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Special Report

Economic Anxiety Extends to Retirement

Morningstar CEO Kunal Kapoor sees a need to combine the flexibility of a 401(k) with the best elements of traditional pensions.

Restoring a greater level of economic security for the American worker was a constant refrain during the election. Although it wasn’t a campaign theme, one key area in which workers have experienced an erosion of confidence is how they feel about their retirement security. As companies have shifted from traditional pensions to 401(k)-style plans, workers have become increasingly anxious about their quality of life after they retire. To help allay those concerns, there’s a need to combine the flexibility of a 401(k) with the best elements of traditional pensions. 

Americans are rightly nostalgic for traditional pensions because these programs offered a simple promise: After a lifetime of work, individuals could continue to collect part of their salary in retirement. During their careers, workers could focus on their jobs instead of worrying about how to fund their retirement and then deciding where and how to invest their money. Further, after the landmark Employee Retirement Income Security Act of 1974, workers in traditional pension plans knew the people managing their retirement money would do so using the highest standard of care—the fiduciary standard—or risk legal consequences.

Unfortunately, traditional pensions are not coming back. Companies do not want the “balance sheet risk,” and traditional pensions are not portable enough for today’s workforce with individuals who regularly change jobs. Even sectors such as state and local government are beginning to shift to 401(k)-style retirement systems.

Instead, our modern 401(k) retirement system asks a lot of ordinary people. These 401(k)-style retirement plans put all of the decision-making—and risk—on individual workers, and many people find the system induces anxiety. In addition to mastering the skills of their jobs—whether they are trained as doctors or lawyers, plumbers or carpenters—American workers have to be investment experts in order to achieve a safe and secure retirement. Importantly, American workers have to find the discipline and resources to save regularly, which is the single most important thing workers can do to retire comfortably.

This shift is not all bad news, because the 401(k) system already has many positive features. Workers can choose their own retirement goals and save accordingly. The system is highly portable, and provides flexibility for workers and companies to increase contributions when times are good. Further, we at Morningstar see ascendant trends that bode well for investors saving for retirement. There has been a sharp focus on controlling costs, and we have seen the dollar-weighted average fee for investing fall year after year. Investment advisors are starting to make money charging for advice rather than taking commissions for selling financial products—and consumers are increasingly demanding fair value for these fees. New technology makes it easier to offer low-cost and high-value advice to savers through vehicles such as managed retirement accounts.

But we believe we need to keep the momentum going, and there is a lot of room for improvement.

So, how can we effect positive change for future American retirees? At Morningstar, through decades of research and advocacy for individual investors, we have come to four conclusions for policymakers, regardless of the specifics of any new retirement proposal.

First, the next labor secretary—who has the power to regulate retirement savings—should continue to make it easy for workers to save for retirement. Policy changes a decade ago encouraged companies to automatically enroll workers in 401(k) plans, dramatically improving savings rates. The next challenge is making sure these assets are preserved for retirement, particularly when workers shift jobs. In 2013, the Government Accountability Office identified seven ways the Labor Department could reduce obstacles and disincentives to keeping retirement savings in 401(k) plans. These are common-sense regulations, such as increasing standardization for plan-to-plan rollovers. While progress has been made, five of those recommendations are still open. The next labor secretary should act to make it easy for workers to keep saving in a disciplined way, and preserve the savings they already have.

Second, transparency is key. For decades, we at Morningstar have sought to help peel back the onion on the fees investors pay and see how these fees erode future returns. That is not to say all fees are bad. But if fees are opaque, investors cannot assess if they are receiving a good value in exchange for the fees that financial services companies take out of their accounts. Congress should ensure that the next labor secretary is committed to improving the disclosure requirements on the annual reports that retirement plans must file, so retirement savers can easily see how their plan compares to others.

Third, policymakers should make it easier to include lifetime income options in 401(k)-style plans. Retirement savers often report anxiety about converting their savings into lifetime income, and current laws and regulations discourage companies from offering products to help workers cope with the risk that they might outlive their savings. Recently introduced legislation, such as the Retirement Enhancement and Savings Act, could go a long way toward correcting some of these issues by providing a safe harbor for employers to include lifetime income options. Congress should swiftly pass these provisions and ensure that the next labor secretary is committed to taking steps to increase lifetime income options in retirement plans.

Finally, there is a tremendous value in financial planning, and policymakers should continue to ensure that it is in a participant’s best interest at every phase of retirement savings. Indeed, our award-winning research into “gamma,” which quantifies the value derived from financial planning decisions, has found that financial planning tools can improve lifetime retirement income by more than 20%. But it is important to ensure that this advice is in the best interest of investors. People may disagree on the best way to ensure advisors meet a best interest (or fiduciary) standard, but pressure from retirement savers to meet this standard is growing and inescapable. Other countries, such as the United Kingdom and Australia, have adopted new fiduciary standards for professionals providing investment advice, and our Labor Department has also recently issued rules to ensure retirement savers only get advice that is in their best interest. Congress and the new administration have indicated they want to adjust these rules. Regardless, while much about how the rule may change and how firms will comply is open to interpretation and debate, this is no longer about a rule. This is about the reality of having a client-centric business model and delivering financial services that put investors' interests first. Congress and the next labor secretary should try to nurture the positive, market-based trends already strongly underway that encourage financial advisors who are moving from a commission-based model to offering best-interest advice.

Retirement security has been eroded over the past few decades for many workers, but there is momentum toward better practices for them—at least those lucky enough to have a retirement plan. We should foster this momentum to help ease workers’ anxieties and ensure the retirement system can meet their needs.