2006, Congress established rules for ways individualized investment advice may be provided to plan participants without employers risking reassuming a fiduciary role in their self-directed plans.
The Act allows ERISA-covered plans to offer participants specific investment advice through what it has termed an "eligible investment advice arrangement."
The "arrangement" must be authorized by disinterested plan fiduciaries that are not affiliated in any way with the adviser providing investment advice. The investment advice must be provided through either: (1) a fiduciary adviser whose fees do not vary based on the investment option selected, or (2) a computer model that meets the Act's requirements as well as independent third-party certifications.
The advisers must disclose compensation, potential conflicts, plan investment option past performance, available services, fiduciary relationship(s), how participant information will be used and inform participants they can obtain advice from an adviser not affiliated with the plan.
In essence, under this arrangement, employees can have access to individually tailored investment advice; although, they will ultimately still make their own investment decisions. In other words, advisers cannot decide investment amounts or direct where the employee should invest funds.
In sum, there is no way for employers to guarantee that all of its employees will successfully handle saving for retirement. That said, there are straightforward steps that can be taken in plan creation to enhance the likelihood of success. Moreover, for employees who need to be told what to do, Congress has created an opening for employers to provide that sort of advice.
Scott D. Schneider is a partner in the New Orleans office of Fisher & Phillips LLP. His email address is firstname.lastname@example.org