401(k) Reform: A Modest Proposal

Costs Less, Does More
The title is irony free; no babies to be roasted in this column. I have, quite literally, a simple idea for improving 401(k) plans. (I use the term 401(k) generically, to mean any employer-sponsored defined-contribution investment plan.) 

And now would seem to be the time. Sporting the usual post-election cheer, our leaders have pledged to reach across the aisle. Easier said than done. So why not try something simple? My suggestion: Huddle on the relatively nonpartisan topic of retirement income--a subject that also happens to be of high importance to voters, who have indicated in the polls deep concern about their economic futures.

Then, after passing the easy legislation, the president, speaker, and senate majority leader can bicker over the hard issues, reach an impasse, and suffer 23 months' worth of deadlock until the next election. Just as before.

My two-part proposal:

1) Remove the fiduciary burden from employers.
Currently, companies are held liable under ERISA regulations for the quality of their 401(k) plans. That legal structure is silly and wasteful. Every year, thousands of employers, few of whom understand the subject, conduct the exact same fiduciary task, largely on a handful of the same investment providers.

Do you support needless government regulations that require businesses to expend millions of hours on unnecessary tasks? If so, the current 401(k) rules are for you.

Here's a better idea. Somebody must oversee 401(k) plans. Employees have the right to expect a plan lineup that carries a suitable mix of affordably priced funds, assembled without conflicts of interest. But that somebody should be a single entity. Have the task done only once, as opposed to thousands of times, and by a party that knows exactly what it is doing, because judging fiduciary acceptability is its only job.

For example: Each year, 401(k) plan providers would submit their 401(k) platforms--standard lineups, common customizations, pricing, vendor relationships. The certifying board would then approve the submission as is or require changes. After any requested changes are made, the finished product would be stamped as "fiduciarily acceptable." Employers could then freely select from these plans, without fear of facing a future lawsuit. No muss, no fuss.

The certifying entity? The Department of Labor is one possible answer, as it enforces ERISA regulations. Another approach would be to establish an independent authority, as done with accounting by the creation of the Financial Accounting Standards Boards (FASB).

The detail of who to conduct the task is minor. If that becomes any sort of block in the political negotiations, then the honeymoon is faux. 

2) Extend 401(k)s to all workers.
In private industry, per the Department of Labor statistics, 65% of workers have access to a retirement benefit of any sort--either a traditional pension plan or a 401(k). The other 35%, mostly at small companies, are on their own.

That is terrible public policy.

With the slow demise of traditional pension plans, the de facto U.S. retirement structure consists of 1) Social Security at the foundation 2) 401(k) plans as a supplement, and--for those with the means to enjoy an affluent retirement, as opposed to merely sufficient--3) personal, discretionary savings. It is an extremely hands-off arrangement, as aside from the initial layer of Social Security, the U.S. government neither mandates contributions nor collects taxes from either businesses or individuals. That contrasts the U.S. with other developed countries, which exert tighter controls on the retirement-savings process in the attempt to ensure at least a moderate living standard for all retirees.

The U.S., in other words, opts for individual choice rather than collective effort. Which is fine, this being the United States after all. But if the program is to be choice, then provide the choice! Establishing a three-tier system, and then leaving it to chance where workers have access to all three tiers, is dumb. To put the matter kindly.

However, the problem is easily fixed.

The key is to adopt the first part of this proposal: removing the fiduciary obligation. Doing so will make 401(k)s practical for the small companies that are currently overwhelmed by the regulatory burdens. They would no longer need to research potential investment providers and record-keepers, document their decisions, and monitor their plans' performances.

From that point, the law could require that small companies select a 401(k) plan from the nationally approved list. The effort required for that task would be minimal--and the legal liability nonexistent. Or, to avoid mandates entirely, businesses could step aside and have the decision made instead by employees. That latter approach would require the appropriate framework--it's no good overwhelming employees with a long list, so winnowing and perhaps even defaulting would be needed. But again, those are details.

(By no mandates, I mean no mandates. Companies would not be required to match employees' 401(k) contributions. They would be welcome to do so, as a benefit for attracting and retaining talent, just as many companies do by enhancing their health-care or vacation policies. But they would not be forced to match.)

There's no reason not to adopt this proposal. It would cut costs for hundreds of thousands of companies that already offer 401(k) plans, and extend retirement coverage to tens of millions of Americans who currently work in the companies that do not offer such plans. It appeals to the Republican sensibility of cutting regulations and avoiding new taxes, and to the Democratic sensibility of extending coverage to those who lack it. And it addresses a critical item--as important an issue for Americans as currently exists.

Our leaders have talked the right talk. Now is the time to walk the right walk. 

*The Comments feature is currently having some technical difficulties. If you have trouble posting a comment, my apologies. We'll get this straightened out as quickly as possible.  

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.