Strengthening The Retirement System Beyond Social Security [1 ed.] 9781613244340, 9781607417521

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Copyright © 2009. Nova Science Publishers, Incorporated. All rights reserved. Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

Copyright © 2009. Nova Science Publishers, Incorporated. All rights reserved. Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

RETIREMENT ISSUES, PLANS AND LIFESTYLES SERIES

Copyright © 2009. Nova Science Publishers, Incorporated. All rights reserved.

STRENGTHENING THE RETIREMENT SYSTEM BEYOND SOCIAL SECURITY

No part of this digital document may be reproduced, stored in a retrieval system or transmitted in any form or by any means. The publisher has taken reasonable care in the preparation of this digital document, but makes no expressed or implied warranty of any kind and assumes no responsibility for any errors or omissions. No liability is assumed for incidental or consequential damages in connection with or arising out of information contained herein. This digital document is soldPublishers, with the Incorporated, clear understanding that the publisher Strengthening The Retirement System Beyond Social Security, Nova Science 2009. ProQuest Ebook Central, is not engaged in

RETIREMENT ISSUES, PLANS AND LIFESTYLES SERIES Challenges Women Face In Retirement Security Jean B. Larou (Editor) 2009. ISBN: 978-1-60741-747-7 Social Security Reform Aaron P. Nazario (Editor) 2009. ISBN: 978-1-60692-275-0 Social Security Solvency Jeffrey K. Bain (Editor) 2009. ISBN: 978-1-60692-833-2

Copyright © 2009. Nova Science Publishers, Incorporated. All rights reserved.

Financial Asset Management and Wealth in Retirement Terrance G. Waverly (Editor) 2010. ISBN: 978-1-60741-696-8 Impact of Financial Crisis on Retirement Security John J. Turner (Editor) 2010: ISBN: 978-1-60692-960-5 Impact of Financial Crisis on Retirement Security John J. Turner (Editor) 2010. ISBN: 978-1-61668-777-9

Pensions: Backgrounds, Trends and Issues Henry J. Mullen (Editor) 2010. ISBN: 978-1-60876-840-0 Social Security Solvency: Issues and Projections Martin G. Roth (Editor) 2010. ISBN: 978-1-60876-877-6 Social Security Reform: Disability, Indexing and Financing Janet U. Burlington (Editor) 2010. ISBN: 978-1-61668-354-2 Social Security Reform: Disability, Indexing and Financing Janet U. Burlington (Editor) 2010. ISBN: 978-1-61668-523-2 (Online) When to Retire: Issues in Working and Saving for a Secure Retirement Maurice R. Davenworth (Editors) 2010. ISBN: 978-1-60876-982-7 Strengthening the Retirement System Beyond Social Security Kala E. Upshaw (Editor) 2010. ISBN: 978-1-60741-752-1

Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

RETIREMENT ISSUES, PLANS AND LIFESTYLES SERIES

STRENGTHENING THE RETIREMENT SYSTEM BEYOND SOCIAL SECURITY

KALA E. UPSHAW

Copyright © 2009. Nova Science Publishers, Incorporated. All rights reserved.

EDITOR

Nova Science Publishers, Inc. New York

Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

Copyright © 2010 by Nova Science Publishers, Inc. All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or by any means: electronic, electrostatic, magnetic, tape, mechanical photocopying, recording or otherwise without the written permission of the Publisher. For permission to use material from this book please contact us: Telephone 631-231-7269; Fax 631-231-8175 Web Site: http://www.novapublishers.com

NOTICE TO THE READER The Publisher has taken reasonable care in the preparation of this book, but makes no expressed or implied warranty of any kind and assumes no responsibility for any errors or omissions. No liability is assumed for incidental or consequential damages in connection with or arising out of information contained in this book. The Publisher shall not be liable for any special, consequential, or exemplary damages resulting, in whole or in part, from the readers‘ use of, or reliance upon, this material. Any parts of this book based on government reports are so indicated and copyright is claimed for those parts to the extent applicable to compilations of such works.

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Independent verification should be sought for any data, advice or recommendations contained in this book. In addition, no responsibility is assumed by the publisher for any injury and/or damage to persons or property arising from any methods, products, instructions, ideas or otherwise contained in this publication. This publication is designed to provide accurate and authoritative information with regard to the subject matter covered herein. It is sold with the clear understanding that the Publisher is not engaged in rendering legal or any other professional services. If legal or any other expert assistance is required, the services of a competent person should be sought. FROM A DECLARATION OF PARTICIPANTS JOINTLY ADOPTED BY A COMMITTEE OF THE AMERICAN BAR ASSOCIATION AND A COMMITTEE OF PUBLISHERS. LIBRARY OF CONGRESS CATALOGING-IN-PUBLICATION DATA Available upon request

ISBN : H%RRN

Published by Nova Science Publishers, Inc.  New York

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CONTENTS Preface Chapter 1

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Chapter 2

vii Fee Disclosure in Defined Contribution Retirement Plans: Background and Current Legislation John J. Topoleski Private Pensions: Fulfilling Fiduciary Obligations Can Present Challenges for 401(k) Plan Sponsors United States Government Accountability Office

1

17

Chapter 3

Retirement Security Hearing - Orszag Testimony Peter R. Orszag

Chapter 4

Strengthening Worker Retirement Security Hearing - American Benefits Council White Paper American Benefits Council

55

Strengthening Worker Retirement Security Hearing - Baker Testimony Dean Baker

73

Strengthening Worker Retirement Security Hearing - Hutcheson Testimony Matthew D. Hutcheson

79

Chapter 5

Chapter 6

Chapter 7

Chapter 8

Chapter 9

Strengthening Worker Retirement Security Hearing - John Bogle, before the Committee on Education and Labor, U.S. House of Representatives John C. Bogle

47

87

Strengthening Worker Retirement Security Hearing - Miller Statement George Miller

101

Strengthening Worker Retirement Security Hearing - Munnell Testimony Alicia H. Munnell

105

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vi Chapter 10

Chapter 11

Contents Strengthening Worker Retirement Security Hearing - PSCA Statement House Committee on Education and Labor

115

Strengthening Worker Retirement Security Hearing - Stevens Testimony Paul Schott Stevens

125 145

Index

145

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Chapter Sources

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PREFACE This book discusses the retirement system in the U.S. beyond Social Security. The Education and Labor Committee is exploring the shortcomings in our nation's retirement system and looking at solutions so that Americans can enjoy a safe and secure retirement. The current economic crisis has exposed deep flaws in our nation's retirement system. These flaws were mostly hidden when the market was doing well. Since the beginning of the crisis, trillions of dollars have evaporated from workers' 401(k) accounts. Millions of workers have seen a significant portion of their retirement balance vanish in just a few short months. The decline has forced many workers to consider postponing retirement or rejoining the workforce if they have already retired. For many retirees coping with rising costs for health care and other basic expenses, this loss in income is simply devastating. While fully restoring the lost wealth of the baby boom cohorts may not prove feasible, Congress can take effective steps to create a better retirement system for future generations. This can done at no cost to taxpayers, simply by having the government assume market risk by averaging returns over time. There are no economic or administrative obstacles to going this route, it is simply a question of political will. In any case, the message is that we need more organized retirement savings. A declining Social Security system and fragile 401(k) plans will not be enough for future retirees. Chapter 1 - As households become more reliant on 401(k) plans and other defined contribution pension plans for future retirement income, policymakers have become more concerned that participants could be unaware of the fees charged in their plans. Small differences in fees charged can have large impacts on account balances upon retirement. This report provides information on the kinds of fees that are charged in 401(k) and other defined contribution plans and details the provisions of three bills in the 110th Congress that addressed fee disclosure in retirement plans: H.R. 3185, the 401(k) Fair Disclosure for Retirement Security Act, which was approved by the Committee on Education and Labor by a vote of 2519 on April 16, 2008; H.R. 3765, the Defined Contribution Plan Fee Transparency Act of 2007, introduced on October 4, 2007; and S. 2473, the Defined Contribution Fee Disclosure Act of 2007, introduced December 13, 2007. As of January 29, 2009, legislation has not been introduced in the 111th Congress that addresses fee disclosure in defined contribution plans. Chapter 2 - American workers increasingly rely on 40 1(k) plans for their retirement security, and sponsors of 401(k) plans—typically employers—have critical obligations under the Employee Retirement Income Security Act of 1974 (ERISA). When acting as fiduciaries, they must act prudently and solely in the interest of plan participants and beneficiaries. The

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viii

Kala E. Upshaw

Department of Labor (Labor) is responsible for protecting private pension plan participants and beneficiaries by enforcing ERISA. GAO examined: (1) common 401(k) plan features, which typically have important fiduciary implications, and factors affecting these decisions; (2) challenges sponsors face in fulfilling their fiduciary obligations when overseeing plan operations; and (3) actions Labor takes to ensure that sponsors fulfill their fiduciary obligations, and the progress Labor has made on its regulatory initiatives. To address these objectives, GAO administered a survey asking sponsors how they select plan features and oversee operations, reviewed industry research, conducted interviews, and reviewed related documents. Chapter 3 - This chapter is edited and excerpted testimony by Peter R. Orszag before the Congressional Committee on Education and Labor on October 7, 2008. Chapter 4 - This chapter is edited and excerpted written statement by the American Benefits Council before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 5 - This chapter is edited and excerpted testimony by Dean Baker, co-director of the Center for Economic and Policy Research (CEPR), before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 6 - This chapter is edited and excerpted testimony by Matthew D. Hutcheson, Independent Pension Fiducuary, before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 7 - This chapter is edited and excerpted testimony by John C. Bogle, Founder and Former Chief Executive of the Vanguard Group, before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 8 - This chapter is edited and excerpted testimony by U.S. Rep. George Miller (D-CA), chairman of the House Education and Labor Committee, before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 9 - This chapter is edited and excerpted testimony by Alicia H. Munnell,Director, Center for Retirement Research, Boston College, Carroll School of Management, before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 10 - This chapter is edited and excerpted testimony by The Profit Sharing / 401k Council of America (PSCA), before the Congressional Committee on Education and Labor on February 24, 2009. Chapter 11 - This chapter is edited and excerpted testimony by Paul Schott Stevens, President and CEO, Investment Company Institute, before the Congressional Committee on Education and Labor on February 24, 2009.

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Chapter 1

FEE DISCLOSURE IN DEFINED CONTRIBUTION RETIREMENT PLANS: BACKGROUND AND CURRENT LEGISLATION John J. Topoleski

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SUMMARY As households become more reliant on 401(k) plans and other defined contribution pension plans for future retirement income, policymakers have become more concerned that participants could be unaware of the fees charged in their plans. Small differences in fees charged can have large impacts on account balances upon retirement. This report provides information on the kinds of fees that are charged in 401(k) and other defined contribution plans and details the provisions of three bills in the 110th Congress that addressed fee disclosure in retirement plans: H.R. 3185, the 401(k) Fair Disclosure for Retirement Security Act, which was approved by the Committee on Education and Labor by a vote of 25-19 on April 16, 2008; H.R. 3765, the Defined Contribution Plan Fee Transparency Act of 2007, introduced on October 4, 2007; and S. 2473, the Defined Contribution Fee Disclosure Act of 2007, introduced December 13, 2007. As of January 29, 2009, legislation has not been introduced in the 111th Congress that addresses fee disclosure in defined contribution plans.

BACKGROUND ON 401(K) FEES The Structure of 401(k) Plans and the Impact of Fees Defined contribution (DC) plans are employer-sponsored retirement plans in which employees and/or employers contribute to an individual employee‘s account that accrues investment returns.1 Upon retirement, employees use the accounts as a source of income. DC plans may be ―qualified‖ if they meet certain Internal Revenue Service (IRS) guidelines with

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John J. Topoleski

respect to pension plan contributions, benefits, and distributions. 401(k) plans are qualified plans that include a cash or deferred arrangement under which participants can choose to contribute part of their before-tax compensation to the plan rather than receive the compensation in cash.2 The tax code allows employees to contribute a pre-tax maximum of $15,500 in 2008 to their individual 401(k) accounts. Although there are other kinds of DC account plans in addition to 401(k) plans (such as 457 plans for employees of state or local governments and 403(b) plans for educational institutions and other tax-exempt organizations), these plans operate similarly to 401(k) plans, and the term 401(k) plan often refers to these other plans as well.3 Unless specifically stated, the term 401(k) plan in this report also refers to these other plans. The percentage of employees covered by DC plans has been increasing in recent years. According to the National Compensation Survey from the Bureau of Labor Statistics, 36% of all workers participated in a DC plan in 1999. This percentage increased to 43% by 2006. DC plans will continue to play an important role in Americans‘ retirement security. There has been a growing interest in the fees that participants in 401(k) plans are charged. Small differences in fees can yield large differences in account balances at retirement, especially in the case of yearly or recurring fees.4 For example, Table 1 shows the effect that a 0.5%, a 1.0%, and a 1.5% annual fee would have on an initial $20,000 account balance that earns 7% yearly. After 20 years, the account would have about $77,000 if no fee is charged, whereas the account would have about $70,000 if a 0.5% fee is charged. The account would have a balance of about $58,000 if a 1.5% fee is charged (17% less than the account that charged a 0.5% fee). If a 1.5% annual fee is charged, over the course of 30 years an account holder would pay more than $52,000 in fees. The complexity of 401(k) plan arrangements may provide opportunities for fees to be higher than they otherwise might be, particularly if plan sponsors and participants are not fully informed of the fees they pay. Policies that increase the transparency of fee arrangements may result in participants paying lower fees. Under the Employee Retirement Income Security Act (ERISA, P.L. 93-406), plan sponsors have a fiduciary responsibility to plan participants; that is, they must carry out their responsibilities prudently and solely in the interest of the plan‘s participants.5 Among other duties, fiduciaries have a responsibility in ERISA to defray reasonable expenses of administering the plan, but there are limited fee disclosure requirements to plan participants.6 Table 1. Effect of Annual Fees on a $20,000 Balance (Assuming 7% Annual Real Rate of Return) (amount in $) Annual Fee Account Balance None 0.5% 1.0% 1.5% After 20 years 7,394 70,473 64,143 58,355 After 30 years 152,245 132,287 114,870 99,679 Source: CRS calculations. Note: The average annual real rate of return on the Standard & Poor‘s 500 Stock Market Index from 1926 to 2007 was 6.99%.

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Fee Disclosure in Defined Contribution Retirement Plans

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Structure of 401(k) Plans Figure 1 details the structure of a typical 401(k) plan, although particular plans may have slightly different structures. Fee arrangements affect three groups in 401(k) plans: (1) plan participants, (2) plan sponsors and plan administrators, and (3) service providers. The plan participants are the employees of the company who have individual accounts to which the employees, the employer, or both contribute. As the plan sponsor, the employer arranges for one or more service providers to provide various services for the plan. Prior to choosing a service provider, plan sponsors might ask several providers for details on the products they offer and the fees they charge. Service providers provide a number of services for plan sponsors and participants including the day-to-day plan business such as recording transactions, arranging for loans, cashing out retirees‘ accounts, and arranging for investment options. Most service providers offer several mutual funds to the retirement plan and may offer other investment options as well, including insurance company offerings such as variable annuities and bank or trust company pooled investment trusts. Employers could purchase these services separately from individual service providers or employers could purchase two or more services from a single service provider in a bundled arrangement. In a bundled arrangement, a service provider offers several services or investment alternatives to the plan for a single fee. The service provider may contract out the provision of these services to one or more third parties. Current law does not require the services in bundled arrangements to be priced separately. The Department of Labor (DOL) has issued regulations to require service providers to identify all parties who receive payments of more than $5,000 from the plan.7 The terms ―plan sponsor‖ and ―plan administrator‖ are often used interchangeably, although they need not be the same entity. A plan sponsor is an employer that establishes a retirement plan. The plan administrator is responsible for the day to day running of the plan. The plan administrator may be the employer, a committee of employees, a company executive, or someone hired for that purpose. The plan administrator is defined in 26 U.S.C. § 414(g) as the person specifically so designated by the terms of the plan or the employer in the absence of such a designation. To avoid confusion, this report‘s use of the term ―plan sponsor‖ includes ―plan administrator.‖ In most DC plans, participants have control over some or all of the assets in their individual accounts, although this control is limited to the investment options made available by the service providers. Less common are plans in which the participants have no control over the assets. Current proposals in Congress would require plan sponsors of all DC plans to receive fee disclosures from service providers, but only participants in plans in which the participants exercise control over the assets would receive fee disclosures from plan sponsors. Table 2 indicates that 401(k) plans where the employee has control over all or a portion of the assets in the plan accounted for 88.8% of all DC plans in 2005. Two of the proposals in Congress (H.R. 3185 and S. 2473) would provide assistance to small employers (employers with less than 100 employees) by providing educational and compliance materials to small employers and by providing assistance with finding and understanding affordable investment options. Table 2 indicates that 13.9% of plan participants are in plans in which there are fewer than 100 participants.

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John J. Topoleski

Source: CRS. Figure 1. Structure of a Typical Defined Contribution Plan

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Types of 401(k) Fees The Employee Benefits Security Administration (EBSA) is an agency within the Department of Labor (DOL). It is charged with protecting the integrity of employee benefits, including retirement plans. An EBSA publication, A Look At 401(k) Plan Fees, describes three types of fees: plan administration fees, investment-related fees, and individual service fees .8 According to EBSA, investment-related fees are the largest component of 401(k) plan fees.

Plan Administration Fees These are fees for the day-to-day operations of plans such as record keeping, accounting, legal, and trustee services. Additional services might also be provided, such as access to customer service representatives, educational seminars, or daily valuation. The amount charged for administrative fees can vary depending on the quantity and quality of the services offered. For example, service providers that offer website access with extensive online services might charge higher fees than service providers that provide only basic website services. Administrative fees may be charged either as a flat fee per participant or as a percentage of plan assets.

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Fee Disclosure in Defined Contribution Retirement Plans

Plans with 100 or More Participants

Plans With 2 99 Participants

All Plans

Table 2. Number of Defined Contribution Plans and Participants, by Size of Plan and Extent of Participant Direction of Investments, 2005

Number of Plans 421,776 362,482 59,294 Number of Participants 54,623 7,573 47,050 (in thousands) Number of Plans 354,849 300,435 54,414 Participant Directs Number of Participants in AllInvestments 43,223 6,592 36,631 thousands) Number of Plans 19,825 17,230 2,595 Participant Directs Number of Participants Portion of Assets 8,480 337 8,143 (in thousands) Number of Plans 47,099 44,816 2,283 Participant Does Not Number of Participants Direct Any Investments 2,921 646 2,275 (in thousands) Source: U.S. Department of Labor, Table D-6 of Private Pension Plan Bulletin, Abstract of 2005 Form 5500 Annual Reports. Notes: Table does not include plans that did not report the number of participants. Employers may have multiple plans. Employees may be in multiple plans and are counted in each plan in which they participate. The small discrepancies in the totals for each column are found in the original source.

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All Plans

Investment Fees Investment fees cover the costs of transactions within investment options, such as the trades a particular mutual fund makes. Some investment fees include the following. Sales Charges: These are also known as loads. A front-end load is charged upon investing in some mutual funds. Front-end loads reduce the amount of the initial investment. Back-end loads (also called deferred sales charges or redemption fees) are charged upon selling mutual funds. Marketing and Distribution Fees: These are called ―Rule 12b-1‖ fees after the 1980 Securities and Exchange Commission‘s (SEC) rule that allowed mutual funds to charge for marketing and distribution of mutual fund shares.9 Rule 12b1 fees are annual fees that may be charged by mutual funds from fund assets to pay for promotional costs and commissions to brokers and other salespeople. A point of contention is that service providers may receive 12b-1 fees for including particular mutual funds as investment options for participants in the plans they administer. Although the SEC does not limit the amount of 12b-1 fees, under the Financial Industry Regulatory Authority (FINRA) rules, 12b-1 fees that are used

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John J. Topoleski to pay marketing and distribution expenses (as opposed to shareholder service expenses) cannot exceed 0.75% of a fund‘s average net assets per year. Soft Dollar Fees: These payments are for brokerage firm services (such as research) other than commissions for trade execution. Surrender and Transfer Charges: These are fees that insurance companies may charge when employers withdraw from variable annuities before the contract expires. Wrap Fee: Wrap fees are ―all-in-one‖ fees that combine asset management, financial planning, and brokerage services together for one fee.

Individual Service Fees Individuals are charged fees that are associated with using optional features in a 401(k) plan, such as loan origination fees and fees for hardship withdrawals.

Documents Required by Current Law

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Three documents required by current law contain information about potential fees: Summary Plan Descriptions (SPDs), Summary Annual Reports, and Account statements.

Summary Plan Descriptions SPDs describe how plans operate.10 Plan sponsors are required to automatically provide copies of these documents to plan participants upon enrollment and upon written request of plan participants. Among other items, SPDs contain information about eligibility and vesting requirements, plan benefits, and the source of contributions. SPDs are required to disclose a summary of provisions that may result in a fee charged to a participant, the payment of which is a condition to the receipt of benefits under the plan. An EBSA Field Assistance Bulletin notes that charges for hardship withdrawals, if a plan allows hardship withdrawals, might be an example of such a charge.11 Plans must also make a Summary of Material Modifications available within seven months of the end of the plan year in which significant changes to the plan were made. Annual Report Form 5500 The Form 5500 was jointly developed by DOL, the IRS, and the Pension Benefit Guaranty Corporation (PBGC) and is required to be submitted annually by ERISA-covered plans. This annual report contains various schedules with information on the financial condition, investments, and operations of the plans. On November 16, 2007, EBSA issued regulations to revise the Form 5500. Among other requirements, the regulations require administrators and sponsors of plans with more than 100 participants to disclose the identity of service providers who receive direct or indirect compensation of $5,000 or greater in connection with services rendered to the plan.12 The types of compensation include 12b-1 fees, brokerage commissions, and soft dollars. A plan‘s annual report may be available from

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Fee Disclosure in Defined Contribution Retirement Plans

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the employer upon request and is available from DOL in the EBSA Public Disclosure Facility.

Benefit Statements Section 508 of the Pension Protection Act of 2006 (P.L. 109-280) requires plan sponsors to provide participants in DC plans with quarterly benefit statements if the investments are participant-directed and annual statements if the investments are not participant-directed. The quarterly benefit statement must include the value of each investment in the individual‘s account, an explanation of any limitations or restrictions on any right of the participant or beneficiary under the plan to direct an investment, and an explanation of the importance of a well-balanced and diversified investment portfolio for long-term retirement security. On July 23, 2008, DOL issued proposed regulations that would require plan fiduciaries to disclose to participants, on a quarterly basis, the actual dollar amount charged to the participant‘s account during the preceding quarter for individual services (such as fees for processing plan loans).13

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FEE DISCLOSURE LEGISLATION IN THE 110TH CONGRESS Three bills were introduced in the 110th Congress to address the expenses and fees charged in 401(k) and other DC plans. The bills would have required service providers to disclose to plan sponsors the services to be provided to the plan and the expected fees and expenses. The disclosures would have to be made prior to entering into a contract for services to a plan and upon any material changes to the contract for services. The bills would also have required plan sponsors to disclose to a participant the expected fees and expenses associated with the plan and the plan‘s investment options. This disclosure would have been made prior to any initial contribution by a participant. Plan sponsors would also have had to provide, on a regular basis, each participant with details of the fees and expenses the participant incurred over a specified period. The following paragraphs summarize the bills. Following the summaries, the report describes the bills‘ details in the following categories: (1) disclosures from service providers to plan sponsors, (2) disclosures from plan sponsors to plan participants, (3) a minimum investment option, (4) assistance to small employers, (5) enforcement and review, and (6) imposition of taxes.

Bill Summaries H.R. 3185 and S. 2473 Representative George Miller introduced H.R. 3185, the 401(k) Fair Disclosure for Retirement Security Act of 2007 on July 14, 2007, and the House Committee on Education and Labor passed this bill by a vote of 25-19 on April 16, 2008. Senator Tom Harkin introduced S. 2473, the Defined Contribution Fee Disclosure Act of 2007, on December 13, 2007. H.R. 3185 and S. 2473 are similar in many respects. The bills would have amended ERISA and would have required

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John J. Topoleski service providers to disclose more information on the fees associated with a particular 401(k) plan to plan sponsors and any relationships that service providers have with entities providing services to a 401(k) plan; plan sponsors to inform 401(k) participants about their investment options and the kinds and amounts of fees associated with the investment options; plan sponsors to provide each participant in a 401(k) plan with a detailed breakdown of the fees a participant paid in each quarter; and the Secretary of Labor to provide sample notices of the required documents; to widely disseminate the identity of service providers found to preclude compliance by plan sponsors; and to audit a representative sampling of 401(k) plans to determine compliance with the provisions of the bill. The Congressional Budget Office estimates that these provisions would increase government spending by $3 million over FY2009-FY2013.14

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Minimum Investment Option Requirement in H.R. 3185 H.R. 3185 had an additional requirement that was not found in S. 2473 or H.R. 3765. H.R. 3185 would have required each 401(k) plan to include at least one investment option that is a broad- based market index fund (or combination of funds) that would likely meet retirement income needs at adequate levels of contributions. 401(k) plans that do not include such an option would have lost their protection against liability from participants‘ investment losses under ERISA § 404(c). H.R. 3765 Representative Richard Neal introduced H.R. 3765, the Defined Contribution Plan Fee Transparency Act of 2007, on October 4, 2007. This bill would have imposed taxes on service providers and plan sponsors that failed to meet the requirements of the bill. The bill would have amended the Internal Revenue Code and would have required plan sponsors to provide participants with disclosures of fees and expenses prior to prior to making investments in the plan; plan sponsors to provide each participant in the plan an annual notice of the fees paid by the participant‘s account; and service providers to disclose to plan sponsors fee information and any third-party relationships that service providers might have.

Details of 401(k) Fee Legislation Disclosure from Service Providers to Plan Sponsors All three bills would have required service providers to supply plan sponsors with a written statement detailing the services to be provided under the contract and an estimate of the expected total fees and expenses or charges expected under the contract.

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Timing of Disclosure H.R. 3185 would have required that plan administrators of individual account plans receive a Service Disclosure Statement from 401(k) plan service providers at least 10 business days prior to entering into any contract for services to the plan if the contract equals or exceeds $5,000. This amount would have been adjusted for inflation beginning in 2010. S. 2473 would have required service providers to provide fee information to plan sponsors of 401(k) and 403(b) plans reasonably in advance of entering into a contract for plan services. The law would have applied to any contract greater than $5,000 or 0.01% of the value of plan assets as of the last day of the preceding plan year. H.R. 3765 would have required service providers to provide an ―initial disclosure‖ statement prior to entering into or materially modifying a contract for the provision of plan services.

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Kinds of Pension Plans The provisions in H.R. 3185 and S. 2473 requiring disclosure from service providers to plan sponsors would have applied to ―individual account plans.‖15 The provisions in H.R. 3765 would have applied to ―applicable defined contribution plans.‖ Both definitions would have included 401(k) plans, 403(a) plans, and 457(b) plans.16 Bundled Service Charges The bills would have required service providers to report the fees and expenses within several categories. H.R. 3185 would have required the allocation of fees to four component charges: (1) plan administration and record keeping; (2) transaction-based charges; (3) investment management; and (4) all other charges as may be specified by the Secretary of the Treasury. S. 2473 would have required the allocation of fees to four component charges: (1) charges for investment management; (2) charges for record keeping and administration; (3) sales charges, including commissions, and charges for advisory services; and (4) any other charges. H.R. 3765 would have required an estimate of the total fees and expenses expected under the plan and the itemization of (1) annual fees and expenses for investment management and (2) annual fees for administration and record keeping. Form of Charges and Permission of Estimates The bills would have required some fees to be reported as dollar amounts and other fees to be reported as percentages of assets. The bills would have allowed service providers to report fees as estimates where the actual amounts of the fees are unknown. In H.R. 3185, plan administration and record keeping and investment management charges would have been presented as aggregate dollar amounts. Transaction-based charges may be presented as percentages of applicable base amounts. Reasonable and representative estimates of the charges would have been permitted, provided the statement indicates the charge as being an estimate and provided the estimate is based on the previous year‘s experience. S. 2473 would have allowed each charge to be expressed as either a dollar amount or as percentage of assets. The form of such charges would have to be consistent throughout the

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statement. In cases where services are bundled or the costs are unknown, S. 2473 would have required service providers to provide reasonable and representative estimates of charges. H.R. 3765 would have allowed the fees and expenses to be expressed as either a dollar amount or as a percentage of assets (or a combination thereof). H.R. 3765 would have allowed reasonable estimates of fees and expenses if the service provider does not separately price such services and if the service provider discloses the basis for such estimates.

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Third Party Payments The bills would have required disclosure of relationships that service providers have with third parties who provide services to plans. H.R. 3185 would have required disclosure of any payments that the service provider receives from any person providing services to the plan. It would also have required the disclosure of any personal, business, or financial relationships that the plan sponsor has if the relationship results in the service provider deriving any material benefit. S. 2473 would have required disclosure of any financial relationships that a service provider has with the plan sponsor and any third party providing services to the plan for which the service provider receives a payment. H.R. 3765 would have required a statement of (1) whether the service provider expects to remit any of the fees and expenses it receives under the contract to one or more third-party service providers or intermediaries, (2) the estimated amount to be remitted, and (3) the identity of each party. The bill would also have required a statement of (1) whether the service provider expects to receive compensation from a source other than the plan or plan sponsor as a result of the contract, (2) the amount of such compensation, and (3) the identity of the source of the compensation. Amounts remitted to third parties and revenues received from sources other than the plan or plan sponsor would have to be disclosed only if they exceed $5,000 during the year. Disclosure of Impact Share Classes Mutual funds may offer shares that offer differing services (with differing fees). For example, a mutual fund may have a share class that provides a low front-end load but may have a higher annual expense charge. Some mutual funds offer share classes that are available only to institutional investors; these share classes typically have lower fees and expenses compared to shares that are offered to retail investors. H.R. 3185 and S. 2473 would have required disclosure of the existence of different share classes within the mutual fund investments offered. H.R. 3765 had no requirement to disclose differing share classes within mutual funds. Frequency of Disclosure H.R. 3185 and S. 2473 would have required that a Service Disclosure Statement be provided to the plan sponsor either (1) after any material change to the terms of the service agreement or (2) at least annually. H.R. 3765 would have required, within 90 days of the end of each plan year, the service provider to disclose to the plan sponsor the fees and expenses paid by the plan during the year, including an itemization of the fees paid for (1) investment management and (2) administration and record-keeping. The service provider would have had to disclose amounts paid to third-parties and the identities of the third parties. It would also

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have had to disclose the amount of compensation it received from parties other than the plan sponsor and the identity of each source of the compensation.

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Disclosures from Plan Sponsors to Plan Participants The following provisions in the bills would have required plan sponsors to provide fee information to each plan participant, prior to any initial contribution or investment by the participant, in individual account plans where the participant exercises control over the assets in the account. Disclosures Prior to Participants' Initial Contributions Required by H.R. 3185 and S. 2473 H.R. 3185 would have required plan sponsors to provide an ―Advance Notice of Available Investment Options‖ to all plan participants at least 10 business days prior to (1) a participant‘s initial investment of any contribution to the plan on an annual basis and (2) the effective date of any material change in investment options in the plan. The notice would have indicated which components of each investment option are payable directly by the participant and how such components are to be paid. The following information would have been required for each investment option: the name of the option, the investment objective, the risk level, whether the option by itself achieves long-term financial security, the historical return, the percentage fee, an explanation of any asset-based fees or annual fees, and a comparison to a nationally recognized index or benchmark. The notice would also have included a statement that investment options should not be evaluated solely on the basis of charges but also on consideration of other factors such as risk and investment objectives. S. 2473 would have required plan sponsors to provide an ―Advance Notice of Available Investment Options‖ to all plan participants 15 days prior to a participant‘s initial investment of any contribution made to the plan. The following information would have been required for each investment option: the name of the option, the investment objective, the risk level, whether the option by itself achieves long-term financial security, the historical return, the percentage fee, an explanation of any asset-based fees or annual fees, and a comparison to a nationally recognized index or benchmark. The provisions in H.R. 3185 and S. 2473 requiring disclosure from service providers to participants would have applies to individual account plans that permit participants to exercise control over the assets of their accounts.17 Plan and Investment Comparison Chart Required by H.R. 3185 and S. 2473 In addition to the ―Advance Notice of Available Investment Options‖ mentioned above, H.R. 3185 would have required a Plan Comparison Chart, and S. 2473 would have required an Investment Comparison Chart that would detail the actual service and investment charges that would or could have been assessed against the account in the plan year. H.R. 3185 would have required the Plan Comparison Chart to provide information in relation to the following three categories of fees: (1) charges that vary depending on the investment option selected (e.g., expense ratios or investment-specific asset-based charges), (2) charges that are assessed as a percentage of total assets in an account regardless of the investment option selected, (3) administration and transaction-based charges that are either

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automatically deducted each year (such as administration, compliance, or record keeping costs) or that are transaction-based (such as loan origination fees, possible redemption fees, or possible surrender charges), and (4) any other charges. S. 2473 would have required the Investment Comparison Chart to provide information in the following three categories of fees: (1) fees that vary depending on the investment option selected (e.g., expense ratios or asset-based fees), (2) fees that are assessed as a percentage of total assets in an account, and (3) administration fees that are either automatically deducted each year or that are transaction-based (such as loan origination fees). The investment comparison chart would have had to describe the purpose of each fee and disclose the extent to which conflicts of interest may exist with respect to service providers or other parties receiving fees.

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Disclosures Prior to Participants' Initial Contributions Required by H.R. 3765 H.R. 3765 would have required plan sponsors to provide each participant, before any contributions are invested on his or her behalf, with a written explanation of the plan‘s fees and expenses. This enrollment notice would also have included the following with regards to each investment alternative: the ―key characteristics‖ of the plan‘s investment alternatives and an explanation of the process of electing investment alternatives; a description of each investment alternative‘s investment objectives, risk and return characteristics, historical rates of return, and the name of the fund manager; a statement of whether the investment alternative is actively or passively managed; and a statement of whether the investment alternative is designed to be a ―comprehensive, stand-alone investment for retirement that provides varying degrees of long-term appreciation and capital preservation through a mix of equity and fixed income exposures.‖ With respect to fees and expenses, the enrollment notice would have had to disclose (1) annual asset-based fees for each investment alternative that reduce the investment‘s rate of return and whether any of the fees or expenses applicable to a particular investment alternative are charged for services other than investment management, (2) fees and expenses that are charged for administration and record-keeping and an explanation of the way such fees are allocated to the participant‘s account, (3) fees and expenses attributable to purchases or sales of interests in investment alternatives, (4) the ―existence of‖ fees and expenses attributable to transactions or services initiated by the participant (other than for purchases and sales of investments) and the process by which participants can acquire additional information about these fees, (5) any other fees or expenses that may be charged to the participant, and (6) a statement explaining that fees are only one of the factors that a participant should consider when selecting an investment alternative. The provisions in H.R. 3765 that would have required disclosure from service providers to participants would have applied to DC plans that permit participants to exercise control over the assets in their accounts.18

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Quarterly Benefits Statements Required by H.R. 3185 and S. 2473 H.R. 3185 and S. 2473 would have required plan sponsors to provide a quarterly statement of the fees and expenses that a participant has paid. H.R. 3185 would have required plan sponsors to provide information to each plan participant regarding the fees paid in their account. H.R. 3185 would have required plan sponsors to provide each plan participant with a quarterly statement (plans that have fewer than 100 participants could have provided an annual statement) that discloses the following information: the starting and ending balances of the participant‘s account; the employer and employee contributions made during the quarter; the investment earnings or loses on the account balance during the quarter; the actual or estimated charges that reduced the account during the quarter, expressed as dollars or as dollar charges as derived from an expense ratio; other charges in connection with the participant‘s account; and the process for obtaining the most recent Fee Comparison Chart. Plan sponsors could have provided reasonable and representative estimates of the charges, provided that the statement indicates the charge as being an estimate and provided the estimate is based on the previous year‘s experience. S. 2473 would have required plan sponsors to provide each participant in a DC plan in which the participant has the right to direct the investment of assets the following information in their quarterly benefits statements: the account‘s starting balance; the participant‘s vesting status; the employer and employee contributions made during the quarter; the interest earnings on the account balance during the quarter; the actual or estimated fees assessed during the quarter, expressed in dollars or as an expense ratio; the account‘s ending balance; the participant‘s asset allocation, categorized by investment option, including the current asset value and the change in the asset‘s value expressed as an amount and as a percentage; and the performance of the investment options selected by the participant during the quarter as compared to at least one nationally recognized market-based index. Plans that have fewer than 100 participants could have provided the benefits statement on an annual basis. S. 2473 would have required a plan sponsor to provide, within 30 days of a participant‘s request, information on service fees charged against the participant‘s account for each investment option. The following information would have been listed separately: fees that vary depending on the investment option selected, such as expense ratios, investment-specific asset based fees, or possible redemption fees or surrender charges; fees that are assessed as a percentage of total assets in the account, regardless of the investment option selected; administration and transaction-based fees; and any other fees that might be deducted from the participant‘s account. Annual Statements Required by H.R. 3765 H.R. 3765 would have required plan sponsors to provide each participant, within 90 days of the end of the plan year, with a written statement of the investment alternatives the participant had selected as of the end of the plan year and the key characteristics of each of these investment alternatives. The statement would have had to include the following information: a description of the percentage of the participant‘s assets invested in each asset class, the fees and expenses attributable to participant-initiated transactions (other than purchases and sales of assets) deducted from the participant‘s account, the fees and expenses for administration and record-

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keeping that were deducted from the participant‘s account, the annual asset-based fees for each investment alternative that reduced the investment alternative‘s rate of return, and the fees and expenses attributable to purchases or sales of each investment alternative that ―have been or may be‖ deducted from the participant‘s account. The annual notice also would have had to include, with respect to each investment alternative, the percentage of the participant‘s assets invested in that alternative, a statement of whether the investment is actively or passively managed, a statement of the alternative‘s risk and return characteristics, and the investment‘s historical rates of return over the most recent one-, five-, and ten-year time period. It also would have had to include a statement that explains that fees are only one of the factors that a participant should consider when selecting an investment alternative and that explain how the participant can access any information required to be disclosed in the enrollment notice that is not included in the annual notice.

Minimum Investment Option Requirement in H.R. 3185 ERISA § 404(c) protects plan sponsors from liability for investment losses in participantdirected DC plans. In order to continue to receive this protection, H.R. 3185 would have required 401(k) plans to include at least one investment option that is a broad-based securities market based index fund or a combination of two or more such funds. The investment option should offer a combination of historical returns, risk, and charges that is likely to meet retirement income needs at adequate contribution levels. The bill specified that the terms of the plan should indicate that the fund is offered without the endorsement of the government or plan sponsor. The bill did not specify particular funds, but examples might include life-cycle or index funds. Life-cycle funds alter their particular investment mix on the basis of the participant‘s investment time horizon. Index funds are mutual funds that replicate the movements of a group of investments. Index funds might track a large group of U.S. stocks (such as the Dow Jones Industrial Average or Standard & Poor‘s (S&P) 500 index), foreign stocks, or various kinds of bonds. Neither H.R. 3765 nor S. 2473 required 401(k) plans to offer a particular investment option. Assistance to Small Employers in H.R. 3185 and S. 2473 H.R. 3185 and S. 2473 would have required the Secretary of Labor to provide educational and compliance materials to assist employers with fewer than 100 employees in selecting and monitoring service providers. The bills would also have required the Secretary of Labor to provide services to assist employers with fewer than 100 employees in finding and understanding affordable investment options for the account plans. H.R. 3765 has no such provisions. Enforcement and Review by the Department of Labor in H.R. 3185 and S. 2473 H.R. 3185 and S. 2473 would have required the Secretary of Labor to widely disseminate the identity of service providers that engage in a pattern or practice of noncompliance with respect to the provisions relating to the Service Disclosure Statements and the Advance Notices of Available Investment Options. The bill would also have required the Secretary of Labor to annually audit a representative sampling of individual account plans to determine their compliance with the requirements of the provisions relating to the Service Disclosure Statements and the Advance Notices of Available Investment Options and to report the results

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of the audit and any related recommendations to the House Committee on Education and Labor and the Senate Committee on Health, Education, Labor, and Pensions.

Imposition of Taxes in H.R. 3765 H.R. 3765 would have imposed a tax on service providers that failed to meet the requirements of the bill with respect to disclosure from service providers to plan sponsors. The amount of the tax would have been $100 per participant per day in the noncompliance period. H.R. 3765 would have imposed a tax on plan administrators that failed to meet the requirements of the bill with respect to disclosure from plan administrators to plan participants. The amount of the tax would have been $1,000 per participant for each day in the noncompliance period.

AUTHOR CONTACT INFORMATION John J. Topoleski Analyst in Income Security [email protected], 7-2290

End Notes

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1

A defined contribution plan is defined in 26 U.S.C. § 414(i) as ―a plan which provides for an individual account for each participant and for benefits based solely on the amount contributed to the participant‘s account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant‘s account.‖ 2 The names for the various types of defined contribution retirement plans are often the section of the Internal Revenue Code that authorizes these plans (e.g., 26 U.S.C. 401(k) or 26 U.S.C. 457(b)). 3 See 26 U.S.C. § 402(g)(1). 4 For a detailed analysis of the effects that fees have on account balances, see CRS Report RL34213, Retirement Savings Accounts: Fees, Expenses, and Account Balances, by Patrick Purcell. 5 For more information, see CRS Report RL34443, Summary of the Employee Retirement Income Security Act (ERISA), by Patrick Purcell and Jennifer Staman. 6 See 29 U.S.C. § 1104(a)(1)(A)(ii). 7 See Department of Labor, ―Annual Reporting and Disclosure,‖ 72 Federal Register 221, November 16, 2007, pp. 64710-64730. 8 Available at http://www.dol.gov/ebsa/pdf/401kFeesEmployee.pdf. 9 Prior to the adoption of Rule 12b-1, the SEC generally took the view that section 12b-1 of the Investment Companies Act of 1940 (15 U.S.C. § § 80a-1 - 80a-64) prohibited mutual funds from using fund assets to pay for the sale of their shares. 10 See 29 CFR § 2520.103-2 and 29 CFR § 2520.103-3 for regulations concerning the style and contents of SPDs. 11 See Field Assistance Bulletin 2003-3 issued by EBSA on May 19, 2003. 12 See Department of Labor, ―Annual Reporting and Disclosure,‖ 72 Federal Register 221, November 16, 2007, pp. 64710-64857. 13 See Department of Labor, ―Fiduciary Requirements for Disclosure in Participant-Directed Individual Account Plans,‖ 73 Federal Register 142, July 23, 2008, pp. 43013-43044. 14 Congressional Budget Office cost estimate, H.R. 3185: 401(k) Fair Disclosure for Retirement Security Act of 2008, available at http://www.cbo.gov/ftpdocs/93xx/doc9323/hr3185.pdf. 15 The term individual account plan or defined contribution plan is defined in 29 U.S.C. 1002(34) as ―a pension plan which provides for an individual account for each participant and for benefits based solely upon the amount contributed to the participant‘s account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant‘s account.‖

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Specifically, H.R. 3765 applies to defined contribution plans described in 26 U.S.C. 402(c)(8)(B)(iii)-(vi): qualified trusts (such as 401(k) plans), 403(a) plans, 457(b) plans, and 403(b) plans. 17 These are defined in 29 U.S.C. 1002(34): ―a pension plan which provides for an individual account for each participant and for benefits based solely upon the amount contributed to the participant‘s account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant‘s account.‖ 18 These plans are described in 26 U.S.C. 402(c)(8)(B)(iii)-(vi): qualified trusts (such as 401(k) plans), 403(a) plans, 457 plans, and 403(b) plans.

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In: Strengthening the Retirement System Beyond Social Security ISBN: 978-1-60741-752-1 Editor: Kala E. Upshaw © 2010 Nova Science Publishers, Inc.

Chapter 2

PRIVATE PENSIONS: FULFILLING FIDUCIARY OBLIGATIONS CAN PRESENT CHALLENGES FOR 401(K) PLAN SPONSORS United States Government Accountability Office

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WHY GAO DID THIS STUDY American workers increasingly rely on 401(k) plans for their retirement security, and sponsors of 401(k) plans—typically employers—have critical obligations under the Employee Retirement Income Security Act of 1974 (ERISA). When acting as fiduciaries, they must act prudently and solely in the interest of plan participants and beneficiaries. The Department of Labor (Labor) is responsible for protecting private pension plan participants and beneficiaries by enforcing ERISA. GAO examined: (1) common 401(k) plan features, which typically have important fiduciary implications, and factors affecting these decisions; (2) challenges sponsors face in fulfilling their fiduciary obligations when overseeing plan operations; and (3) actions Labor takes to ensure that sponsors fulfill their fiduciary obligations, and the progress Labor has made on its regulatory initiatives. To address these objectives, GAO administered a survey asking sponsors how they select plan features and oversee operations, reviewed industry research, conducted interviews, and reviewed related documents.

WHAT GAO RECOMMENDS GAO is not making any additional recommendations in this report, but GAO has previously suggested that Congress consider changes to ERISA addressing fiduciary roles. To view the full product, including the scope and methodology, click on GAO-08-774. To view the survey results, click on GAO-08-870SP. For more information, contact Barbara Bovbjerg at (202) 512-7215 or [email protected].

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United States Government Accountability Office

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WHAT GAO FOUND Plan sponsors commonly select certain noninvestment and investment features, and their decisions about which investment features to select generally have important fiduciary implications. According to industry research, most 40 1(k) plans offer a number of common features, such as employer contributions and loans for employees. Some of these decisions seldom involve fiduciary obligations set by ERISA because they are mainly business decisions related to establishing the plan. However, a sponsor‘s decisions about investment features, like the menu of investment options, entail important fiduciary obligations under ERISA. ERISA and its regulations stipulate certain requirements for these investment decisions, like offering diversified funds and prudently selecting and monitoring investment options. Various other factors also affect a sponsor‘s menu decisions, including the size of the plan and the role of external advisers and other providers. Plan sponsors face challenges in fulfilling their obligations when fiduciary roles are not clearly defined or when sponsors lack important information about arrangements between service providers. Fiduciary roles that are not clearly defined can lead to gaps in plan oversight. For example, several industry professionals noted situations when sponsors assumed they had delegated fiduciary investment advice for the selection and monitoring of investment funds to a service provider, but the service provider did not acknowledge that fiduciary role. Sponsors also have fiduciary obligations when selecting and monitoring one or more service providers. To fulfill these obligations, Labor‘s guidance indicates that sponsors should obtain information about service providers‘ compensation arrangements and potential conflicts of interest that could affect the service provider‘s performance. Labor and various industry practitioners have proposed new ways to improve fiduciary oversight that may address some of the challenges of unclear fiduciary roles and providers‘ arrangements. Labor takes various actions to monitor sponsors‘ fiduciary oversight of 401(k) plans and has made some progress on its regulatory initiatives. Labor‘s actions include investigating reports of questionable 401(k) plan practices, collecting information from plan sponsors, and conducting outreach to educate plan sponsors about their responsibilities. Labor is also proceeding with several initiatives to improve disclosures to participants, plan sponsors, government agencies and the public. For example, Labor recently published a proposed rule on the information that service providers must disclose to plan sponsors but is trying to resolve several questions before issuing a final rule. In addition, certain matters that GAO has asked Congress to consider would help Labor in its efforts to improve sponsors‘ fiduciary oversight. We previously suggested that Congress amend ERISA to (1) explicitly require 401(k) service providers to disclose to plan sponsors the compensation they receive from other service providers and (2) give Labor authority to recover plan losses against certain types of service providers even if they are not currently considered fiduciaries under ERISA.

ABBREVIATIONS CAP EBSA ERISA

Consultant/Adviser Project Employee Benefits Security Administration Employee Retirement Income Security Act of 1974

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Private Pensions: Fulfilling Fiduciary Obligations… IPS Labor OPA Plansponsor PSCA RFI RIA VFCP

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investment policy statement Department of Labor Office of Participant Assistance Plansponsor Magazine Profit Sharing/401(k) Council of America request for information Registered Investment Adviser Voluntary Fiduciary Correction Program

July 16, 2008 The Honorable George Miller Chairman Committee on Education and Labor House of Representatives

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Dear Mr. Chairman: Over the past two decades, American workers have become increasingly reliant on 40 1(k) plans for their retirement security. These employer-sponsored pension plans typically allow workers to divert a portion of their pretax income, often with employer contributions, into an investment account that can grow tax free until withdrawn in retirement. According to the Department of Labor (Labor), in 2005, there were about 436,000 401(k) plans that held about $2.4 trillion in assets for the retirement savings of more than 54 million plan participants—more than any other type of employer-sponsored pension plan in the United States. To administer these plans, the sponsor—typically the employer offering the 401(k) plan—selects plan features and other characteristics, including the types of investment options offered to participants, and monitors the performance of one or more service providers, such as investment advisers and record keepers. The Employee Retirement Income Security Act of 1974 (ERISA) imposes significant fiduciary obligations on plan sponsors and other plan fiduciaries, requiring them to act prudently and in the interests of the plan‘s participants and beneficiaries.1 Labor is responsible for ensuring that plan sponsors and other plan fiduciaries fulfill these obligations. In two recent reports, we asked Congress to consider amending ERISA to expand Labor‘s statutory authority over plan service providers and help ensure that sponsors are properly overseeing plan services.2 While Congress continues to consider new legislation, Labor has also tried to address some of these underlying issues through regulatory initiatives. As Congress considers changes to the law that governs how these plans are designed, managed, and overseen, GAO was asked to identify the following: common 401(k) plan features, those that typically have important fiduciary implications, and what factors affect these decisions; challenges sponsors face in fulfilling their fiduciary obligations when overseeing plan operations; and actions Labor takes to ensure that sponsors fulfill their fiduciary obligations, and the progress Labor has made on its regulatory initiatives.

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To determine common plan features and which decisions typically have fiduciary implications and related factors, and the challenges sponsors face in fulfilling their fiduciary obligations, we collected and analyzed the results of published industry research. We also collected information on sponsor practices from a range of plan sponsors, service providers, industry associations, and other industry professionals—including fiduciary advisers— through interviews and reviews of documents, such as materials on fiduciary obligations given by service providers to sponsors. In addition, we administered a survey in coordination with Plansponsor Magazine (Plansponsor) asking sponsors how they select plan features and oversee plan operations. The survey and a more complete tabulation of the results can be viewed at GAO-08-870SP. The survey respondents were members of Plansponsor’s subscription list, and their responses cannot be considered representative of the overall population of 401(k) plan sponsors. We received a total of 448 completed survey responses after distributing the survey to a population of about 22,000. Because of the methodological limitations of this survey, information from this survey is anecdotal and represents only the views of the 448 survey respondents. To determine the actions that Labor takes to ensure that sponsors fulfill their fiduciary obligations, we interviewed Labor officials and reviewed Labor‘s legal and regulatory authority and its procedures for assuring that plans are meeting the overall requirements. See appendix I for more details regarding our scope and methodology. We conducted our review from January 2007 through June 2008 in accordance with generally accepted government auditing standards.

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RESULTS IN BRIEF Plan sponsors determine a number of common noninvestment plan features, but they also make decisions about investment features with important fiduciary implications. Industry research indicates that most 401(k) plans offer a number of common features, including an employer contribution, a loan program, eligibility of employees, and vesting of benefits. Some selections are primarily business decisions, similar to whether or not to establish the plan, that seldom involve fiduciary obligations. About one-half of sponsors responding to our survey said that a committee of the sponsor and about one-half said that employer management was the primary decision maker on various noninvestment features, but this information cannot be considered representative of all 401(k) plan sponsors.3 However, when a sponsor makes decisions about investment features—like selecting the menu of investment options—it acts as a fiduciary and is subject to fiduciary obligations under ERISA, including the duties to act prudently and solely in the interest of participants and beneficiaries. In our survey, most responding sponsors said that a committee of the sponsor was the primary decision maker for areas like the investment menu or investment goals. While sponsors that act as a fiduciary for investment functions must satisfy their fiduciary obligations, they have considerable latitude in selecting investment options, such as the number and types of options. Besides ERISA and its regulations, various other factors affect a sponsor‘s decision regarding the selection of the investment menu, including the size of the plan and the role of external advisers and providers. For example, many sponsors responding to our survey used a third-party investment adviser.

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Plan sponsors face challenges in fulfilling their obligations when fiduciary roles are not clearly defined or when sponsors lack important information about arrangements between service providers. Sponsors often hire outside professionals to manage some or all of a 401(k) plan‘s day-to-day operations. Some of these service providers provide investment advice for a fee, or exercise sufficient control or discretion over the plan or its assets, thereby becoming fiduciaries under ERISA. However, fiduciary roles that are not clearly defined between the sponsor and other plan fiduciaries can lead to gaps in plan oversight. For example, several industry professionals noted situations when sponsors assumed they had delegated fiduciary investment advice for the selection and monitoring of investment funds to a service provider, but the service provider did not acknowledge that fiduciary role. Sponsors also have fiduciary obligations when they select and monitor one or multiple service providers. To fulfill these obligations, Labor‘s guidance indicates that sponsors should obtain information about service providers‘ compensation arrangements and potential conflicts of interest that could affect the service provider‘s performance. To improve fiduciary oversight in these areas, Labor has proposed a rule to require pension plan service contracts to disclose additional information, including the extent to which service providers will become fiduciaries for the functions they will perform.4 If finalized, compliance with this rule could eliminate some of the confusion surrounding the sharing of fiduciary duties between sponsors and their service providers and help sponsors provide better oversight of plan services. Labor takes various actions to monitor sponsors‘ fiduciary oversight of 401(k) plans and has made some progress on its regulatory initiatives. Labor investigates reports of questionable 401(k) plan practices, collects information from plan sponsors, and conducts outreach to educate plan sponsors about their responsibilities. Labor is also pursuing severalregulatory initiatives to improve disclosures provided to participants, plan sponsors and fiduciaries, government agencies and the public. Labor has recently issued proposed regulations to specify the information that service providers must disclose to plan sponsors. However, Labor is in the process of resolving several questions before it can issue final regulations, such as the extent to which providers within a bundled arrangement—a package of plan services—would be bound by the disclosure requirements of the regulations. Some of the matters that GAO has asked Congress to consider, if addressed, would also help Labor in its efforts to improve sponsors‘ fiduciary oversight. For example, we previously suggested that Congress amend ERISA to explicitly require 401(k) service providers to disclose to plan sponsors the compensation they receive from other service providers.5 Furthermore, we found that undisclosed business arrangements or conflicts of interest may have resulted in financial harm to some plans.6 Given this risk, we asked that Congress consider amending ERISA to give Labor greater authority to recover plan losses against certain types of service providers even if they are not currently considered fiduciaries under ERISA. These changes would provide Labor with greater statutory authority over plan service providers and help ensure that sponsors are properly overseeing plan services.

BACKGROUND Roughly half of all workers participate in an employer-sponsored retirement, or pension, plan. Private sector pension plans are classified as either defined benefit or defined

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contribution plans. Defined benefit plans promise to provide, generally, a fixed level of monthly retirement income that is based on salary, years of service, and age at retirement, regardless of how the plan‘s investments perform. In contrast, benefits from defined contribution plans are based on the contributions to and the performance of the investments in individual accounts, which may fluctuate in value. These accounts are tax-advantaged in that contributions are typically excluded from current income, and earnings on balances grow taxdeferred until they are withdrawn.7 One type of defined contribution, or individual account, plan is the 401(k) plan.

Fiduciary Obligations under ERISA In accordance with ERISA and related Labor regulations and guidance, plan sponsors and other fiduciaries must exercise an appropriate level of care and diligence given the scope of the plan and act for the exclusive benefit of plan participants and beneficiaries, rather than for their own or another party‘s gain. Responsibilities of fiduciaries include:

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selecting and monitoring any service providers to the plan; reporting plan information to the government and to participants; adhering to the plan documents, including any investment policy statement; identifying parties-in-interest to the plan and taking steps to monitor transactions with them; selecting and monitoring investment options the plan will offer and diversifying plan investments; and ensuring that the services provided to their plan are necessary and that the cost of those services is reasonable. ERISA allows plan sponsors to hire companies that will provide services necessary to operate their 401(k) plan if certain conditions are met. In general, ERISA prohibits parties-ininterest—such as service providers, plan fiduciaries, the employer, the union, owners, officers, and relatives of parties-in-interest—from doing business with the plan, but provides various exemptions to these prohibited transactions.8 Some of the exemptions provide for dealings with banks, insurance companies, and other financial institutions essential to the ongoing operations of the plan. The Internal Revenue Code sets forth parallel prohibited transaction provisions with respect to ―disqualified persons,‖ such as service providers, and provides a parallel conditional exemption for the provision of services. The exemption requires that: (1) the contract or arrangement must be reasonable, (2) the services must be necessary to operate the plan, and (3) the compensation can not exceed what is reasonable for the services provided.9 Some other prohibited transactions relate solely to fiduciaries using plan assets in their own interest or acting on both sides of a transaction involving a plan. Fiduciaries cannot receive money or any other consideration for their personal account from any party doing business with the plan related to that business. In the course of providing services, a service provider may become a fiduciary by reason of providing investment advice for a fee, or exercising sufficient control over, or discretion with respect to, the administration or assets of the plan.10 For example, holding plan assets in

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trust to assure that they are used solely to benefit the participants and their beneficiaries would make the trustee a fiduciary. An outside professional that provides advice for a fee to plan sponsors about the selection of funds to be included in the menu of options made available to participants would also be a fiduciary. Providers of many other necessary services—such as keeping the record of participants‘ individual accounts and providing the investment funds being made available to plan participants—are typically not fiduciaries.

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The Department of Labor’s Role Labor‘s Employee Benefits Security Administration (EBSA) is the primary agency responsible for protecting private pension plan participants and beneficiaries from the misuse or theft of their pension assets by enforcing ERISA, which defines and sets certain standards for employee benefit plans sponsored by private sector employers. EBSA oversees 401(k) plans because they are considered employee benefit plans under ERISA. Enacted before the 40 1(k) provision was added to the Internal Revenue Code, ERISA establishes the responsibilities of employee benefit plan decision makers. EBSA conducts civil and criminal investigations to determine whether the provisions of ERISA or other federal laws related to employee benefit plans have been violated. EBSA regularly works in coordination with other federal and state enforcement agencies, including Labor‘s Office of the Inspector General, the Pension Benefit Guaranty Corporation, the Internal Revenue Service, the Department of Justice (including the Federal Bureau of Investigation), the Securities and Exchange Commission, the federal banking agencies, state insurance commissioners, and state attorneys general. In addition to its investigations, Benefits Advisors in the field and in EBSA‘s Office of Participant Assistance (OPA), help workers get the information they need to protect their benefit rights and obtain benefits that have been improperly denied. In fiscal year 2007, Benefits Advisors recovered over $96 million on behalf of participants and beneficiaries through informal resolution of participant complaints. Benefits Advisors also refer cases for investigation. There were 611 enforcement cases closed in fiscal year 2007 whose original source was a Benefit Advisor referral. Of these, 451 were 401(k) plan investigations, including 389 that were closed with monetary results of over $46 million.11 EBSA‘s policy is to resolve 401(k) participant complaints involving late or unremitted employee contributions at the earliest possible opportunity. Benefits Advisors are provided with guidance on how to handle these 401(k) contribution-related complaints. While Benefits Advisors do not have investigative authority and cannot make formal demands on employers or plan sponsors, they are authorized to request that the employer, plan sponsor, or other appropriate third-party official provide documents or information related to a participant‘s complaint on an individual or plan-wide basis. EBSA‘s Benefits Advisors may also attempt to resolve the complaints and correct any violations on a plan-wide basis through informal dispute resolution. If the complaint involves unremitted or untimely employee contributions, Benefits Advisors can request information from the plan sponsor and, after review, advise the plan on the amount of contributions due. In fiscal year 2007, $5.8 million in pension benefits were restored to plans by Benefits Advisors as a result of this procedure.

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EBSA also has regional initiatives focused on fiduciary oversight. Several of them have produced results related to 40 1(k) fiduciary issues. Even with an initiative focused on settlor fees,12 one regional office still obtained results related to fiduciary issues under the project. According to an EBSA official, 401(k) plans have obtained monetary results related to fiduciary issues in three cases under the project, totaling more than $8 million.13

Sources: GAO and Art Explosion (clip art).

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Figure 1. Services That 401(k) Plan Sponsors May Hire Various Outside Companies to Provide

Sources: GAO analysis of information from industry practitioners and Art Explosion (clip art). Note: This figure depicts a simplified example of one possible arrangement and is not intended to depict all arrangements. Figure 2. Flow of Bundled and Unbundled Plan Services

Labor‘s ERISA Advisory Council, created by ERISA to provide advice to the U.S. Secretary of Labor, is another resource for Labor. For example, in 2007, this council formed the Working Group on Fiduciary Responsibilities and Revenue Sharing Practices to study

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numerous issues regarding fiduciary responsibilities arising from the enactment of the Pension Protection Act of 200614 and to address issues relative to the practice of revenue sharing, a now-common practice used to offset plan expenses with respect to defined contribution 401(k) plans. The working group‘s report concluded that there is a role for Labor to take the lead in formally defining 401(k) terms, such as ―revenue sharing,‖ and that Labor should compile appropriate terminology in connection with that definition. According to the report, the provision of concise definitions would be a considerable step in reducing the confusion about the flows of revenues, fees, and costs, and could only benefit the plan sponsors, fiduciaries, and service providers in fulfilling their role to participants.

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Plan Services Plan sponsors of 401(k) plans often hire various outside companies to provide a number of services necessary to operate a 401(k) plan. As shown in figure 1, these services can include investment management (e.g., selecting and managing the securities included in a bank collective trust fund); consulting and providing financial advice (e.g., selecting vendors for investment options or other services); record keeping (e.g., tracking individual account contributions); custodial or trustee services for plan assets (e.g., holding the plan assets in a bank); and telephone or Web-based customer services for participants. The delivery structure for providing plan services can vary. Generally, there are two structures: ―bundled‖ (the sponsor hires one company that provides the full range of services directly or through subcontracts) and ―unbundled‖ (the sponsor uses a combination of service providers), as shown in Figure 2. In a bundled arrangement, a sponsor might delegate the oversight for the selection and monitoring of plan services, except for the selection and monitoring of the bundled provider itself. In contrast, in an unbundled arrangement, the sponsor might retain oversight of the selection and monitoring for some or all other service providers.

SPONSORS DETERMINE A NUMBER OF COMMON PLAN FEATURES, AND THEIR DECISIONS ABOUT INVESTMENT FEATURES HAVE IMPORTANT FIDUCIARY IMPLICATIONS Although, when determining a number of common, noninvestment features and other plan characteristics, plan sponsors are frequently acting as settlors,15 their decisions about investment features have important fiduciary implications. Industry research finds that most 401(k) plans offer a number of common noninvestment features such as employer contributions and loan programs. For example, industry research shows that at least 94 percent of sponsors offered some type of employer contribution.16 Like whether or not to establish a plan, these determinations are primarily business decisions that seldom involve fiduciary duties. However, when a sponsor makes decisions about investment features—like selecting the menu of investment options—it acts as a fiduciary and is subject to fiduciary obligations under ERISA. While sponsors must act prudently and solely in the interest of participants and beneficiaries when acting as a fiduciary for investment functions, they have

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considerable latitude in selecting fund options, such as the number and types of options. Besides ERISA and its regulations, various other factors affect a sponsor when it makes investment decisions regarding the selection of the investment menu, including the size of the plan and the role of external advisers and providers.

Plan Sponsors Determine Some Common Plan Features to Establish the Plan

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Some common plan features and other characteristics include an employer contribution, a loan program, eligibility of employees, and vesting of benefits. While an employer contribution and a loan program are optional, a 401(k) plan is required to have eligibility and vesting rules. An employer contribution can take different forms, such as a matching contribution and/or nonmatching contribution made regardless of participant contributions. In industry research we reviewed, at least 94 percent of sponsors indicated that they offer some type of employer contribution, while 6 percent or fewer do not offer such contributions.17 Research by the Bureau of Labor Statistics and industry groups shows the different methods to determine any employer contribution, such as formulas based on participant contributions, years of service, company profits, or other means.18 A loan program enables participants to take one or more loans from the contributions in their account. In industry research we reviewed, at least 84 percent of sponsors include a loan program.19 Eligibility of employees refers to the requirements for employees to become eligible to participate in the plan, such as an age or service requirement. Sponsors can choose less restrictive requirements for eligibility than required by law. For example, in industry research GAO reviewed, about half of respondents to industry research offer immediate eligibility with no age or service requirements.20 Vesting of benefits refers to the length of time before a plan participant has a nonforfeitable right to an accrued benefit. For 401(k) plans, participant contributions are required to be vested immediately, but employer contributions may be vested over time according to plan terms. As with employee eligibility, the law sets the maximum amounts of time before an employee is vested, but sponsors can decide on less restrictive vesting provisions. For example, in industry research GAO reviewed, about 40 percent of respondents have immediate vesting in employer matching contributions.21 When making decisions about some noninvestment plan features, sponsors act as settlors rather than fiduciaries. According to our survey, 186 of 441 sponsors said the sponsor‘s committee was the primary decision maker for various noninvestment, settlor decisions, while 205 sponsors said that company management was.22 Sponsors make many settlor function decisions, such as those related to establishing, amending, or terminating a plan. They are considered business decisions and include the decision to offer a particular type of plan, the levels of benefits to provide, and the termination of the plan. The fiduciary obligations under

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ERISA, including the overarching duties to act prudently and solely in participants‘ interest, are seldom involved in many of these decisions.23

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Sponsors’ Decisions about Investment Features Have Important Fiduciary Implications When making decisions about investment features, ERISA‘s fiduciary duties apply. As a result, when plan sponsors acting as a fiduciary for investment functions make such decisions, they must offer prudent, diversified choices for participants to fulfill the duties of acting prudently and diversifying plan investments. Several pension professionals told us, in fact, that the main plan feature with important fiduciary implications is the investment menu.24 When developing that menu, sponsors must act for the sole benefit of participants and beneficiaries, rather than that of their own or another party. According to our survey, 349 of 440 responding sponsors said that the sponsor committee or management was the primary decision maker for selecting the menu of investment options. Industry research shows that the median number of options was in the range of 11 to 15, with as many as 24 percent of responding plans offering 20 or more funds.25 When acting as fiduciaries for investment functions, sponsors have considerable latitude in selecting fund options, including the number and types of funds, from which participants choose. Table 1 shows funds available for participant contributions, according to research from one industry group. These funds involve different categories of investments. ERISA‘s fiduciary obligations require that fees paid by the plan are reasonable and that services provided to the plan are necessary. Thus, sponsors must consider the fees and other characteristics of the funds, including potential returns and risk. For example, index funds are passively managed funds with lower management fees than actively managed funds, for which the investment provider pursues particular investments in an attempt to obtain higher than average returns. Similarly, sponsors must prudently select the service providers to the plan, such as the providers of record keeping services and service providers that make investment options available to the plan. In our survey, the primary decision maker for selecting service providers for investment options was the sponsor committee for 283 of 445 respondents and sponsor management for 108 respondents. For selecting providers of record keeping, the primary decision maker was the sponsor committee for 256 of 445 respondents and sponsor management for 135 respondents. As with selecting funds, fees are one of many issues—such as providers‘ qualifications and quality of services—to consider when selecting providers. ERISA‘s fiduciary duties also apply to a sponsor including a default option for participants not making an investment choice. These duties include prudently selecting and monitoring the option based on an objective, thorough, and analytical process that involves careful consideration of the quality of competing providers and investment products, as appropriate. A recent Labor regulation provides certain fiduciary relief when participants‘ contributions are invested in qualified default investment alternatives that include lifecycle funds, balanced funds, or managed accounts.26 Labor decided on these alternatives, which combine stocks and fixed income securities like bonds, based on considerations that included diversification and adequacy of savings for retirement. Thus, if participants do not provide

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instructions on how to invest their contributions, sponsors may place contributions into a default investment. For example, participants may not provide investment instructions when automatically enrolled in a plan by their sponsor. Once the investment menu is selected, sponsors must monitor the fund options as part of their fiduciary obligations. Several pension professionals noted that monitoring funds may involve quantitative criteria that include investment returns as compared to benchmarks, risk, and fees, along with qualitative criteria such as the stability of the provider. In our survey, 362 of 448 sponsors said they benchmark the investment performance of the 401(k) plan.27 Of those who do benchmarking, 297 respondents said they benchmark each option to the performance of a peer group as one way of monitoring performance. As part of this monitoring of fund options, efforts of sponsors may include reviewing reports about the performance of the funds, holding meetings, placing poorly performing funds on a watch list, ultimately removing funds or replacing them with better options, and documenting their decisions. Some pension professionals told us that investment monitoring efforts generally were of good quality overall but that certain fund characteristics, such as risk, or particular plan sizes, such as some small plans, were not always monitored adequately. Table 1. Investment Funds Available for Participant Contributions, Expressed as a Percentage of Respondents

200-999

1,000-4,999

5,000+

All plans

Balanced stock/bond fund Bond-actively managed, domestic Bond-indexed, domestic Cash equivalents (CD/money market) Company stock Equity-actively managed, domestic Equity-actively managed, international Equity-indexed, domestic Equity-indexed, international Real estate fund Other sector fund Self-directed (brokerage window)a Self-directed (mutual fund window)a Stable value fund Target retirement date Other lifestyle fund(s) Other

50-199

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Fund type

1-49

Plan size, by number of participants

52.0 50.0 25.3 53.3 4.7 70.7 62.0 53.3 18.7 29.3 12.7 12.0 8.0 34.0 22.0 20.7 18.0

62.8 62.0 30.2 48.8 0.8 78.3 76.7 69.8 14.0 25.6 11.6 9.3 5.4 55.8 24.8 24.8 11.6

66.1 58.8 26.1 41.8 10.3 76.4 74.5 72.1 19.4 15.8 10.9 12.1 4.8 58.8 37.0 25.5 10.3

75.3 69.8 28.0 39.6 28.6 87.4 85.2 78.0 14.3 14.8 7.7 14.8 3.8 69.2 41.8 22.0 9.3

65.0 60.2 43.9 48.8 56.9 79.7 79.7 87.0 35.8 10.6 4.1 20.3 6.5 68.3 39.0 26.0 11.4

64.8 60.5 30.0 45.9 19.6 78.8 75.8 71.8 19.8 19.1 9.5 13.6 5.6 57.4 33.4 23.6 12.0

Source: Profit Sharing/401(k) Council of America. a A self-directed window allows participants to invest in individual stocks or mutual funds.

Some pension professionals are concerned that sponsors may rely on the investment provider or record keeper to monitor the funds. For example, one fiduciary adviser noted that research by an industry group showed that the provider may conduct investment monitoring Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

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for as many as 38 percent of respondents. According to this fiduciary adviser, if a sponsor relies on the provider for fund monitoring and lacks an independent adviser, an objective analysis of the funds may not occur, which could result in a prohibited transaction under certain circumstances. According to our survey, the entity primarily responsible for monitoring the performance of the plan investments as compared to investment goals or policy was frequently the plan sponsor committee (214 of 443 respondents) or an external investment/financial adviser (107 respondents). Sponsors may also set investment goals and policies for the 401(k) plan. Before selecting funds for the menu, sponsors may set investment goals and policies that affect which particular categories of funds it can include in the menu. Many pension professionals noted that such planning by the sponsor should take into account the needs of its workforce, such as its age profile or level of knowledge about investments.28 This planning may be documented in a written investment policy statement (IPS), which 339 of 440 sponsors responding to our survey have. An IPS is a document that can guide future decisions by documenting the intended goals and performance of the plan, as well as the guidelines for selecting, monitoring, and altering investments.29 According to our survey, 208 of 339 respondents said the sponsor‘s committee was the primary decision maker for establishing a written IPS. Despite the advantages of an IPS, the policy statement may present difficulties for certain sponsors, such as greater risks of fiduciary breaches and potential liability if the sponsor does not follow it. Regardless of a plan‘s goals and policies, Labor‘s regulation on investment duties specifies factors for sponsors to consider for prudent investment decisions, including diversification, liquidity, return, and risk in relation to the overall portfolio.30 The asset size of the plan may affect the investment menu, as sponsors of larger plans generally have greater internal expertise and/or capacity for committees to aid in overseeing the plan, as well as more leverage to negotiate the menu and fees. Of 447 sponsors answering this question in our survey, 396 had one or more plan committees with typically three to seven members, while research by an industry group found 72 percent had committees. For plans with $200 million or more in assets, 60 of 90 sponsors reported that they have exactly one committee, and 29 reported having more than one committee. However, for some employers, particularly smaller businesses, the owner of the company acts as the fiduciary to decide about the plan investments and providers but may have less time, knowledge, and resources to make those decisions. In addition, larger plans typically have more leverage as they negotiate with providers about fund options and the fees to operate the plan. Several professionals stated that large and sometimes medium-sized sponsors have greater ability to prescribe the investment menu than small sponsors who are more likely to face restricted choices with requirements to include the investment provider‘s own funds. For example, one adviser noted that plans with over $100 million in assets can generally offer the funds they want in the menu. Plans with more assets are also better positioned to negotiate lower fees, given the competition among providers to manage sponsors‘ pension assets.31 Furthermore, advisers assisting sponsors may affect decisions about the investment menu. While ERISA allows the hiring of external advisers and other providers, they must be prudently selected and monitored for the quality of their services and conflicts of interest, among other things. Of 445 sponsors responding to this survey question, 308 said they use a third- party investment adviser. According to Labor‘s guidance, a plan fiduciary should hire and monitor external experts if the sponsor lacks the expertise internally. Several types of advisers are available to assist the sponsor, such as registered investment advisers,

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consultants, and insurance or securities brokers. However, advisers differ in a number of ways, including by the services they provide, the extent to which they are willing to serve as a fiduciary, how they are compensated, and whether they are affiliated with a larger company like an insurance company or a broker-dealer. As a result, some of these advisers may have incentives not to act solely in the interest of participants, which may shape the investment menu. In our survey, for 170 of 438 sponsors, a sponsor committee monitors plan investment decisions for such potential conflicts of interest, while an external investment/financial adviser does so for 94 of the sponsors. As with advisers, other service providers—such as the investment provider or the record keeper—may shape the menu of investments in different ways. For example, sponsors or providers can limit the menu largely or entirely to the provider‘s own proprietary funds, which tend to have greater profit margins or may not always perform as well as funds offered by other investment providers. Also, a number of pension professionals indicated that sponsors may defer to the provider about the menu, and thus about fund performance and fees.32 However, according to our survey, most sponsors said that the sponsor‘s committee was the primary decision maker for the investment goals, menu, and any investment policy statement, with relatively few saying the primary decision maker was the 401(k) provider.

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PLAN SPONSORS CAN FACE CHALLENGES IN FULFILLING THEIR FIDUCIARY OBLIGATIONS WHEN BUSINESS ARRANGEMENTS ARE UNCLEAR OR UNDISCLOSED Plan sponsors face challenges in fulfilling their obligations when fiduciary roles are not clearly defined or when sponsors lack important information about arrangements between service providers. Fiduciary roles that are not clearly defined between the sponsor and other plan fiduciaries can lead to gaps in plan oversight. Sponsors also have fiduciary obligations when they select and monitor one or multiple service providers. To fulfill these obligations, Labor‘s guidance indicates that sponsors should obtain information about service providers‘ compensation arrangements and potential conflicts of interest that could affect the service provider‘s performance. To improve fiduciary oversight in these areas, Labor has proposed a rule to require pension plan service contracts to disclose additional information, including the extent to which service providers will become fiduciaries for the functions they will perform.33 If finalized, compliance with this rule could eliminate some of the confusion surrounding the sharing of fiduciary duties between sponsors and their service providers and help sponsors provide better oversight of plan services.

A Sponsor’s Failure to Clearly Define Fiduciary Relationships Can Lead to Gaps in Oversight Plans may have one or multiple plan fiduciaries, but who is and who is not a fiduciary is not always apparent. ERISA requires that at least one fiduciary be named in the plan documents, although others may be identified voluntarily.34 Depending on how the delivery of plan services is structured, the sponsor may retain, share, or delegate certain fiduciary roles

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with the advisers or other providers it hires. For example, sponsors may use an officer or company manager, one or more internal committees, or an outside professional—sometimes called a third-party service provider—as a fiduciary to manage some or all of a plan‘s day-today operations. These services can include investment management, consulting and providing financial advice, record keeping, custodial or trustee services for plan assets, and telephone or Web-based customer services for participants. Providers may also assist sponsors to fulfill their fiduciary obligations by educating sponsors or helping them comply with ERISA requirements. For example, one provider we met has informational materials for its clients, including checklists about fiduciary obligations, sample documents, and newsletters on regulatory updates. While ERISA allows a plan sponsor to hire outside professionals to manage some or all of their plan‘s day-to-day operations, this does not relieve the sponsor of all fiduciary obligation. The hiring of any service provider is itself a fiduciary act, and under ERISA, a sponsor must act prudently when selecting one or multiple service providers and monitor their performance. To comply with ERISA, the plan sponsor must have sufficient information to make informed decisions about the services, costs and the qualifications of the service providers, and the quality of the services being provided. The sponsor must ensure that expenses paid out of plan assets, including fees paid to service providers, are and continue to be reasonable in light of the level and quality of services provided. The sponsor must also determine whether there are conflicts of interest related to service provider compensation. Conflicts of interest can occur, for example, when a service provider steers a plan sponsor toward offering investment options that benefit the service provider but may not be in the best interest of the plan participants.

Source: GAO analysis of information from industry practitioners. Figure 3. Differences in Fiduciary Role and Possible Fee and Service Arrangements Using an Investment Adviser versus a Broker

Rather than prescribing the specific actions that a sponsor needs to take when selecting and monitoring one or multiple service providers, ERISA requires that a prudent process be followed to ensure that the sponsor‘s fiduciary obligations are met. According to Labor, prudence requires expertise in a variety of areas, such as investments. Lacking that expertise, a fiduciary will want to hire someone with that professional knowledge to carry out the investment and other functions. Prudence focuses on the process for making fiduciary

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decisions. For instance, in hiring a plan service provider, a fiduciary may decide to survey a number of potential providers, asking for the same information and providing the same requirements. By so doing, a fiduciary can make a meaningful comparison and selection. According to Labor, however, many of the specific actions that sponsors may take to meet these duties can vary. Labor recommends that sponsors establish and follow a formal review process at reasonable intervals. Sponsors may assume that they have delegated all their fiduciary duties to an outside professional hired to run the plan, but the sponsor always retains some fiduciary obligation. While plan sponsors may hire various advisers and consultants to provide advice on the selection and monitoring of investment funds, fiduciary duties may be distributed differently depending on the service arrangement. For example, an investment adviser who recommends investment funds to a plan sponsor for a fee, may be a fiduciary under ERISA.35 In contrast, if the sponsor is selecting funds from a broker and the broker provides no investment advice, the fiduciary obligations may lie entirely with the sponsor under ERISA, as shown in figure 3. Sharing or delegating fiduciary duties among service providers can contribute to indistinct fiduciary roles if their respective roles are not well defined. Some sponsors may be more concerned with hiring a provider to perform a particular service than about determining whether or not the provider will be acting as a plan fiduciary. For example, several industry professionals noted situations when sponsors assumed they had delegated fiduciary investment advice for the selection and monitoring of investment funds to a service provider, but the service provider did not acknowledge that fiduciary role. Several pension practitioners observed that most sponsors, especially sponsors of small plans, have very little fiduciary knowledge. For example, one attorney with an employee benefits firm stated that while sponsors may know they are fiduciaries, without understanding the concept and extra duties of being responsible for plan assets, they primarily see their function as hiring service providers who they may view as the ―real‖ fiduciaries. A number of practitioners have stated that some service providers understand fiduciary roles better than plan sponsors do but may wish to avoid the liability associated with certain fiduciary duties, even though their actions may define them as fiduciaries under the law. This can lead some sponsors to assume that they have delegated certain fiduciary duties to a service provider, although the provider may not acknowledge any fiduciary role. When the service provider is not a fiduciary, it is not bound by the fiduciary duties to act prudently and solely in the plan‘s best interest. For example, according to several practitioners, Registered Investment Advisers (RIA) are generally fiduciaries, while some other advisers describe themselves as consultants in an attempt to avoid fiduciary responsibility. Because ERISA generally does not require that additional fiduciaries be named, determinations may not be made unless a lawsuit is filed claiming that the plan has been harmed. Misunderstanding can also occur because many large providers offer a range of services that a sponsor can choose from, including some that involve fiduciary duties and others that may not.

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Sponsors Cannot Fulfill Their Fiduciary Obligations without Disclosures about Compensation Arrangements and Potential Conflicts of Interest Labor‘s guidance indicates that to fulfill their fiduciary obligations sponsors should obtain certain information about service providers‘ compensation arrangements and potential conflicts of interest. However, some sponsors do not understand their service providers‘ revenue sharing arrangements or may be unaware of potential conflicts of interest. Research by one industry group found that about 60 percent of responding sponsors said that providers fully disclosed revenue sharing. According to pension practitioners, sponsors of large plans, helped by advisers or consultants, may have a better understanding of revenue sharing and are negotiating lower fees than in the past, but sponsors of medium-sized plans generally do not understand how undisclosed compensation flows between service providers behind the scenes, even if they understand mutual fund expense ratios. Significant differences in ways that advisers and other providers are compensated may have important implications for the sponsor‘s oversight, including identifying potential conflicts of interest. According to an RIA that we spoke with, if the adviser is an RIA hired by a plan sponsor on a fee-for-service basis, his allegiance may be different than an adviser who is a broker and receives a commission based on the value of the investment product that is selected. Furthermore, other experts noted that a sponsor may opt for what appears to be a ―free‖ 401(k) plan (with no record keeping fees for the employer) without understanding that the providers‘ compensation may be passed on to participants by embedding fees in the plan‘s investment options. ―Hidden‖ fees may also mask the existence of a conflict of interest. Hidden fees are usually related to business arrangements where one service provider to a 401(k) plan pays a third-party provider for services, such as record keeping, but does not disclose this compensation to the plan sponsor. Without disclosing these arrangements, service providers may be steering plan sponsors toward investment products or services that may not be in the best interest of participants. Research by one industry group showed that 36 percent of responding sponsors either did not know the fees being charged to participants or thought no fees were charged at all. An RIA told us that if a ―free‖ 401(k) plan has been selected by the sponsor, it is unlikely that the sponsor used an RIA to examine the underlying fee structure. In a situation like this, one practitioner said that it is more likely that the human resources department, rather than the finance department, selected the free plan option. In addition to failing to understand the fee structure, some less knowledgeable staff may act out of loyalty to their employer without fully understanding ERISA‘s fiduciary duty to act in the best interests of the plan. Consequently, they may select an arrangement that reduces the employer‘s fees at the expense of the higher embedded fees paid by participants, which may involve a fiduciary breach under certain circumstances.

Various Ways to Improve Fiduciary Oversight Have Been Proposed Labor officials and various industry practitioners have proposed new ways to improve fiduciary oversight. A regulation recently proposed by Labor could eliminate some of the confusion surrounding fiduciary obligations. In December 2007, Labor proposed a regulation that would require, among other things, a service provider of an employee benefit plan,

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including 401(k) plans, to state whether it will provide services to the plan as a fiduciary.36 Labor believes that plan fiduciaries, including sponsors and service providers, would benefit from regulatory guidance in this area. According to Labor, the increased complexity of administering services and benefits for these plans has made it more difficult for plan sponsors to understand compensation arrangements between service providers. The proposed regulation would amend the current regulations under ERISA to clarify the meaning of a reasonable contract or arrangement between sponsors (or other fiduciaries) and service providers to include the disclosure of information concerning all compensation to be received by the service providers and any conflicts of interest that may have adverse effects on the cost and quality of plan services. Among the information that would be required under the proposed provision on conflicts of interest, is a requirement to determine whether the entity will provide services to the plan as a fiduciary. If finalized, compliance with this rule could eliminate some of the confusion surrounding the sharing of fiduciary duties between sponsors and their service providers and help sponsors provide better oversight of plan services. Labor is in the process of analyzing the information from the public comments it received earlier this year and the hearings it held regarding this regulation. Labor officials anticipate issuing a final regulation by the end of this year. In addition, consulting organizations have suggested other measures to improve accountability for fulfilling fiduciary obligations, such as fiduciary training for plan sponsors and auditing plans for fiduciary compliance.

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LABOR MONITORS SPONSORS’ OPERATION OF 401(K) PLANS AND HAS MADE PROGRESS ON RECENT REGULATORY INITIATIVES Labor takes various actions to monitor sponsors‘ fiduciary oversight of 40 1(k) plans and has made some progress on its regulatory initiatives. Labor investigates reports of questionable 401(k) plan practices, collects information from plan sponsors, and conducts outreach to educate plan sponsors about their responsibilities. Labor is also pursuing several initiatives to improve disclosures provided to participants, plan sponsors and fiduciaries, government agencies and the public. Recently, Labor issued proposed regulations to clarify the information that service providers must disclose to plan sponsors.37 However, Labor is in the process of resolving several questions before it can issue a clear set of final regulations. In previous reports, we asked Congress to consider certain matters that, if addressed, could provide Labor with greater statutory authority over plan service providers and help ensure that sponsors are properly overseeing plan services.38

Labor Investigates Fiduciary Breaches and Conducts Outreach to Educate Plan Sponsors Labor uses a variety of methods to ensure that sponsors fulfill their fiduciary obligations. These include enforcement efforts, such as investigations of employee benefit plans, and outreach efforts to educate plan sponsors about their responsibilities.

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EBSA‘s regional offices seek to detect, correct, and deter violations, such as excessive fees and expenses, and failure by fiduciaries to monitor ongoing fee structure arrangements. EBSA opened 3,746 civil investigations and obtained nearly $1.3 billion monetary results in fiscal year 2007. Over $245 million of those monetary results were related to 40 1(k) investigations. These investigations cited violations, such as failure to act prudently, payment of excessive administrative expenses, and failure to monitor ongoing arrangements. We reported in 2007 that EBSA does not conduct routine compliance examinations, such as evaluations of a company‘s books, records, and internal controls. Instead, EBSA uses participant complaints and other agency referrals as sources of investigative leads and to detect potential violations. EBSA also identifies leads through informal targeting efforts by investigators, primarily using data reported by plan sponsors on their Form 5500 annual returns. During our 2007 review, EBSA officials raised concerns that conducting such examinations would divert resources from EBSA‘s current enforcement practices.39 When EBSA uncovers a fiduciary breach, it can take several actions against the fiduciary. These actions can result in a monetary result for the plan (such as restored plan assets), or an action taken by EBSA that results in the fiduciary or a service provider being enjoined or removed (these commonly include compelling the fiduciary to fulfill its obligations, enjoining the fiduciary from committing a further violation, compelling the fiduciary to make restitution for the violation, removing the fiduciary, and/or disallowing the fiduciary from ever serving in another fiduciary capacity, to name a few). Labor receives complaints regarding fiduciary breaches in several areas, such as fees or expenses charged for plan services. This can include the plan having paid unreasonable/excessive fees or settlor fees. situations where the employer has filed for or may file for bankruptcy. This includes alleged mismanagement and/or misuse of plan assets combined with the fact that the employer has filed bankruptcy. how long an employer may take to deposit participant contributions into the plan (including participant‘s loan repayments). This includes inquiries regarding possible fiduciary violations and missing or delinquent contributions. Contributions are delinquent when an employer fails to transmit employee contributions as soon as reasonably possible.40 investment of funds. This includes imprudent investments, those prohibited by the plan document or failure of the plan administrator to offer a diversified menu of investment options in a 401(k) plan. loans or sales to parties in interest and/or the use of plan assets for personal or company use. This includes prohibited transactions related to self-dealing (a fiduciary acting in its own interest); dual loyalties (representing adverse parties); or receipt of consideration from a third party, also known as kickbacks. EBSA also focuses some of its enforcement efforts on compensation arrangements between pension plan sponsors and service providers hired to assist in the investment of plan assets. EBSA‘s Consultant/Adviser Project (CAP), created in October 2006, is focused on identifying conflicts of interest and the receipt of indirect, undisclosed compensation by pension consultants and other investment advisers. Its investigations determine whether the

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receipt of such compensation violates ERISA because the adviser or consultant used its status with respect to a benefit plan to generate additional fees for itself or its affiliates.41 According to an EBSA official, the agency has not yet taken enforcement action against consultants or advisers or 401(k) plan fiduciaries. However, the official told us that by implementing this initiative, EBSA has demonstrated its concern about the receipt of indirect, undisclosed compensation by fiduciary consultants and advisers doing business with 401(k) plans. CAP also seeks to identify potential criminal violations, such as kickbacks or fraud.

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Table 2. Summary of Labor’s Disclosure Initiatives Disclosure by plan sponsors to participants Information In April 2007, Labor published a request for information (RFI) to solicit the views, suggathering 72 gestions, and comments from plan participants, plan sponsors, plan service providers, Fed. Reg. and members of the financial community, as well as the general public, on the extent to 20,457 which rules should be adopted or modified, or other actions taken, to ensure that participants and beneficiaries have the information they need to make informed decisions about the management of their individual accounts and the investment of their retirement savings. Labor officials have stated that they soon plan to publish a proposed regulation that will govern disclosure by plans to plan participants. Disclosures by service providers to plan sponsors Proposed On December 13, 2007, EBSA published a proposed rule to amend its current regulaterule 72 Fed. ons under section 408(b)(2) of ERISA to clarify the information fiduciaries must receReg. 70,988 ive and service providers must disclose for purposes of determining whether a contract or arrangement is ―reasonable,‖ as required by ERISA‘s statutory exemption for service arrangements.a The regulation would require service providers to disclose, in writing, to plan fiduciaries of 401(k) plans, all services to be furnished; all direct and indirect compensation to be received; and any potential conflict of interest, such as certain third-party relationships, that could affect their objectivity under a service contract or arrangement. The information provided must be sufficient for fiduciaries to make informed decisions about the services that will be provided, the costs of those services, and potential conflicts of interest. Labor believes that such disclosures are critical to ensuring that contracts and arrangements are ―reasonable‖ within the meaning of the statute. Disclosure by plan sponsors to Labor and the public Final rule 72 On November 16, 2007, EBSA published a final rule revising the annual reporting Fed. Reg. requirements of plans concerning service provider compensation. For the most part, the 64,710 reporting changes, including the requirement to file forms electronically, go into effect for plan years beginning on or after January 1, 2009. The new regulations expanded Schedule C of the Form 5500 so that, in addition to compensation paid directly by a plan to a service provider, it requires the reporting of ―indirect compensation‖ paid to those who directly or indirectly provide services to the plan. All persons receiving $5,000 or more of total compensation must be identified on Schedule C. In general, the Schedule requires additional information for any service provider who is a fiduciary or provides contract administrator, consulting, custodial, investment advisory, investment management, broker, or record keeping services. It is expected that existing regulatory disclosures may be used to meet these requirements, e.g., prospectus, SEC Form ADV, if they meet certain requirements. Labor‘s intent is to ensure that revenue sharing pay-ments and other forms of indirect compensation, such as float, are reported at least to the plan administrators if not to Labor.b Source: GAO analysis. a Labor‘s December 2007, notice of proposed rule making also proposed a class exemption that would provide relief from certain prohibited transaction restrictions of ERISA. The proposed class exemption would relieve the responsible plan fiduciary from any liability for a prohibited transaction that would result from entering into a contract or arrangement for the provision of services when the service provider failed to comply with the proposed regulation. b Float revenue is revenue earned from the short-term investment of plan assets.

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In addition to its enforcement efforts, EBSA works to educate and assist employers (particularly small employers), auditors and other service providers in understanding and complying with their obligations under the law and related regulations and procedures, including those related to 401(k) plans.42 EBSA also has a program called the Voluntary Fiduciary Correction Program (VFCP), which allows plan officials to disclose and correct certain violations without penalty. In fiscal year 2007, 1,303 401(k) VFCP applications were received by EBSA‘s regional offices, and over $20.7 million was restored to 401(k) plans as a result of this program. According to EBSA, virtually all transactions under the VFCP program are related to fiduciary issues.

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Labor Has Made Some Progress on Relevant Regulatory Initiatives but Legislation Could Also Promote Fiduciary Oversight Since our November 2006 report, EBSA has made progress on three regulatory initiatives to improve the transparency of fee and expense information to participants, plan sponsors and fiduciaries, government agencies and the public. It began these initiatives, in part, amid concerns that participants were not receiving information in a format useful to them when making investment decisions and that plan fiduciaries were having difficulty getting needed fee and compensation arrangement information from service providers to fully satisfy their fiduciary obligations. EBSA‘s regulatory initiatives to expand disclosure requirements cover three distinct areas, (1) disclosures by plan sponsors to participants to assist in making informed investment decisions; (2) disclosures by service providers to plan fiduciaries to assist in assessing the reasonableness of provider compensation and potential conflicts of interest; and (3) more efficient, expanded fee and compensation disclosures to the government and the public through a substantially revised, electronically filed Form 5500 Annual Report.43 At the time of our last review, EBSA had a proposed rule for its initiative on disclosures to the government and the public. Table 2 shows the progress EBSA has made since our November 2006 report.

Status of Initiative on Disclosure by Plan Sponsors to Participants Labor‘s request for information (RFI) requested comments on fee and expense disclosure issues affecting participants and beneficiaries of 401(k)-type plans governed by ERISA. Specifically, Labor sought information on what administrative and investment-related fee and expense information participants should consider when investing their retirement savings, the manner in which the information should be furnished to participants, and who should provide that information. The RFI cited our November 2006 report on fees as part of the impetus for issuing the RFI. However, while we did suggest that Congress consider amending ERISA to require all sponsors to disclose fee information to participants in a way that facilitates comparison among the options, our recommendation to the Secretary of Labor was to require

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plan sponsors to report a summary of all fees that are paid out of plan assets or by participants to Labor. Labor has not yet published a proposed regulation related to the RFI.

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Status of Initiative on Disclosures by Service Providers to Plan Sponsors According to Labor officials, they are in the process of resolving several questions before Labor can issue final regulations, such as the extent to which providers within a bundled arrangement—a package of plan services—would be bound by the disclosure requirements of the regulations. Labor held a hearing on March 31, 2008, to further develop the public record regarding the regulation and the class exemption and to assist the department in understanding the issues involved. Labor heard testimony from a variety of interested parties, including plan service providers, industry and participant associations, plan sponsors, and law firms. According to Labor officials, they are still reviewing the comments and testimony received. The Assistant Secretary for the Employee Benefits Security Administration told Congress that EBSA will work to ensure that the benefits of the proposed regulation—which may include lower fees, increased efficiencies, and some reduced costs—will outweigh the costs of compliance. According to the Assistant Secretary, plan fiduciaries could be provided an exemption if they enter into contracts that are not ―reasonable‖ because, unbeknownst to them, the service provider failed to comply with its disclosure obligations.44 Several members of Congress sent a letter to Labor expressing their displeasure over the proposed regulation. Among other things, the letter stated that Labor, rather than excusing failures with class exemptions for fiduciaries who fail to receive required disclosures, should update its guidance on fiduciary responsibility and provide model documents and explanations of key terms to pension plan officials. Several members of Congress have introduced bills that would require various additional disclosures related to individual account plans, including information from service providers.45 One bill, as introduced, would require service providers to disclose to the plan sponsor all fees that workers will pay, including such things as sales commissions, trading costs, and termination or surrender charges. The bill would require service providers to outline any financial or other conflicts of interest to plan sponsors. Some sponsors, however, have expressed concern about the introduction of fee disclosure legislation. For example, in our survey, sponsors expressed concern about the amount and manner in which information is disclosed to plan participants. Given the complexity of the information being provided, sponsors felt that disclosures should be simple and easy to understand. In our survey, sponsors also stated that fees should be disclosed in a transparent manner and should be readily identifiable by the plan sponsor and participants. In addition to concerns about fee disclosures, several sponsors suggested that disclosures would work best if standardized and that legislation may help providers be consistent in their data preparation and allow ―apples to apples‖ comparisons of fee information. While the Assistant Secretary of Labor for the Employee Benefits Security Administration has stated that a statutory amendment is not necessary for the department to complete its work, we continue to believe that a statutory change is necessary to ensure that these matters are fully addressed and that the matters that GAO has recently asked Congress

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to consider, if addressed, would help Labor in its efforts to improve sponsors‘ fiduciary oversight.46 For example, We previously asked that Congress consider amending ERISA to explicitly require 401(k) service providers to disclose to plan sponsors the compensation they receive from other service providers. This change would provide Labor with explicit statutory authority over plan service providers for this purpose and help sponsors properly oversee plan services. In addition, in our 2007 report on conflicts of interest in defined benefit plans, we found that undisclosed business arrangements or conflicts of interest may have resulted in financial harm to some plans.47 Given this risk, we asked that Congress consider amending ERISA to give Labor authority to recover plan losses against certain types of service providers even if they are not currently considered fiduciaries under ERISA. These findings may have similar implications for defined contribution plans, especially 401(k) plans.

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CONCLUDING OBSERVATIONS As the retirement security of American workers increasingly depends on 401(k) plans, it is important that plan sponsors fulfill their fiduciary responsibilities in connection with such plans. Sponsors make decisions about the investment features of a 401(k) plan that carry significant fiduciary implications. Some, particularly those with small plans, may have limited time, specialization, knowledge, and ability to negotiate about service providers or investment funds. Absent a greater understanding of how sharing plan functions with their service providers or delegating functions to them may lead to confusion about fiduciary roles, some sponsors are likely to remain vulnerable to advisers or other providers whose compensation and affiliation may promote interests besides those of the plan, such as higher plan fees. Since our 2006 report, Labor has made progress on its disclosure initiatives but some important fiduciary issues have yet to be fully addressed. In our previous reports, we asked Congress to consider amending ERISA to (1) explicitly require 401(k) service providers to disclose to plan sponsors the compensation they receive from other service providers and (2) give Labor authority to recover plan losses against certain types of service providers, even if they are not currently considered fiduciaries to that plan under ERISA. While Labor has proposed a regulatory change that could eliminate some of the confusion surrounding certain fiduciary obligations, it is unclear how closely the final regulation will follow the proposed rule. We continue to believe that changes to ERISA would help Labor in its efforts to promote sponsors‘ fiduciary oversight and be in the best interest of participants.

AGENCY COMMENTS AND OUR EVALUATION We provided a draft of this report to the Department of Labor (Labor). Labor provided technical comments, which we have incorporated where appropriate.

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As agreed with your staff, unless you publicly announce its contents earlier, we plan no further distribution of this report until 30 days after its issue date. At that time, we will send copies of this report to the Secretary of Labor, as well as to other interested parties. We will also make copies available to others upon request. In addition, the report will be available at no charge on the GAO Web site at http://www.gao.gov. If you or your staff have any questions concerning this report, please contact me at (202) 512-7215 or [email protected]. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made key contributions to this report are listed in appendix II. Sincerely yours,

Barbara D. Bovbjerg Director, Education, Workforce, and Income Security Issues

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APPENDIX I: SCOPE AND METHODOLOGY To determine common 401(k) plan features and which typically have important fiduciary implications as well as challenges sponsors face in fulfilling their fiduciary obligations, we collected and analyzed industry research and information from the Department of Labor (Labor), such as Bureau of Labor Statistics information, as well as previous GAO work. Although comprehensive data on 401(k) features is limited, industry research provides some indication of the prevalence of these features. The industry research that we reviewed has limitations, such as the lack of random sampling that prevents results generalizable to the universe of 401(k) plan sponsors. Thus, we used the following three sources of industry research that reached different audiences to corroborate one another, where possible. We also checked the reliability of the data by interviewing the surveyors about their methodology. Profit Sharing/401(k) Council of America‘s (PSCA) survey results are based on responses from 1,000 plan sponsors that have profit-sharing plans, 401(k) plans, or a combination of both and represent 1 to 5,000-plus employees. Thirty-nine of 1000 respondents had profit-sharing plans without a 401(k) component. The survey was mailed, faxed, or made available online to respondents and conducted from April to June 2007. The survey provides a snapshot as of the end of 2006. The survey response rate was 13 percent. PSCA is a national, nonprofit association of 1,200 companies and their 6 million plan participants. According to PSCA, it represents the interests of its members to federal policy makers and offers assistance with profit

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sharing and 401(k) plan design, administration, investment, compliance, and communication. Hewitt Associates‘ survey results are based on responses from 302 employers with mostly 1,000 employees or more. Twenty-nine percent represented Fortune 500 companies. The survey was conducted from March through June 2007. The survey was online, and paper copies of the questionnaire that included the survey Web site were also mailed out. Most respondents completed the survey online. The survey had a 6 percent response rate. Hewitt Associates is a human resources outsourcing and consulting firm. Deloitte Consulting received responses from 830 employers for its survey that was initially sent to over 3,000 contacts. The survey was sent by e-mail and made available online to a wide array of sponsors based on the contacts of Deloitte and partnering organizations, along with other interested sponsors who became aware of the survey. It is possible that contacts beyond the initial mailing completed the survey, so a response rate was not calculated. As with other industry surveys, Deloitte‘s survey covers a range of plan sizes but under-represents small plans, as measuredby number of participants. Deloitte is a professional services organization that provides pension consulting services. In addition to analysis of industry research, we conducted a Web-based survey to learn more about how sponsors select plan features and oversee plan operations. In conducting our design work, we determined that a representative survey of sponsors would not be feasible for this study, given the methodological and administrative challenges associated with (1) establishing a sampling frame using Labor‘s Form 5500 data, (2) identifying appropriate points of contact for sponsors from the universe of over 400,000 plans, and (3) the perceived sensitivity of the survey‘s content and the willingness of sponsors to provide candid responses about their fiduciary obligations. To overcome the methodological and administrative challenges, we administered our survey in coordination with Plansponsor Magazine (Plansponsor). The sponsors who responded to our survey were members of Plansponsor’s subscription list – which contains approximately 41,000 members who receive the organization‘s electronic newsletters and magazine. Plansponsor used two methods for soliciting survey responses from their subscription list. These methods included the distribution of notices in their daily newsletter and a more targeted electronic mailing sent to the sponsors who responded to Plansponsor’s 2007 Defined Contributions Survey. While there is some overlap between the sponsors that receive the daily newsletter and those who responded to Plansponsor‘s 2007 Defined Contributions Survey, Plansponsor estimates that the daily newsletter was distributed to approximately 41,000 subscribers. The targeted electronic mailing was sent to approximately 5,500 sponsors. Using Plansponsor’s distribution estimates, we estimate the number of 401(k) sponsors that received our survey notification to be approximately 22,000. We received 448 usable responses to our survey, representing 594 plans. Labor‘s Abstract of 2005 Form 5500 Annual Reports shows that there are over 400,000 plans in the United States. We do not have evidence to determine the extent to which our survey respondents are representative of the general sponsor population. Our respondent population excludes sponsors who do not belong to Plansponsor’s subscriber list. Therefore, the extent to which our survey results provide useful information about the general population depends on

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whether or not there are differences between the excluded sponsors and those belonging to Plansponsor’s subscriber list. For example, as members of Plansponsor’s subscriber list, our survey respondents are self-selected recipients of a publication that provides information to managers of pensions and 401(k) retirement plans. Because of their affiliation with Plansponsor, our survey respondents are likely to be more informed than the average sponsor, given that they are actively engaged in learning through the magazine. Although our survey respondents may be more informed than the average sponsor, Plansponsor affirms that their membership represents the overall sponsor demographic. To minimize the variability of survey results, we took steps in the development of the questionnaire, the data collection, and data analysis to minimize nonsampling errors. For example, prior to administering the survey, the questionnaire was reviewed by an independent survey expert in our methodology group, as well as an official from Plansponsor. In addition, we conducted six pretests by telephone to determine the extent to which (1) the survey questions were clear, (2) the terms used were precise, (3) respondents were able to provide the information we were seeking, and (4) the questions were unbiased. We identified sponsors for the pretest through a series of questions posted in a survey that Plansponsor administers weekly to its subscribers. Sponsors were selected for the pretest based upon the total number of participants and the total amount of assets in the plan. We made changes to the content and format of the questionnaire based on the feedback we received. The Web-based questionnaire was accessible through a secure GAO server. Sponsors completing the survey created usernames and passwords to access the survey. Plansponsor notified its subscribers of the survey‘s availability in its daily newsletter over a period of several weeks between March 2008 and May 2008. To solicit additional responses, Plansponsor sent a targeted electronic mailing to sponsors who responded to Plansponsor’s 2007 Defined Contribution Survey, within the same period. No follow-up discussions with survey respondents were conducted for this study. To further determine which features typically have important fiduciary implications and factors when making such decisions, as well as challenges sponsors face in fulfilling their fiduciary obligations when overseeing plan operations, we identified the relevant laws and regulations for 401(k) plans under ERISA. We interviewed and collected documentation from a variety of stakeholders, including plan sponsors, service providers, fiduciary advisers, industry and consumer associations, attorneys, and Labor. We also obtained their views on sponsors‘ awareness of fiduciary responsibilities and identified any challenges sponsors might face. We also collected and analyzed information on plan sponsor oversight from other sources, such as the reports and testimonies from ERISA Advisory Council working groups. To determine the actions that Labor takes to ensure that sponsors are fulfilling their fiduciary obligations and the progress Labor has made on its regulatory initiatives, we reviewed ERISA and Labor‘s regulations to clearly define Labor‘s authority to oversee the conduct of 401(k) plan sponsors in fulfilling their key fiduciary obligations. We reviewed Labor‘s enforcement strategies for overseeing plan sponsors (e.g., reviewing the types of complaints about fiduciary breaches). We reviewed the actions Labor has taken against plan sponsors and the reasons for such actions. We also reviewed the recent work of other GAO staff in order to provide an update on Labor‘s compliance assistance and outreach efforts; participated in certain fiduciary education seminars; and conducted follow-up interviews with agency officials about their current initiatives.

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We conducted our review from January 2007 through June 2008 in accordance with generally accepted government auditing standards.

End Notes

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1

Under ERISA, a fiduciary is anyone, such as a sponsor, trustee, investment adviser, or other service provider, to the extent they exercise any discretionary authority or control over plan management or any authority or control over the management or disposition of plan assets, render investment advice respecting plan money or property for a fee or other compensation, or have discretionary authority or responsibility for plan administration. 29 U.S.C. § 1002(21)(a). 2 GAO, Private Pensions: Changes Needed to Provide 401(k) Plan Participants and the Department of Labor Better Information on Fees, GAO-07-21 (Washington, D.C.: Nov. 16, 2006) and GAO, Defined Benefit Plans: Conflicts of Interest Involving High Risk or Terminated Plans Pose Enforcement Challenges, GAO-07-703 (Washington, D.C.: June 28, 2007). 3 Respondents to the survey as a whole exclude sponsors who are not part of Plansponsor’s subscription list and recipients of the survey who chose not to complete it. These other sponsors may differ from our respondents, such as their knowledge and practices about deciding plan features or monitoring operations. Thus, the results of our survey may not represent and cannot be generalized to the population of all 401(k) sponsors. 4 72 Fed. Reg. 70,988 (Dec. 13, 2007). 5 GAO-07-21. 6 GAO-07-703. 7 Beginning in 2006, plans were permitted to allow employees to designate some or all of their elective contributions to Roth 40 1(k) plans, which are not excluded from current income but allow for tax-free withdrawals after 5 years of participation and if certain other conditions related to age, death or disability have been met. Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16, § 617, 115 Stat. 38, 103-06 (codified at 26 U.S.C. § 402A). According to the industry research that we reviewed, 18 percent or fewer of sponsors of 401(k) plans also offered a Roth 401(k) opportunity. 8 29 U.S.C. § 1106. Prohibited transactions under ERISA included a sale, exchange, or lease between the plan and party-in-interest; lending money or other extension of credit between the plan and party-in-interest; and furnishing goods, services, or facilities between the plan and party-in-interest. Labor may grant, by regulation, exemptions to certain prohibited transactions. 9 26 U.S.C. § 4975(c) and (d)(2). The Internal Revenue Code imposes a significant tax on disqualified persons involved in such prohibited transactions unless they fit within this or various other exemptions. 26 U.S.C. § 4975(a), (b) and (d). 10 A person is deemed to be providing investment advice only if such person (1) provides advice as to the value of, or makes recommendations as to the advisability of investing in, purchasing or selling, securities or other property, and (2) has direct or indirect discretionary authority or control over the purchase or sell of securities or other property for the plan, or regularly provides advice as to the value of securities or other property, pursuant to a mutual agreement, arrangement, or understanding, that will serve as a primary basis for plan investment decisions and is based on the particular needs of the plan. 29 C.F.R. § 2510.3-21(c) (2007). 11 Benefits Advisors also provided assistance to 62,000 inquirers with questions about their pension plans. In fiscal year 2007, fiduciary related pension issues were discussed 5,980 times with participants and 1,612 times with employers and other plan officials. Topics discussed included administrative charges, bankruptcy, employee contributions, fund investments, abandoned plans, and prohibited transactions. 12 Labor has taken the position that there is a class of activities which relates to the formation, rather than the management, of plans. These activities, generally referred to as settlor functions, include decisions relating to the formation, design, and termination of plans and, with few exceptions, are generally not activities subject to Title I of ERISA. Expenses incurred in connection with settlor functions would not be reasonable expenses of a plan. 13 In two cases the plan fiduciaries selected the plan sponsor to provide administrative services to its employee benefit plans. As a result, the sponsor was reimbursed for more than direct and indirect expenses. In the third case, the plan fiduciaries used plan assets to settle a legal claim made by former plan participants who alleged the sponsor failed to make timely distributions of their accounts upon termination of employment. 14 Pub. L. No. 109-280, 120 Stat. 780. 15 Plan sponsors are often characterized as wearing two hats under ERISA: As the creator of a plan and the trust to fund it, they are referred to as settlors. As the entity responsible for the administration of a plan and management of its trust, depending on the function performed, they often fall within the definition of a fiduciary under ERISA. Only in the latter capacity are plan sponsors obligated to make decisions solely in the interest of plan participants and beneficiaries. Lockheed Corp. v. Spink, 517 U.S. 882, 890-91 (1996).

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16

The 50th Annual Survey of Profit Sharing and 401(k) Plans for 2006 by the Profit-Sharing/401(k) Council of America (PSCA), Trends and Experience in 401(k) Plans 2007 by Hewitt Associates, and the Annual 40 1(k) Benchmarking Survey 2005/2006 edition by Deloitte Consulting. 17 We drew on the following industry research: the 50th Annual Survey of Profit Sharing and 401(k) Plans for 2006 by the Profit-Sharing/401(k) Council of America (PSCA), Trends and Experience in 401(k) Plans 2007 by Hewitt Associates, and the Annual 401(k) Benchmarking Survey 2005/2006 edition by Deloitte Consulting. While a new Deloitte survey is to be issued soon, it was not available at the time of our review. Where possible, we compared their results for convergence. For more information, see appendix I. 18 See, for example, Keenan Dworak-Fisher, ―Employer Generosity in Employer-Matched 401(k) Plans, 2002-03,‖ Bureau of Labor Statistics Monthly Labor Review (Washington, D.C., July/August 2007). 19 The 50th Annual Survey of Profit Sharing and 401(k) Plans, Trends and Experience in 401(k) Plans 2007, and the Annual 401(k) Benchmarking Survey 2005/2006 edition. 20 Trends and Experience in 401(k) Plans 2007 and the Annual 401(k) Benchmarking Survey 2005/2006 edition. 21 The 50th Annual Survey of Profit Sharing and 401(k) Plans, Trends and Experience in 401(k) Plans 2007, and the Annual 401(k) Benchmarking Survey 2005/2006 edition. 22 Our respondents represent a nonrandom sample of sponsors from the subscription list of an industry publication. While 448 sponsors completed our survey, the number of sponsors answering particular questions varies. Survey responses represent the views of the 448 respondents to our survey and cannot be generalized to the population of 401(k) plan sponsors. See appendix I for more information about our survey methodology. 23 However, once sponsors make these settlor decisions, then the fiduciary obligations may apply when implementing these decisions. 24 Sponsors may include other features with fiduciary implications, such as providing employer stock as a fund option or offering investment advice to participants. These features have their own distinct considerations, such as the undiversified nature of employer stock or differences between education versus advice for plan participants. Industry research indicates that about half of responding 401(k) sponsors or less offered these features. Also, areas of plan operations other than investments, such as administration or communication with participants, may have fiduciary implications. For example, the sponsor must ensure the timely deposit of employee contributions to comply with ERISA and related Labor regulations. 25 The 50th Annual Survey of Profit Sharing and 401(k) Plans, Trends and Experience in 401(k) Plans 2007, and the Annual 401(k) Benchmarking Survey 2005/2006 edition. 26 72 Fed. Reg. 60,452 (Oct. 24, 2007). According to the regulation, lifecycle, or target-date, funds combine different funds and automatically rebalance asset allocations toward more conservative investments as the participant nears retirement. Balanced funds are pooled accounts for different risk levels. Managed accounts resemble lifecycle funds but differ by the potential funds composing the portfolio and how they are provided. Besides these three alternatives, the regulation included grandfathered and short-term principal preservation funds. 27 Our survey provides anecdotal information that represents the views of the 448 respondents and cannot be generalized to the population of 401(k) plan sponsors. See appendix I for more information about our survey methodology. 28 For example, some professionals noted that a workforce with limited knowledge of investments may not be well served by a complex plan with dozens of funds, including less diversified funds specializing in particular economic sectors or a self-directed brokerage allowing investment in individual mutual funds or stocks. 29 An investment policy statement (IPS) has fiduciary implications and can help demonstrate the execution of fiduciary obligations, including following a prudent process and offering diversified funds. Part of an ERISA fiduciary‘s duty is to follow plan documents, including any IPS. 29 U.S.C. § 1104(a)(1)(D). Labor‘s regulation on this issue states that a written statement of investment policy is consistent with ERISA‘s provisions to have a funding policy but does not say that one is required. 29 C.F.R. § 2509.94-2 (2007). 30 29 C.F.R. § 2550.404a-1 (2007). 31 In light of the fiduciary obligation to act for the sole benefit of participants and to pay only reasonable fees, plans over a certain size may pursue nonretail investment vehicles, including separate accounts or collective trusts, which typically have lower fees than retail investment vehicles. However, some professionals noted that these vehicles with lower fees may not have listings in financial news for participants or obvious benchmarks for sponsors to monitor fund performance. 32 For example, investment providers or record keepers may try to steer sponsors to funds which result in higher hidden fees for themselves or other providers, while sponsors have a fiduciary obligation to pay only reasonable plan expenses. 33 72 Fed. Reg. 70,988 (Dec. 13, 2007). 34 29 U.S.C. § 1102(a). 35 A person is deemed to be providing investment advice only if such person (1) provides advice as to the value of, or makes recommendations as to the advisability of investing in, purchasing or selling, securities or other property, and (2) has direct or indirect discretionary authority or control over the purchase or sell of securities or other property for the plan, or regularly provides advice as to the value of securities or other property,

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pursuant to a mutual agreement, arrangement, or understanding, that will serve as a primary basis for plan investment decisions and is based on the particular needs of the plan. 29 C.F.R. § 2510.3-21(c) (2007). 36 On December 13, 2007, Labor published a notice of proposed rulemaking to amend its regulations under section 408(b)(2) of ERISA, 29 C.F.R. § 2550.408b-2, relating to the provision of services to employee benefit plans. 72 Fed. Reg. 70,988. 37 72 Fed. Reg. 70,988 (Dec. 13, 2007). 38 GAO-07-21 and GAO-07-703. 39 GAO, Employee Benefits Security Administration: Enforcement Improvements Made but Additional Actions Could Further Enhance Pension Plan Oversight, GAO-07-22 (Washington, D.C.: Jan. 18, 2007). 40 In no event is ―as soon as reasonably possible‖ later than the 15 th business day of the month following the month in which the participant contribution amounts are received by the employer (in the case of amounts that a participant or beneficiary pays to an employer) or the 15th business day of the month following the month in which such amounts would have been payable to the participant in cash (in the case of amounts withheld by an employer from a participant‘s wages). 29 C.F.R. § 2510.3-102(b). 41 A related objective is to determine whether plan sponsors and fiduciaries understand the compensation and fee arrangements they enter into in order to prudently select, retain, and monitor pension consultants and investment advisers. 42 One example of EBSA‘s efforts is its Fiduciary Education Campaign. Since the campaign was launched in May 2004, EBSA has conducted 24 seminars attended by 2,720 plan sponsors and practitioners. EBSA also provides a number of tools— such as its interactive ERISA Fiduciary Advisor on EBSA‘s Web site—as well as tips for employers on selecting and monitoring plan service providers. The ERISA Fiduciary Advisor was launched on October 9, 2007. From the launch date until April 30, 2008, the site was visited by 16,723 unique visitors. 43 The Form 5500 includes information on the plan‘s sponsor and the number of participants, among other things. The form also provides more specific information, such as plan assets, liabilities, insurance, and financial transactions. Filing this form satisfies the requirement for the plan administrator to file annual reports concerning, among other things, the financial condition and operation of plans. Labor uses this form as a tool to monitor and enforce plan sponsors‘ responsibilities under ERISA. 44 Statement of Bradford P. Campbell, Assistant Secretary of Labor, Before the Committee on Education and Labor, U.S. House of Representatives, Oct. 4, 2007. Statement of Bradford P. Campbell, Assistant Secretary of Labor, Before the Special Committee on Aging, U.S. Senate, Oct. 24, 2007. 45 H.R. 3185, the 401(k) Fair Disclosure for Retirement Security Act of 2007, was introduced in Congress on July 26, 2007; H.R. 3765, the Defined Contribution Plan Fee Transparency Act of 2007, was introduced on October 4, 2007; and S. 2473, the Defined Contribution Fee Disclosure Act of 2007, was introduced on December 13, 2007. 46 Statement of Bradford P. Campbell, Assistant Secretary of Labor, Before the Committee on Education and Labor, U.S. House of Representatives, Oct. 4, 2007. 47 GAO-07-703.

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Chapter 3

RETIREMENT SECURITY HEARING-ORSZAG TESTIMONY Congressional Budget Office Chairman Miller, Ranking Member McKeon, thank you for inviting me to testify this afternoon about the effects of the crisis in financial markets on pensions and retirement security.

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TURMOIL IN FINANCIAL MARKETS Financial markets have experienced substantial stress for over a year. The turmoil emanated from the bursting of the housing bubble, which led to substantial losses on mortgage loans and mortgage-related securities. In part because the mortgage-related securities are complex and in part because future rates of defaults on the individual mortgages underlying those securities are hard to predict, financial markets have had difficulty gauging the magnitude of the losses on the securities. That opacity, in turn, has made it difficult to evaluate the financial condition of the institutions holding them. Those problems have contributed to a broader collapse in confidence, leading to a general pullback from all types of risky lending. Financial institutions have become increasingly unwilling to lend to one another, creating stress in the interbank market for short-term loans that became particularly severe over the past several weeks. The issuance of corporate debt plummeted in the third quarter, and the commercial paper market has also been hit hard. Bank lending, which has thus far remained relatively strong, will likely be severely curtailed by the difficulties that banks are facing in raising capital. The general collapse in confidence is reflected in significant increases in risk spreads (or the difference between the interest rates charged on risky assets and those on Treasury securities). For example, the spread between the interest rate on corporate bonds with the lowest risk (AAA-rated bonds) and the interest rate on Treasury securities has risen by more than a percentage point since the middle of last year.

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In sum, recent developments in financial markets represent a severe credit crunch, which could have devastating effects on the U.S. and world economies. In response, the Congress recently enacted a financial rescue package that, among other things, creates the Troubled Assets Relief Program (TARP), under which the Secretary of the Treasury is authorized to purchase, insure, hold, and sell a wide variety of financial instruments. The Congressional Budget Office (CBO) analyzed many aspects of that program in recent testimony before the House Budget Committee.1 The turmoil in financial markets has affected many aspects of the economy, including pensions. The most direct effect on pensions is through the prices of financial assets such as corporate equities and bonds. The Standard & Poor‘s 500 stock market index, for example, has fallen by more than 25 percent over the past year as the outlook for the economy and corporate profits has worsened. Because the majority of pension assets are held in equities, drops in stock prices have had a significant adverse effect on pension plans.2 Data from the Federal Reserve suggest that the decline in the value of financial assets cost pension funds (private-sector and public-sector combined) roughly $1 trillion—almost 10 percent of their assets— from the second quarter of 2007 to the second quarter of 2008 (the latest period for which data are available), and there has been a significant further drop in asset prices since then.

PRIVATE-SECTOR PENSION PLANS

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The two principal types of pension plans are defined-benefit plans and definedcontribution plans. Over the past several decades, the private-sector pension system has shifted dramatically toward defined-contribution plans, such as 401(k) plans.

Defined-Benefit Pension Plans In a defined-benefit pension plan, benefits are specified by a fixed formula unrelated to the value of the pension fund. The sponsor of the plan is generally responsible for financing the benefits and must therefore make larger contributions when the value of the assets held by the pension fund declines. By CBO‘s estimates, the value of the assets held by defined-benefit plans has declined by roughly 15 percent over the past year. Because of the way the obligations of the plans are calculated, their funding position (that is, the relationship between their assets and liabilities) is also affected by the level of interest rates. Because payments will extend far in the future, the amount of funding today necessary to make those payments is adjusted for the time value of money by ―discounting‖ them using certain interest rates. Those rates have increased over the past year, lowering the discounted value of plans‘ liabilities by roughly 5 percent to 10 percent and partially offsetting the drop in asset values.3 Overall, according to CBO‘s estimates, defined-benefit plans‘ assets net of liabilities may have decreased by 5 percent to 10 percent over the past year. Those developments have probably left private-sector defined-benefit pension plans‘ obligations exceeding their assets by a greater amount than last year. That circumstance could force employers to raise contributions to help trim the shortfall, reducing the cash that they

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have available for investment, hiring, or distribution to shareholders. However, such funding requirements are sensitive to future asset prices, which are highly uncertain given the turmoil in financial markets.

Defined-Contribution Pension Plans Changes in asset prices have also affected the value of assets in defined-contribution pension plans. In those plans, the resources available to workers upon retirement depend directly on the value of assets in their plan account. Defined-contribution plans apparently are more heavily weighted toward stocks than defined-benefit plans are; over two-thirds of the assets in defined-contribution plans are invested in equities (either directly or through mutual funds). Because of that heavy emphasis on equities, the value of assets in definedcontribution plans may have declined by slightly more than that of assets in defined-benefit plans. To the extent households view balances in defined-contribution plans as part of their overall portfolio of wealth, a decline in those balances could lead people to reduce or delay purchases of goods and services. As described below, it could also lead some workers to delay their retirement.

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STATE AND LOCAL PENSION PLANS Public pension plans have also been affected by market developments. According to data from the Federal Reserve, for example, the assets held by state and local governments‘ pension plans declined by more than $300 billion between the second quarter of 2007 and the second quarter of 2008.4 The composition of public-sector funds mimics that of corporate pension funds. Overall, about 60 percent of the assets in public pension funds are invested in equities, 30 percent in domestic fixed-income securities, 5 percent in real estate, and the remaining 5 percent in alternatives.5 Even before the current downturn, concerns had been raised about the funding levels of some public-sector pension plans. According to the most recent survey of public pension funds by the National Association of State Retirement Administrators, plans accounting for about 85 percent of the assets had funded ratios of 86 percent, on average.6 (Funded ratios measure the degree to which assets and future contributions match current and future liabilities.) Some analysts have expressed concerns that reported funded ratios may be inflated because some public pension plans use relatively high discount rates when computing their future liabilities. The 20 largest public pension plans, which account for about half of all assets in such plans, have funded ratios of about 90 percent on average, but some smaller plans have funded ratios below 60 percent. Smaller plans, particularly those with lower funded ratios, may have a more difficult time weathering the decline in asset values. Funded ratios have been steadily declining in recent years. In 2000, about 90 percent of public pension plans had funded ratios greater than 80 percent.7 By 2006, that share had decreased to about 40 percent (though, again, a much larger share of large plans have funded ratios above 80 percent). Lower returns caused by a declining market and the economic

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slowdown, which will translate into lower corporate and personal income tax revenues, will exacerbate the downward trend in funded ratios. Many public pension plans use actuarial methods that will mute the effects of recent changes in asset values on funded status. One of those methods is ―smoothing,‖ or valuing current assets on the basis of averages over recent years, rather than on current market values. That method generally causes the reported valuations to lag behind the market; in the current environment, it can cause reported valuations to be higher than current market values. Although the laws governing state and local pension plans vary, significant drops in funded ratios could trigger requirements for higher contributions to the plans from state and local coffers or from public-sector employees at a time when tax collections are also waning.

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HOUSEHOLDS’ ASSETS AND RETIREMENT BEHAVIOR Asset prices affect households not only through pension plans but also through their other holdings. Although most households have few assets outside retirement plans, those assets are still substantial in the aggregate. In 2006, income from assets outside retirement plans provided almost as much income for households with elderly members as pensions did: Pensions provided 18 percent of the aggregate income for the population age 65 and older, and asset income accounted for 15 percent.8 Social Security provided 37 percent, on average; and earnings, 28 percent. The shares of income coming from pensions and asset income vary widely across the income distribution, however (see Figure 1). Among households with elderly members, those in the lowest income quintile obtained only 4 percent of their aggregate income from pensions and just 3 percent from asset income. At the other end of the distribution, households in the highest quintile received 18 percent of their income from pensions and 21 percent from asset income.

Source: Congressional Budget Office based on data from the Federal Interagency Forum on AgingRelated Statistics, Older Americans 2008: Key Indicators of Well-Being. Figure 1. Sources of Income for People Age 65 and Older, by Income Quintile, 2006

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Some people on the verge of retirement might respond to a decline in financial markets by working longer. In 2006, 36 percent of people age 65 and older were in families with earnings; that share could rise somewhat over the next few years, both because of underlying trends in the labor market and because of the recent turmoil in financial markets. Older workers‘ participation in the labor force decreased during the 1970s and early 1980s but has increased since then (see Figure 2). The labor force participation rate of workers 55 to 64 years old, for example, fell from about 62 percent in 1970 to 54 percent in 1986 and then rose steadily, to nearly 64 percent in 2007.9 The rate for workers age 65 and older followed a similar pattern and is at nearly the same level today as it was in 1970. Moreover, the fraction of people age 55 and older who work full time grew from about 22 percent in 1990 to nearly 30 percent in 2007 (see Figure 3). Studies that have examined the impact of the stock market boom of the 1990s and the subsequent decline of the early 2000s on retirement decisions show mixed results. One paper, for example, found no evidence of an increase in the retirement age among people in households owning stocks after the stock market decline of 2000.10 Another paper, however, showed that survey respondents who held corporate equity immediately prior to the bull market of the 1990s retired, on average, 7 months earlier than other respondents.11

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MITIGATING FINANCIAL MARKET RISKS Although severe stresses in financial markets almost inevitably cause wrenching adjustments by workers and employers, the risks can be attenuated by sensibly designing pension plans. For example, although workers enrolled in defined-contribution plans may not be able to avoid bearing the risks associated with broad price changes in financial markets, they can avoid unnecessary risks associated with a lack of diversification. Such unnecessary risks can arise, for example, by overweighting portfolios with individual stocks rather than diversified index funds.

Source: Congressional Budget Office based on data from the Bureau of Labor Statistics. Figure 2. Percentage of Older People Participating in the Labor Force, 1970 to 2007 Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

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Source: Congressional Budget Office based on data from the Bureau of Labor Statistics.

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Figure 3. Percentage of People Age 55 and Older Working Full- or Part-Time, 1990 to 2007

In recent years, many firms have adopted automatic enrollment in defined-contribution pension plans.12 Such automatic enrollment dramatically increases participation rates, especially for subgroups such as workers with low income, for whom participation is otherwise very low. Perhaps of more relevance to a discussion of financial market risks, however, the Pension Protection Act of 2006 requires that the allocation of assets by automatic-enrollment pension plans meet certain criteria that protect against excessive risk for participants. As a result, pension assets for automatically enrolled workers tend to be weighted toward more-diversified portfolios. Such protections against nondiversified investment portfolios can help avoid excessive exposure to financial market risks. By design, however, workers in defined-contribution plans must inevitably bear the risks associated with broad market fluctuations.

End Notes 1

Statement of Peter R. Orszag, Director, Congressional Budget Office, before the House Committee on the Budget, Federal Responses to Market Turmoil (September 24, 2008). 2 One important question is whether the current value of stocks represents a temporary dip or a permanent adjustment to a new, lower value. Economists have not resolved empirically the question of whether stocks depart only temporarily from some relatively stable average. However, some evidence suggests that stock prices tend to revert to a more stable long-run value after particularly sharp declines. See, for example, James M. Poterba and Lawrence Summers, ―Mean Reversion in Stock Prices,‖ Journal of Financial Economics, vol. 22, no. 1 (1988), pp. 27–59; Eugene Fama and Kenneth French, ―Permanent and Temporary Components of Stock Prices,‖ Journal of Political Economy, vol. 96, no. 2 (1988), pp. 246–273; and Jeremy J. Siegel, Stocks for the Long Run (New York: McGraw Hill, 2007). 3 That calculation is based on the yields on corporate debt rated A or higher, which have increased over the year, according to several indexes. 4 Federal Reserve, Flow of Funds Accounts of the United States, Table L. 119, ―State and Local Government Employee Retirement Funds,‖ September 18, 2008, available at www.federalreserve.gov/ releases/Z1/Current/z1r-4.pdf. 5 Alternatives include private equity, hedge funds, currency, commodities, and cash. 6 See Public Fund Survey, ―Actuarial Funding Levels,‖ (2007), available at www.publicfundsurvey. org/publicfundsurvey/index.htm .

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Statement of Barbara D. Bovbjerg, Director, Education, Workforce, and Income Security, Government Accountability Office, before the Joint Economic Committee, published as Government Accountability Office, State and Local Government Pension Plans: Current Structure and Funded Status, GAO-08-983T (July 10, 2008). 8 Federal Interagency Forum on Aging-Related Statistics, Older Americans 2008: Key Indicators of Well-Being, available at agingstats.gov/agingstatsdotnet/Main_Site/Data/Data_2008.aspx . 9 Based on data from the Current Population Survey compiled by the Department of Commerce‘s Bureau of Labor Statistics, available at www.bls.gov/data/#employment . 10 Courtney C. Coile and Phillip B. Levine, ―Bulls, Bears, and Retirement Behavior,‖ Industrial and Labor Relations Review, vol. 59, no. 3 (April 2006), pp. 408–429, available at digitalcommons. ilr.cornell.edu/cgi/viewcontent.cgi?article=1218&context=ilrreview. 11 Julia Lynn Coronado and Maria G. Perozek, ―Wealth Effects and the Consumption of Leisure: Retirement Decisions During the Stock Market Boom of the 1990s,‖ FEDS Working Paper No. 2003-20 (Federal Reserve Board, May 2003), available at ssrn.com/abstract=419721 . 12 See, for example, William E. Nesmith, Stephen P. Utkus, and Jean A. Young, ―Measuring the Effectiveness of Automatic Enrollment,‖ Vanguard Center for Retirement Research, vol. 31 (2007).

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Chapter 4

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - AMERICAN BENEFITS COUNCIL WHITE PAPER

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American Benefits Council Employer-sponsored 401(k) and other defined contribution retirement plans are a core element of our nation‘s retirement system and successfully assist tens of millions of families in accumulating retirement savings. While individuals have understandable retirement income concerns resulting from the recent market and economic downturns – concerns fully shared by the American Benefits Council – it is critical to acknowledge the vital role defined contribution plans play in creating personal financial security. Congress has adopted rules that facilitate employer sponsorship of these plans, encourage employee participation, promote prudent investing, allow operation at reasonable cost, and safeguard participant interests through strict fiduciary obligations. As a result 401(k) plans are valued by workers who participate in them as important resources for delivering retirement benefits. Nevertheless, improvements to the system can certainly be made. Helping workers to manage market risk and to translate their defined contribution plan savings into retirement income are areas that would benefit from additional policy deliberations. An additional area in which reform would be particularly constructive is increasing the number of Americans who have access to a defined contribution or other workplace retirement plan. The goal should be a 401(k) system that functions in a transparent manner and provides meaningful benefits at a fair price. At the same time, we all must bear in mind that unnecessary burdens and cost imposed on these plans will slow their growth and reduce participants‘ benefits, thus undermining the very purpose of the plans. It is important to understand the facts relating to these plans. The Council believes the following principles are critical in evaluating any reform measures in this area: Defined Contribution Plans Reach Tens of Millions of Workers and Provide an Important Source of Retirement Savings. There are now more than 630,000 private-sector defined contribution plans covering more than 75 million active and Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

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American Benefits Council retired workers, with another 10 million employees covered by tax-exempt and governmental defined contribution plans. Employers Make Significant Contributions Into Defined Contribution Plans. Many employers make matching, non-elective, and profit-sharing contributions to complement employee deferrals and share the responsibility for financing retirement. Recent surveys of defined contribution plan sponsors found that at least 95% make some form of employer contribution. Employer Sponsorship Offers Advantages to Employees. Employer sponsors of defined contribution plans must adhere to strict fiduciary obligations established by Congress to protect the interests of plan participants. Employers exercise oversight through selection of plan investment options, educational materials and workshops about saving and investing and professional investment advice. Defined Contribution Plan Coverage and Participation Rates Are Increasing. The number of employees participating in these plans grew from 11.5 million in 1975 to more than 75 million in 2005, and 65% of full-time employees in private industry had access to a defined contribution plan in 2008.

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Defined Contribution Plan Rules Promote Benefit Fairness. Congress has established detailed rules to ensure that benefits in defined contribution plans are delivered across all income groups. Extensive coverage, nondiscrimination and topheavy rules promote fairness regarding which employees are covered by a defined contribution plan and the contributions made to these plans. 401(k) Plans Have Evolved in Ways That Benefit Workers. Both Congress and private innovation have enhanced 401(k) plans, aiding their evolution from barebones savings plans into retirement plans. Among these enhancements have been incentives for plan creation, catch-up contributions for older workers, accelerated vesting schedules, tax credits, automatic contribution escalation, single-fund investment solutions and investment education programs. Recent Enhancements to the Defined Contribution System Are Working. The Pension Protection Act of 2006 (PPA) encourages automatic enrollment and automatic contribution escalation. PPA also provided new rights to diversify contributions made in company stock, accelerating existing trends toward greater diversification of 401(k) assets. Defined Contribution Plan Savings is an Important Source of Investment Capital. With more than $4 trillion in combined assets as of March 2008, these plans represent ownership of a significant share of the total pool of stocks and bonds, provide an important and ready source of American investment capital.

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Defined Contribution Plans Should Not Be Judged on Short-Term Market Conditions. Workers and retirees are naturally concerned about the impact of the recent market turmoil. It is important, however, for policymakers and participants to judge defined contribution plans based on whether they serve workers‘ retirement interests over the long term. Inquiries About Risk Are Appropriate But No Retirement Plan Design is Immune from Risk. The recent market downturn has spawned questions about whether defined contribution plan participants may be subject to undue investment risk. Yet it is difficult to imagine any retirement plan design that does not have some kinds of risk. Any efforts to mitigate risk should focus on refinements to the existing successful employer-sponsored retirement plan system and shoring up the Social Security safety net. The Council has prepared the attached white paper to more fully develop these principles. We encourage a full and vigorous debate over ways to improve retirement security for American workers. At the same time, it is critical that the debate not serve to undermine retirement security by inadvertently increasing the costs to participants or discouraging plan sponsorship. Defined Contribution Plans: A Successful Cornerstone of Our Nation’s Retirement System

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INTRODUCTION Employer-sponsored 401(k) and other defined contribution retirement plans are a core element of our nation‘s retirement system, playing a critical role along with Social Security, personal savings and employer-sponsored defined benefit plans. Defined contribution plans successfully assist tens of millions of American families in accumulating retirement savings. Congress has adopted rules for defined contribution plans that: facilitate employer sponsorship of plans, encourage employee participation, promote prudent investing by plan participants, allow operation of plans at reasonable cost, and safeguard plan assets and participant interests through strict fiduciary obligations and intensive regulatory oversight. While individuals have understandable retirement income concerns resulting from the recent market and economic downturns — concerns fully shared by the American Benefits Council — it is critical to acknowledge the vital role defined contribution plans play in building personal financial security.

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American Benefits Council

Defined Contribution Plans Reach Tens of Millions of Workers and Provide an Important Source of Retirement Savings

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Over the past three decades, 401(k) and other defined contribution plans have increased dramatically in number, asset value, and employee participation. As of June 30, 2008, defined contribution plans (including 401(k), 403(b) and 457 plans) held $4.3 trillion in assets, and assets in individual retirement accounts (a significant share of which is attributable to amounts rolled over from employer-sponsored retirement plans, including defined contribution plans) stood at $4.5 trillion.1 Of course, assets have declined significantly since then due to the downturn in the financial markets. Assets in 401(k) plans are projected to have declined from $2.9 trillion on June 30, 2008 to $2.4 trillion on December 31, 2008,2 and the average 401(k) account balance is down 27% in 2008 relative to 2007.3 Nonetheless, 401(k) account balances are up 140% when compared to levels as of January 1, 2000.4 Thus, even in the face of the recent downturn (which of course has also affected workers‘ non-retirement investments and home values), employees have seen a net increase in workplace retirement savings. This has been facilitated by our robust and expanding defined contribution plan system. As discussed more fully below, employees have also remained committed to this system despite the current market conditions, with the vast majority continuing to contribute to their plans. In terms of the growth in plans and participating employees, the most recent statistics reveal that there are more than 630,000 defined contribution plans covering more than 75 million active and retired workers with more than 55 million current workers now participating in these plans.5 Together with Social Security, defined contribution plan accumulations can enable retirees to replace a significant percentage of pre-retirement income (and many workers, of course, will also have income from defined benefit plans).6

Employers Make Significant Contributions Into Defined Contribution Plans When discussing defined contribution plans, the focus is often solely on employee deferrals into 401(k) plans. However, contributions consist of more than employee deferrals. Employers make matching, non-elective, and profit-sharing contributions to defined contribution plans to complement employee deferrals and share with employees the responsibility for funding retirement. Indeed, a recent survey of 401(k) plan sponsors with more than 1,000 employees found that 98% make some form of employer contribution.7 Another recent study of employers of all sizes indicated that 62% of defined contribution sponsors made matching contributions, 28% made both matching and profit-sharing contributions, and 5% made profit-sharing contributions only.8 While certain employers have reduced or suspended matching contributions as a result of current economic conditions, the vast majority have not.9 Those that have are often doing so as a direct result of substantially increased required contributions to their defined benefit plans or institution of a series of costcutting measures to preserve jobs. As intended, matching contributions play a strong role in encouraging employee participation in defined contribution plans.10

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The Defined Contribution System is More Than 401(k) Plans The defined contribution system also includes many individuals beyond those who participate in the 401(k) and other defined contribution plans offered by private-sector employers. More than 7 million employees of tax-exempt and educational institutions participate in 403(b) arrangements,11 which held more than $700 billion in assets as of earlier this year.12 Millions of employees of state and local governments participate in 457 plans, which held more than $160 billion in assets as of earlier this year.13 Finally, 3.9 million individuals participate in the federal government‘s defined contribution plan (the Thrift Savings Plan), which held $226 billion in assets as of June 30, 2008.14

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401(k) Plans Have Evolved in Ways That Benefit Workers Even when focusing on 401(k) plans, it is important to keep in mind that these plans have evolved significantly from the bare-bones employee savings plans that came into being in the early 1980s. As discussed more fully below, employers have enhanced these arrangements in numerous ways, aiding their evolution into robust retirement plans. Congress has likewise enacted numerous enhancements to 401(k) plans, making major improvements to the 401(k) system in the Small Business Job Protection Act of 1996, the Taxpayer Relief Act of 1997, the Economic Growth and Tax Relief Reconciliation Act of 2001, and the Pension Protection Act of 2006. Among the many positive results have been incentives for plan creation, promotion of automatic enrollment, catch-up contributions for workers 50 and older, safe harbor 401(k) designs, accelerated vesting schedules, greater benefit portability, tax credits for retirement savings, and enhanced rights to diversify company stock contributions. There also has been tremendous innovation in the 401(k) marketplace, with employer plan sponsors and plan service providers independently developing and adopting many features that have assisted employees. For example, both automatic enrollment and automatic contribution escalation were first developed in the private sector. Intense competition among service providers has helped spur this innovation and has driven down costs. Among the market innovations that have greatly enhanced defined contribution plans for participants are: on-line and telephonic access to participant accounts and plan services, extensive financial planning, investment education and investment advice offerings, single-fund investment solutions such as retirement target date funds and risk-based lifestyle funds, and in-plan annuity options and guaranteed withdrawal features that allow workers to replicate attributes of defined benefit plans. These legislative changes and market innovations have resulted in more employers wanting to sponsor 401(k) plans and have — together with employer enhancements to plan design — improved both employee participation rates and employee outcomes.

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Long-Term Retirement Plans Should Not Be Judged on Short-Term Market Conditions Workers and retirees are naturally concerned about the impact of the recent market turmoil. It is important, however, for policymakers and participants to evaluate defined contribution plans based on whether they serve workers‘ retirement interests over the long term rather than over a period of months. Defined contribution plans and the investments they offer employees are designed to weather changes in economic conditions — even conditions as anxiety-provoking as the ones we are experiencing today. (Market declines and volatility are, of course, affecting all types of retirement plans and investment vehicles, not just defined contribution plans.) Although it is difficult to predict short-run market returns, over the long run stock market returns are linked to the growth of the economy and this upward trend will aid 401(k) investors. Indeed, one of the benefits for employees of participating in a defined contribution plan through regular payroll deduction is that those who select equity vehicles purchase these investments at varying prices as markets rise and fall, achieving effective dollar cost averaging. If historical trends continue, defined contribution plan participants who remain in the system can expect their plan account balances to rebound and grow significantly over time.15 That being said, the American Benefits Council favors development of policy ideas (and market innovations) to help those defined contribution plan participants nearing retirement improve their retirement security and generate adequate retirement income. It is important to note that in the face of the current economic crisis and market decline, plan participants remain committed to retirement savings and few are reducing their contributions. Rather, the large majority of participants continue to contribute at significant rates and remain in appropriately diversified investments. One leading 401(k) provider saw only 2% of participants decrease contribution levels in October 2008 (1% actually increased contributions) despite the stock market decline and volatility experienced during that month.16 Another leading provider found that 96% of 401(k) participants who contributed to plans in the third quarter of 2008 continued to contribute in the fourth quarter.17 Research from the prior bear market confirms that employees tend to hold steady in the face of declining stock prices, remaining appropriately focused on their long-term retirement savings and investment goals.18 Demonstrating the importance of defined contribution plans to employees, a recent survey found that defined contribution plans are the second-most important benefit to employees behind health insurance.19 The same survey found that 9% of employees viewed greater deferrals to their defined contribution plan as one of their top priorities for 2009.20

Defined Contribution Plan Coverage and Participation Rates Are Increasing Participation in employer-sponsored defined contribution plans has grown from 11.5 million in 1975 to more than 75 million in 2005.21 This substantial increase is a result of many more employers making defined contribution plans available to their workforces. Today, the vast majority of large employers offer a defined contribution plan,22 and the number of small employers offering such plans to their employees has been increasing modestly as well.23 In total, 65% of full-time employees in private industry had access to a

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defined contribution plan at work in 2008 (of which 78% participated).24 Small businesses that do not offer a 401(k) or profit-sharing plan are increasingly offering workers a SIMPLE IRA, which provides both a saving opportunity and employer contributions.25 Indeed, as of 2007, 2.2 million workers at eligible small businesses participated in a SIMPLE IRA.26 The rate of employee participation in defined contribution plans offered by employers also has increased modestly over time27 — with further increases anticipated as a result of automatic enrollment adoption. Moreover, participating employees are generally saving at significant levels -- levels that have risen over time.28 Younger workers, in particular, increasingly look to defined contribution plans as a primary source of retirement income.29 There are understandable economic impediments that keep some small employers, particularly the smallest firms, from offering plans. The uncertainty of revenues is the leading reason given by small businesses for not offering a plan, while cost, administrative challenges, and lack of employee demand are other impediments cited by small business.30 Indeed, research reveals that employees at small companies place less priority on retirement benefits relative to salary than their counterparts at large companies.31 As firms expand and grow, the likelihood that they will offer a retirement plan increases.32 Congress can and should consider additional incentives and reforms to assist small businesses in offering retirement plans, but some small firms will simply not have the economic stability to do so. Mandates on small business to offer or contribute to plans will only serve to exacerbate the economic challenges they face, reducing the odds of success for the enterprise, hampering job creation and reducing wages. Some have understandably focused on the number of Americans who do not currently have access to an employer-sponsored defined contribution plan. Certainly expanding plan coverage to more Americans is a universally shared goal. Yet statistics about retirement plan coverage rates must be viewed in the appropriate context. Statistics about the percentage of workers with access to an employer retirement plan provide only a snapshot of coverage at any one moment in time. Given job mobility and the fact that growing employers sometimes initiate plan sponsorship during an employee‘s tenure, a significantly higher percentage of workers have access to a plan for a substantial portion of their careers.33 This coverage provides individuals with the opportunity to add defined contribution plan savings to other sources of retirement income. It is likewise important to note that individuals‘ savings behavior tends to evolve over the course of a working life. Younger workers typically earn less and therefore save less. What younger workers do save is often directed to non-retirement goals such as their own continuing education, the education of their children or the purchase of a home.34 As they age and earn more, employees prioritize retirement savings and are increasingly likely to work for employers offering retirement plans.35

Defined Contribution Plan Rules Promote Benefit Fairness The rules that Congress has established to govern the defined contribution plan system ensure that retirement benefits in these plans are delivered across all income groups. Indeed, the Internal Revenue Code contains a variety of rules to promote fairness regarding which employees are covered by a defined contribution plan and the contributions made to these plans. These requirements include coverage rules to ensure that a fair cross-section of

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employees (including sufficient numbers of non-highly compensated workers) are covered by the defined contribution plan and nondiscrimination rules to make certain that both voluntary employee contributions and employer contributions for non-highly compensated employees are being made at a rate that is not dissimilar to the rate for highly compensated workers.36 There are also top-heavy rules that require minimum contributions to non-highly compensated employees‘ accounts when the plan delivers significant benefits to top employees. Congress has also imposed various vesting requirements with respect to contributions made to defined contribution plans. These requirements specify the timetable by which employer contributions become the property of employees. Employees are always 100% vested in their own contributions, and employer contributions made to employee accounts must vest according to a specified schedule (either all at once after three years of service or in 20% increments between the second and sixth years of service).37 In addition, the two 401(k) safe harbor designs that Congress has adopted -- the original safe harbor enacted in 1996 and the automatic enrollment safe harbor enacted in 2006 — require vesting of employer contributions on an even more accelerated schedule.38

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Employer Sponsorship of Defined Contribution Plans Offers Advantages to Employees As plan sponsors, employers must adhere to strict fiduciary obligations established by Congress to protect the interests of plan participants. ERISA imposes, among other things, duties of prudence and loyalty upon plan fiduciaries. ERISA also requires that plan fiduciaries discharge their duties ―solely in the interest of the participants and beneficiaries‖ and for the ―exclusive purpose‖ of providing participants and beneficiaries with benefits.39 These exceedingly demanding fiduciary obligations (which are enforced through both civil and criminal penalties) offer investor protections not typically associated with savings vehicles individuals might use outside the workplace. One area in which employers exercise oversight is through selection and monitoring of the investment options made available in the plan. Through use of their often considerable bargaining power, employers select high-quality, reasonably-priced investment options and monitor these options on an ongoing basis to ensure they remain high-quality and reasonablypriced. Large plans also benefit from economies of scale that help to reduce costs. Illustrating the value of this employer involvement, the mutual funds that 401(k) participants invest in are, on average, of lower cost than those that retail investors use.40 Recognizing these benefits, an increasing number of retirees are leaving their savings in defined contribution plans after retirement, managing their money using the plan‘s investment options and taking periodic distributions. With the investment oversight they bring to bear, employers are providing a valuable service that employees would not be able easily or inexpensively to replicate on their own outside the plan. Employers also typically provide educational materials about retirement saving, investing and planning, and in many instances also provide access to investment advice services.41 To supplement educational materials and on-line resources, well over half of 401(k) plan sponsors offer in-person seminars and workshops for employees to learn more about

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retirement investing, and more than 40% provide communications to employees that are targeted to the workers‘ individual situations.42 Surveys reveal that a significant percentage of plan participants utilize employer-provided investment education and advice tools.43 Although participants can obtain such information outside of the workplace, it can be costly or require significant effort to do so, yielding yet another advantage to participation in an employer-sponsored defined contribution plan.

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Recent Enhancements to the Defined Contribution System Are Working Recent legislative reforms are improving outcomes for defined contribution plan participants. The Pension Protection Act of 2006 (―PPA‖), in particular, included several landmark changes to the defined contribution system that are already beginning to assist employees in their retirement savings efforts. Employee participation rates are beginning to increase thanks to PPA‘s provisions encouraging the adoption of automatic enrollment. This plan design, under which workers must opt out of plan participation rather than opt in, has been demonstrated to increase participation rates significantly, helping to move toward the universal employee coverage typically associated with defined benefit plans.44 And more employers are adopting this design in the wake of PPA, in numbers that are particularly notable given that the IRS‘s implementing regulations have not yet been finalized and the Department of Labor‘s regulations were not finalized until more than a year after PPA‘s enactment.45 One leading defined contribution plan service provider saw a tripling in the number of its clients adopting automatic enrollment between year-end 2005 and year-end 2007,46 and other industry surveys show a similarly rapid increase in adoption by employers.47 Moreover, many employers that have not yet adopted automatic enrollment are seriously considering doing so.48 Employers are also beginning to increase the default savings rate at which workers are automatically enrolled,49 which is important to ensuring that workers have saved enough to generate meaningful income in retirement. Studies show that automatic enrollment has a particularly notable impact on the participation rates of lower-income, younger, and minority workers because these groups are typically less likely to participate in a 401(k) plan where affirmative elections are required.50 Thus, PPA‘s encouragement of auto enrollment is helping to improve retirement security for these often vulnerable groups. PPA also encouraged the use of automatic escalation designs that automatically increase an employee‘s rate of savings into the plan over time, typically on a yearly basis. This approach is critical in helping workers save at levels sufficient to generate meaningful retirement income and can be useful in ensuring that employees save at the levels required to earn the full employer matching contribution.51 Employers are increasingly adopting automatic escalation features.52 In PPA, Congress also directed the Department of Labor (DOL) to develop guidance providing for qualified default investment alternatives, or QDIAs — investments into which employers could automatically enroll workers and receive a measure of fiduciary protection. QDIAs are diversified, professionally managed investment vehicles and can be retirement target date or life-cycle funds, managed account services or funds balanced between stocks and bonds. There has been widespread adoption of QDIAs by employers and this has helped

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improve the diversification of employee investments in 401(k) and other defined contribution plans.53 Congress also directed DOL in PPA to reform the fiduciary standards governing selection of annuity distribution options for defined contribution plans, and the DOL has recently issued final regulations on this topic.54 As a result, fiduciaries now have a clearer road map for the addition of an annuity payout option to their plan, which can give participants another tool for translating their retirement savings into lifelong retirement income.

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Defined Contribution Plans Provide Employees with the Tools to Make Sound Investments As a result of legislative reform and employer practices, employees in defined contribution plans have a robust set of tools to assist them in pursuing sound, diversified investment strategies. As noted above, employers provide educational materials on key investing principles such as asset classes and asset allocation, diversification, risk tolerance and time horizons. Employers also provide the opportunity for sound investing by selecting a menu of high-quality investments from diverse asset classes that, as discussed above, often reflect lower prices relative to retail investment options.55 Moreover, the vast majority of employers operate their defined contribution plans pursuant to ERISA section 404(c),56 which imposes a legal obligation to offer a ―broad range of investment alternatives‖ including at least three options, each of which is diversified and has materially different risk and return characteristics. The development and greater use by employers of investment options that in one menu choice provide a diversified, professionally managed asset mix that grows more conservative as workers age (retirement target date funds, life-cycle funds, managed account services) has been extremely significant and has helped employees seeking to maintain age-appropriate diversified investments.57 As mentioned above, the use of such options has accelerated pursuant to the qualified default investment alternatives guidance issued under PPA.58 These investment options typically retain some exposure to equities for workers as they approach retirement age. Given that many such workers are likely to live decades beyond retirement and through numerous economic cycles, some continued investment in stocks is desirable for most individuals in order to protect against inflation risk.59 One potential challenge when considering the diversification of employee defined contribution plan savings is the role of company stock. Traditionally, company stock has been a popular investment option in a number of defined contribution plans, and employers sometimes make matching contributions in the form of company stock. Congress and employers have responded to encourage diversification of company stock contributions. PPA contained provisions requiring defined contribution plans (other than employee stock ownership plans) to permit participants to immediately diversify their own employee contributions, and for those who have completed at least three years of service, to diversify employer contributions made in the form of company stock.60 And today, fewer employers (23%) make their matching contributions in the form of company stock, down from 45% in 2001.61 Moreover, more employers that do so are permitting employees to diversify these

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matching contributions immediately (67%), up from 24% that permitted such immediate diversification in 2004.62 The result has been greater diversification of 401(k) assets. In 2006, a total of 11.1% of all 401(k) assets were held in company stock.63 This is a significant reduction from 1999, when 19.1% of all 401(k) assets were held in company stock.64

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New Proposals for Early Access Would Upset the Balance between Liquidity and Asset Preservation The rules of the defined contribution system strike a balance between offering limited access to retirement savings and restricting such saving for retirement purposes. Some degree of access is necessary in order to encourage participation as certain workers would not contribute to a plan if they were unable under any circumstances (e.g., health emergency, higher education needs, first-home purchase) to access their savings prior to retirement.65 Congress has recognized this relationship between some measure of liquidity and plan participation rates and has permitted pre-retirement access to plan savings in some circumstances. For example, the law permits employers to offer workers the ability to take loans from their plan accounts and/or receive so-called hardship distributions in times of pressing financial need.66 However, a low percentage of plan participants actually use these provisions, and loans and hardship distributions do not appear to have increased markedly as a result of the current economic situation.67 To prevent undue access, Congress has limited the circumstances in which employees may take pre-retirement distributions and has imposed a 10% penalty tax on most such distributions.68 In 2001, as part of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), Congress took further steps to ease portability of defined contribution plan savings and combat leakage of retirement savings. EGTRRA required automatic rollovers into IRAs for forced distributions of balances of between $1,000 and $5,000 and allowed individuals to roll savings over between and among 401(k), 403(b), 457 and IRA arrangements at the time of job change.69 As a result of changes like these, leakage from the retirement system at the time of job change has been declining modestly over time — although leakage is certainly an issue worthy of additional attention.70 Participants, particularly those at or near retirement, are generally quite responsible in handling the distributions they take from their plans when they leave a company, with the vast majority leaving their money in the plan, taking partial withdrawals, annuitizing the balance or reinvesting their lump sum distributions.71 In sum, policymakers should acknowledge the careful balance between liquidity and preservation of assets and should be wary of proposals that would provide additional ways to tap into retirement savings early.

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Defined Contribution Plan Savings is an Important Source of Investment Capital The amounts held in defined contribution plans have an economic impact that extends well beyond the retirement security of the individual workers who save in these plans. Retirement plans held approximately $16.9 trillion in assets as of June 30, 2008.72 As noted earlier, amounts in defined contribution plans accounted for approximately $4.3 trillion of this amount, and amounts in IRAs represented approximately $4.5 trillion (much of which is attributable to rollovers from employer-sponsored plans, including defined contribution plans).73 Indeed, defined contribution plans and IRAs hold nearly 20% of corporate equities.74 These trillions of dollars in assets, representing ownership of a significant share of the total pool of stocks and bonds, provide an important and ready source of investment capital for American businesses. This capital permits greater production of goods and services and makes possible additional productivity- enhancing investments. These investments thereby help companies grow, add jobs to their payrolls and raise employee wages.

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Inquiries about Risk Are Appropriate but No Retirement Plan Design is Immune from Risk The recent market downturn has generated reasonable inquiries about whether participants in defined contribution plans may be subject to undue investment risk. As noted above, the American Benefits Council favors development of policy proposals and market innovations that seek to address these concerns. Yet it is difficult to imagine any retirement plan design that does not have some kind or degree of risk. Defined benefit pensions, for example, are extremely valuable retirement plans that serve millions of Americans. However, employees may not stay with a firm long enough to accrue a meaningful benefit, benefits are often not portable, required contributions can impose financial burdens on employers that can constrain pay levels or job growth, and companies on occasion enter bankruptcy (in which case not all benefits may be guaranteed). Some have suggested that a new federal governmental retirement system would be the best way to protect workers against risk. Certain of these proposals would promise governmentally guaranteed investment returns, which would entail a massive expansion of government and taxpayer liabilities at a time of already unprecedented federal budget deficits. Other proposals would establish governmental clearinghouses or agencies to oversee retirement plan investments and administration. Such approaches would likewise have significant costs to taxpayers and would unnecessarily and unwisely displace the activities of the private sector. Under these approaches, the federal government also would typically regulate the investment style and fee levels of retirement plan investments. These invasive proposals would constrain the investment choices and flexibility that defined contribution plan participants enjoy today and would establish the federal government as an unprecedented rate-setter for many retirement investments. Rather than focusing on new governmental guarantees or systems, any efforts to mitigate risk should instead focus on refinements to the existing successful employer-sponsored retirement plan system and shoring up the Social Security safety net.

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The Strong Defined Contribution System Can Still Be Improved While today‘s defined contribution plan system is proving remarkably successful at assisting workers in achieving retirement security, refinements and improvements to the system can certainly be made. Helping workers to manage market risk and to translate their defined contribution plan savings into retirement income are areas that would benefit from additional policy deliberations. An additional area in which reform would be particularly constructive is increasing the number of Americans who have access to a defined contribution or other workplace retirement plan. The American Benefits Council will soon issue a set of policy recommendations as to how this goal of expanded coverage can be achieved. We believe coverage can best be expanded through adoption of a multi-faceted set of reforms that will build on the successful employer-sponsored retirement system and encourage more employers to facilitate workplace savings by their employees. This multi-faceted agenda will include improvements to the current rules governing defined contribution and defined benefit plans, expansion of default systems such as automatic enrollment and automatic escalation, new simplified retirement plan designs, expanded retirement tax incentives for individuals and employers, greater use of workplace IRA arrangements (such as SIMPLE IRAs and discretionary payroll deduction IRAs), more effective promotion of existing retirement plan options, and efforts to enhance Americans‘ financial literacy.

End Notes

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1

Peter Brady & Sarah Holden, The U.S. Retirement Market, Second Quarter 2008, INVESTMENT COMPANY INST. FUNDAMENTALS 17, no. 3-Q2, Dec. 2008. This paper reveals that, as of June 30, 2008, total U.S. retirement accumulations were $16.9 trillion, a 13.4% increase over 2005 and a 59.4% increase over 2002. As noted above, these asset figures have decreased in light of recent market declines although assets held in defined contribution plans and individual retirement accounts still make up more than half of total U.S. retirement assets. See Brian Reid & Sarah Holden, Retirement Saving in Wake of Financial Market Volatility, INVESTMENT COMPANY INST., Dec. 2008. 2 2007 Account Balances: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project; 2008 Account Balances: Estimates from Jack VanDerhei, EBRI. 3 Press Release, Fidelity Investments, Fidelity Reports on 2008 Trends in 401(k) Plans (Jan. 28, 2009). 4 1999 and 2006 Account Balances: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project; 2007 and 2008 Account Balances: Estimates from Jack VanDerhei, EBRI. The analysis is based on a consistent sample of 2.2 million participants with account balances at the end of each year from 1999 through 2006 and compares account balances on January 1, 2000 and November 26, 2008. See also Jack VanDerhei, Research Director, Employee Benefit Research Institute, What Is Left of Our Retirement Assets?, PowerPoint Presentation at Urban Institute (Feb. 3, 2009). 5 According to the Department of Labor, there were 103,346 defined benefit plans and 207,748 defined contribution plans in 1975. In 2005, there were 47,614 defined benefit plans and 631,481 defined contribution plans. U.S. Department of Labor, Employee Benefits Security Administration, Private Pension Plan Bulletin Historical Tables (Feb. 2008). See also Sarah Holden, Peter Brady, & Michael Hadley, 401(k) Plans: A 25-Year Retrospective, INVESTMENT COMPANY INST. PERSPECTIVE 12, no. 2, Nov. 2006. 6 A joint ICI and EBRI study projected that 401(k) participants in their late 20s in 2000 who are continuously employed, continuously covered by a 401(k) plan, and earned historical financial market returns could replace significant amounts of their pre-retirement income (103% for the top income quartile; 85% for the lowest income quartile) with their 401(k) accumulations at retirement. Sarah Holden & Jack VanDerhei, Can 401(k) Accumulations Generate Significant Income for Future Retirees?, INVESTMENT COMPANY INST. PERSPECTIVE 8, no. 3, Nov. 2002. 7 Report on Retirement Plans – 2007, Diversified Investment Advisors (Nov. 2007). 8 401(k) Benchmarking Survey – 2008 Edition, Deloitte Consulting LLP (2008).

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9

In an October 2008 survey, only 2% of employers reported having reduced their 401(k)/403(b) matching contribution and only 4% said they planned to do so in the upcoming 12 months. WATSON WYATT WORLDWIDE, EFFECT OF THE ECONOMIC CRISIS ON HR PROGRAMS 4 (2008). 10 According to one study, defined contribution plans with matching contributions have a participation rate of 73% compared with 44% for plans that do not offer matching contributions. Retirement Plan Trends in Today’s Healthcare Market – 2008, American Hospital Association & Diversified Investment Advisors (2008). Some have wondered whether employers would reduce matching contributions as they adopt automatic enrollment since automatic enrollment is proving successful in raising participation rates. Current data suggest this is not occurring. For example, from 2005 to 2007 the number of Vanguard plans offering automatic enrollment tripled. During the same period, the percentage of Vanguard plans offering employer matching contributions increased by 4%. How America Saves 2008: A Report on Vanguard 2007 Defined Contribution Plan Data, The Vanguard Group, Inc. (2008); How America Saves 2006: A Report on Vanguard 2005 Defined Contribution Plan Data, The Vanguard Group, Inc. (2006). 11 W. Scott Simon, Fiduciary Focus, Morningstar Advisor, Apr. 5, 2007. 12 Brady & Holden (Dec. 2008), supra note 1. 13 Brady & Holden (Dec. 2008), supra note 1. 14 Gregory T. Long, Executive Dir., Fed. Ret. Thrift Inv. Fund, Statement Before the House Subcommittee on Federal Workforce, Postal Service, and the District of Columbia (July 10, 2008). 15 The average 401(k) account balance increased at an annual rate of 8.7% from 1999 to 2006, despite the fact that this period included one of the worst bear markets since the Great Depression. Sarah Holden, Jack VanDerhei, Luis Alonso, & Craig Copeland, 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2006, IINVESTMENT COMPANY INST. PERSPECTIVE 13, no. 1/EMPLOYEE BENEFIT RESEARCH INST. ISSUE BRIEF, no. 308, Aug. 2007. 16 Jilian Mincer, 401(k) Plans Face Disparity Issue, WALL ST. J., Nov. 6, 2008, at D9. 17 Fidelity Investments (Jan. 28, 2009), supra note 3. See also Reid & Holden (Dec. 2008), supra note 1 (noting that only 3% of defined contribution plan participants ceased contributions in 2008); The Principal Financial WellBeing Index Summary – Fourth Quarter 2008, Principal Financial Group (2008) (finding that, in the six months leading up to its October 2008 survey, 11% of employees increased 401(k) contributions, while only 4% decreased contributions and only 1% ceased contributions entirely); Retirement Outlook and Policy Priorities, Transamerica Center for Retirement Studies (Oct. 2008) (finding that participation rates are holding steady among full-time workers who have access to a 401(k) or similar employer-sponsored plan, with 77% currently participating; 31% of participants have increased their contribution rates into their retirement plans in the last twelve months; only 11% have decreased their contribution rates or stopped contributing); Press Release, Hewitt Associates, Hewitt Data Shows Americans Continue to Save in 401(k) Plans Despite Economic Woes (Nov. 24, 2008) (finding, in a November analysis, that average savings rates in 401(k) plans have only dipped by 0.2%, from 8.0% in 2007 to 7.8% in 2008). 18 See Sarah Holden & Jack VanDerhei, Contribution Behavior of 401(k) Plan Participants During Bull and Bear Markets, NAT‘L TAX ASS‘N 44 (2004) (citing a number of studies which indicate little variation in before-tax contributions and a slight decrease in employer contributions as a percentage of participant pay during the 1999-2002 bear market). 19 Principal Financial Group (2008), supra note 17. 20 Id. 21 Private Pension Plan Bulletin Historical Tables (Feb. 2008), supra note 5. 22 In 2007, 82% of employers with 500 or more employees offered 401(k) plans to their employees, and 19% of these employers offered a defined contribution plan other than a 401(k) plan to their employees. 9th Annual Retirement Survey, Transamerica Center for Retirement Studies (2008). 23 59% of employers with between 10 and 499 employees offered their employees 401(k) plans in 2007, as compared with 56% in 2006. Transamerica Center for Retirement Studies (2008), supra note 22; 8th Annual Retirement Survey, Transamerica Center for Retirement Studies (2007). 24 U.S. DEP‘T OF LABOR & U.S. BUREAU OF LABOR STATISTICS, BULL. NO. 2715, NATIONAL COMPENSATION SURVEY: EMPLOYEE BENEFITS IN THE UNITED STATES, MARCH 2008, tbl. 2 (Sept. 2008). 25 As of December 2007, there were more than 500,000 SIMPLE IRAs. At the end of 2007, $61 billion was held in SIMPLE IRAs. See Brady & Holden (Dec. 2008), supra note 1; Peter Brady & Stephen Sigrist, Who Gets Retirement Plans and Why, INVESTMENT COMPANY INST. PERSPECTIVE 14, no. 2, Sept. 2008. 26 Brady & Sigrist (Sept. 2008), supra note 25. See also U.S. DEP‘T OF LABOR & U.S. BUREAU OF LABOR STATISTICS, BULL. NO. 2589, NATIONAL COMPENSATION SURVEY: EMPLOYEE BENEFITS IN PRIVATE INDUSTRY THE UNITED STATES, 2005 (May 2007) (indicating 8% of private-sector workers at eligible small businesses participated in a SIMPLE IRA). 27 Among all full-time, full-year wage and salary workers ages 21 to 64, 55.3% participated in a retirement plan in 2007. This is up from approximately 53% in 2006. Craig Copeland, Employment-Based Retirement Plan Participation: Geographic Differences and Trends, 2007, EMPLOYEE BENEFIT RESEARCH INST. ISSUE BRIEF, no. 322, Oct. 2008 (examining the U.S. Census Bureau‘s March 2008 Current Population Survey). See also

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The Vanguard Group, Inc. (2008), supra note 10 (noting that, out of all employees in Vanguard- administered plans, 66% of eligible employees participated in their employer‘s defined contribution plan); 51st Annual Survey of Profit Sharing and 401(k) Plans, Profit Sharing/401(k) Council of America (Sept. 2008) (noting that 81.9% of eligible employees currently have a balance in their 401(k) plans). 28 Participants in plans administered by Vanguard saved 7.3% of income in their employer‘s defined contribution plan in 2007. The Vanguard Group, Inc. (2008), supra note 10. Among non-highly compensated employees, the level of pre-tax deferrals into 401(k) plans has risen from 4.2% of salary in 1991 to 5.6% in 2007. Profit Sharing/401(k) Council of America (Sept. 2008), supra note 27. 29 See Transamerica Center for Retirement Studies (Oct. 2008), supra note 17 (finding that 35% of Echo Boomers, 34% of Generation X, 28% of Baby Boomers, and 7% of Matures consider employer-sponsored defined contribution plans as their primary source of retirement income). 30 Jack VanDerhei, Findings from the 2003 Small Employer Retirement Survey, EMPLOYEE BENEFIT RESEARCH INST. ISSUE NOTES 24, no. 9, Sept. 2003. 31 Both small employers and workers in small businesses consider salary to be a greater priority than retirement benefits, but the inverse is true for the majority of larger employers and workers in larger businesses. See Transamerica Center for Retirement Studies (2008), supra note 22 (finding that 56% of employees in larger businesses consider retirement benefits to be a greater priority, where 54% of employees in smaller companies rank salary as a priority over retirement benefits). See also Brady & Sigrist (Sept. 2008), supra note 25. 32 For example, one survey found that more than half of small business respondents would be ―much more likely‖ to consider offering a retirement plan if company profits increased. VanDerhei (Sept. 2003), supra note 30. See also Transamerica Center for Retirement Studies (2008), supra note 22 (finding that large companies are more likely than smaller companies to offer 401(k) plans (82% large, 59% small)). 33 It should also be remembered that those without employer plan coverage may be building retirement savings through non-workplace tax-preferred vehicles such as individual retirement accounts or deferred annuities. 34 See Brady & Sigrist (Sept. 2008), supra note 25. 35 Based on an analysis of the Bureau of Labor Statistics‘ Current Population Survey, March Supplement (2007), of those most likely to want to save for retirement in a given year, almost 75% had access to a retirement plan through their employer or their spouse‘s employer, and 92% of those with access participated. Brady & Sigrist (Sept. 2008), supra note 25. 36 Voluntary pre-tax and Roth after-tax contributions must satisfy the Actual Deferral Percentage test (―ADP test‖). The ADP test compares the elective contributions made by highly compensated employees and non-highly compensated employees. Each eligible employee‘s elective contributions are expressed as a percentage of his or her compensation. The numbers are then averaged for (i) all eligible highly compensated employees, and (ii) all other eligible employees (each resulting in a number, an ―average ADP‖). The ADP test is satisfied if (i) the average ADP for the eligible highly compensated employees for a plan year is no greater than 125% of the average ADP for all other eligible employees in the preceding plan year, or (ii) the average ADP for the eligible highly compensated employees for a plan year does not exceed the average ADP for the other eligible employees in the preceding plan year by more than 2% and the average ADP for the eligible highly compensated employees for a plan year is not more than twice the average ADP for all other eligible employees in the preceding plan year. Treas. Reg. § 1.401(k)-2. Employer matching contributions and employee after-tax contributions (other than Roth contributions) must satisfy the Actual Contribution Percentage test (―ACP test‖). The ACP test compares the employee and matching contributions made by highly compensated employees and non-highly compensated employees. Each eligible employee‘s elective and matching contributions are expressed as a percentage of his or her compensation, and the resulting numbers are averaged for (i) all eligible highly compensated employees, and (ii) all other eligible employees (each resulting in a number, an ―average ACP‖). The ACP test utilizes the same percentage testing criteria as the ADP test. Treas. Reg. § 1.401(m)-2. 37 A trust shall not constitute a qualified trust under 401(a) unless the plan of which such trust is a part satisfies the requirements of section 411 (relating to minimum vesting standards). See I.R.C. § 401(a)(7). 38 See I.R.C. §§ 401(k)(12) and (13). 39 ERISA § 404. I.R.C. § 401(a) also requires that a qualified trust be organized for the exclusive benefit of employees and their beneficiaries. 40 Sarah Holden & Michael Hadley, The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2007, INVESTMENT COMPANY INST. PERSPECTIVE 17, no. 5, Dec. 2008. 41 See Transamerica Center for Retirement Studies (2008), supra note 22 (finding that, regardless of company size, almost two-thirds of employers offer investment guidance or advice as part of their retirement plan; of those who do not currently offer guidance or advice, 18% of large employers and 7% of small employers plan to offer advice in the future); Deloitte Consulting LLP (2008), supra note 8 (51% of 401(k) sponsors surveyed offer employees access to individualized financial counseling or investment advice services (whether paid for by employees or by the employer)); Trends and Experience in 401(k) Plans 2007 – Survey Highlights, Hewitt Associates LLC (June 2008) (40% of employers offer outside investment advisory services to employees). 42 Profit Sharing/401(k) Council of America (Sept. 2008), supra note 27.

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46% of plan participants consulted materials, tools, or services provided by their employers. John Sabelhaus, Michael Bogdan, & Sarah Holden, Defined Contribution Plan Distribution Choices at Retirement: A Survey of Employees Retiring Between 2002 and 2007, INVESTMENT COMPANY INST. RESEARCH SERIES, Fall 2008. 44 See, e.g., Measuring the Effectiveness of Automatic Enrollment, Vanguard Center for Retirement Research (Dec. 2007) (stating that ―[a]n analysis of about 50 plans adopting automatic enrollment confirms that the feature does improve participation rates, particularly among low-income and younger employees‖); Deloitte Consulting LLP (2008), supra note 8 (stating that ―[a] full 82% of survey respondents reported that autoenrollment had increased participation rates‖); Building Futures Volume VIII: A Report on Corporate Defined Contribution Plans, Fidelity Investments (2007) (stating that in 2006 overall participation rates were 28% higher for automatic enrollment-eligible employees than for eligible employees in plans that did not offer automatic enrollment; overall, automatic enrollment eligible employees had an average participation rate of 81%). 45 A recently-surveyed panel of experts expects automatic enrollment to be offered in 73% of defined contribution plans by 2013. Prescience 2013: Expert Opinions on the Future of Retirement Plans, Diversified Investment Advisors (Nov. 2008). 46 See The Vanguard Group, Inc. (2008), supra note 10. 47 See Deloitte Consulting LLP (2008), supra note 8 (42% of surveyed employers have an automatic enrollment feature compared with 23% in last survey); Hewitt Associates LLC (June 2008), supra note 41 (34% of surveyed employers have an automatic enrollment feature compared with 19% in 2005); Profit Sharing/401(k) Council of America (Sept. 2008), supra note 27 (more than half of large plans use automatic enrollment and usage by small plans has doubled). 48 See Deloitte Consulting LLP (2008), supra note 8 (stating that 26% of respondents reported they are considering adding an auto-enrollment feature). 49 One leading provider has noted an upward shift since 2005 in the percentage of sponsors that use a default deferral rate of 3% or higher, and a corresponding decrease in the percentage of sponsors that use a default deferral rate of 1% or 2%. The Vanguard Group, Inc. (2008), supra note 10. 50 See, e.g., Copeland (Oct. 2008), supra note 27 (noting that Hispanic workers were significantly less likely than both black and white workers to participate in a retirement plan); Jack VanDerhei & Craig Copeland, The Impact of PPA on Retirement Savings for 401(k) Participants, EMPLOYEE BENEFIT RESEARCH INST. ISSUE BRIEF, no. 318 (June 2008) (noting that industry studies have shown relatively low participation rates among young and low-income workers); Fidelity Investments (2007), supra note 44 (stating that, in 2006, among employees earning less than $20,000, the participation boost from automatic enrollment was approximately 50%); U.S. GOV‘T ACCOUNTABILITY OFFICE, GAO-08-8, PRIVATE PENSIONS: LOW DEFINED CONTRIBUTION PLAN SAVINGS MAY POSE CHALLENGES TO RETIREMENT SECURITY, ESPECIALLY FOR MANY LOW-INCOME WORKERS (Nov. 2007); Daniel Sorid, Employers Discover a Troubling Racial Split in 401(k) Plans, WASH. POST, Oct. 14, 2007, at F6. 51 See Fidelity Investments (2007), supra note 44 (noting that, in 2006, the average deferral rate for participants in automatic escalation programs was 8.3%, as compared to 7.1% in 2005). 52 See The Vanguard Group, Inc. (2008), supra note 10 (post-PPA, two-thirds of Vanguard‘s automatic enrollment plans implemented automatic annual savings increases, compared with one-third of its plans in 2005); Hewitt Associates LLC (June 2008), supra note 41 (35% of employers offer automatic contribution escalation, compared with 9% of employers in 2005); Transamerica Center for Retirement Studies (2008), supra note 22 (26% of employers with automatic enrollment automatically increase the contribution rate based on their employees‘ anniversary date of hire). 53 A leading provider states that ―QDIA investments are often more broadly diversified than portfolios constructed by participants. Increased reliance on QDIA investments should enhance portfolio diversification.‖ The Vanguard Group, Inc. (2008), supra note 10. See also Fidelity Investments (2007), supra note 44 (where a lifecycle fund was the plan default option, overall participant asset allocation to that option was 19.4% in 2006; where the lifecycle fund was offered but not as the default option, overall participant asset allocation to that option was only 9.8%). 54 Selection of Annuity Providers: Safe Harbor for Individual Account Plans, 73 Fed. Reg. 58,447 (Oct. 7, 2008) (to be codified at 29 C.F.R. pt. 2550). 55 See Holden & Hadley (Dec. 2008), supra note 40. 56 One survey found that 92% of companies surveyed stated that their plan is intended to comply with ERISA section 404(c). Deloitte Consulting LLP (2008), supra note 8. 57 In 2006, the percentage of single investment option holders who invested in lifecycle funds – ―blended‖ investment options – was 24%. 42% of plan participants invested some portion of their assets in lifecycle funds. The average number of investment options held by participants was 3.8 options in 2006. Fidelity Investments (2007), supra note 44. 58 In 2007, 77% of employers offered lifecycle funds as an investment option, compared with 63% in 2005. Hewitt Associates LLC (June 2008), supra note 41. See also Fidelity Investments (2007), supra note 44 (noting that, in 2006, 19% of participant assets were invested in a lifecycle fund in plans that offered the lifecycle fund as

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the default investment option, compared with 10% of participant assets in plans that did not offer the lifecycle fund as the default investment option). 59 See Target-Date Funds: Still the Right Rationale for Investors, The Vanguard Group, Inc. (Nov. 28, 2008) (noting that ―even investors entering and in retirement need a significant equity allocation‖ and citing the 17to 20-year life expectancy for retirees who are age 65). See also Fidelity Investments (2007), supra note 44 (―In general . . . the average percentage of assets invested in equities decreased appropriately with age . . . to a low of 45% for those in their 70s.‖). 60 I.R.C. § 401(a)(35); ERISA § 204(j). 61 Hewitt Associates LLC (June 2008), supra note 41. 62 Hewitt Associates LLC (June 2008), supra note 41. 63 Holden, VanDerhei, Alonso, & Copeland (Aug. 2007), supra note 15. See also Fidelity Investments (Jan. 28, 2009), supra note 3 (noting that, at year-end 2008, company stock made up approximately 10% of Fidelity‘s overall assets in workplace savings accounts, compared with 20% in early 2000). 64 Holden, VanDerhei, Alonso, & Copeland (Aug. 2007), supra note 15. See also William J. Wiatrowski, 401(k) Plans Move Away from Employer Stock as an Investment Vehicle, MONTHLY LAB. REV., Nov. 2008, at 3, 6 (stating that (i) in 2005, 23% of 401(k) participants permitted to choose their investments could pick company stock as an investment option for their employee contributions, compared to 63% in 1985, and (ii) in 2005, 14% of 401(k) participants permitted to choose their investments could pick company stock as an investment option for employer matching contributions, compared to 29% in 1985). 65 See U.S. GOV‘T ACCOUNTABILITY OFFICE, GAO/HEHS-98-2, 401(K) PENSION PLANS: LOAN PROVISIONS ENHANCE PARTICIPATION BUT MAY AFFECT INCOME SECURITY FOR SOME (Oct. 1997) (noting that plans that allow borrowing tend to have a somewhat higher proportion of employees participating than other plans). 66 See I.R.C. §§ 72(p) and 401(k)(2)(B). 67 See, e.g., Reid & Holden (Dec. 2008), supra note 1 (stating that, in 2008, 1.2% of defined contribution plan participants took a hardship withdrawal and 15% had a loan outstanding); Fidelity Investments (Jan. 28, 2009), supra note 3 (noting that only 2.2% of its participant base initiated a loan during the fourth quarter of 2008, compared with 2.8% during the fourth quarter of 2007, and 0.7% of its participant base took a hardship distribution during the fourth quarter of 2008, compared with 0.6% during the fourth quarter of 2007); Holden, VanDerhei, Alonso, & Copeland (Aug. 2007), supra note 15 (noting that most eligible participants do not take loans); Fidelity Investments (2007), supra note 44 (noting that only 20% of active participants had one or more loans outstanding at the end of 2006). Most participants who take loans repay them. See Transamerica Center for Retirement Studies (2008), supra note 22 (only 18% of participants have loans outstanding, and almost all participants repay their loans). 68 I.R.C. § 72(t). 69 See I.R.C. § 402(c)(4). 70 In 2007, among participants eligible for a distribution due to a separation of service, 70% chose to preserve their retirement savings by rolling assets to an IRA or by remaining in their former employer‘s plan, compared with only 60% in 2001. The Vanguard Group, Inc. (2008), supra note 10; How America Saves 2002: A Report on Vanguard Defined Contribution Plans, The Vanguard Group, Inc. (2002). 71 See Sabelhaus, Bogdan, & Holden (Fall 2008), supra note 43 (stating that retirees make prudent choices at retirement regarding their defined contribution plan balances: 18% annuitized their entire balance, 6% elected to receive installment payments, 16% deferred distribution of their entire balance, 34% took a lump sum and reinvested the entire amount, 11% took a lump sum and reinvested part of the amount, 7% took a lump sum and spent all of the amount, and 9% elected multiple dispositions; additionally, only about 3% of accumulated defined contribution account assets were spent immediately at retirement). 72 Brady & Holden (Dec. 2008), supra note 1. 73 Id. It is highly doubtful that Americans would have saved at these levels in the absence of defined contribution plans given the powerful combination of pre-tax treatment, payroll deduction, automatic enrollment and matching contributions. 74 See BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM, FEDERAL RESERVE STATISTICAL RELEASE Z.1, FLOW OF FUNDS ACCOUNTS OF THE UNITED STATES (December 11, 2008); Brady & Holden (Dec. 2008), supra note 1.

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Chapter 5

STRENGTHENING WORKER RETIREMENT SECURITY HEARING- BAKER TESTIMONY

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Dean Baker Thank you, Chairman Miller for inviting me to share my views on the problems of the current system of retirement income, and ways to improve it, with the committee. My name is Dean Baker and I am the co-director of the Center for Economic and Policy Research (CEPR). I am an economist and I have been writing about issues related to retirement security since 1992. My testimony will have three parts. The first part, which will be the bulk of the testimony, will explain how the current crisis has jeopardized the retirement security of tens of millions of workers. The second part will briefly reference some of the longstanding inadequacies of our system retirement income, reminding members of problems with which they are already quite familiar. The third part will outline some principles that may guide the committee in constructing legislation to improve retirement security.

HOW THE CURRENT CRISIS HAS JEAPORDIZED RETIREMENT SECURITY The collapse of the housing bubble, coupled with the plunge in the stock market, has exposed the gross inadequacy of our system of retirement income. CEPR‘s analysis of data from the Federal Reserve Board‘s 2004 Survey of Consumer Finance (SCF), indicates that the median household with a person between the ages of 45 to 54, saw their net worth fall by more than 45 percent between 2004 and 2009, from $150,500 in 2004, to just $82,200 in 2009 (all amounts are in 2009 dollars).1 This figure, which includes home equity, is not even sufficient to cover half of the value of the median house in the United States. In other words, if the median late baby boomer household took all of the wealth they had accumulated during their lifetime, they would still owe more than half of the price of a typical house in a mortgage and have no other asset whatsoever.2

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The situation for older baby boomers is similar. The median household between the ages of 55 and 64 saw their wealth fall by almost 38 percent from $229,600 in 2004 to $142,700 in 2009. This net worth would be sufficient to allow these households, who are at the peak ages for wealth accumulation, to cover approximately 80 percent of the cost of the median home, if they had no other asset. Even prior to the recent downturn, the baby boom cohorts were not well prepared for retirement. Most members of these cohorts had been able to save far too little to maintain their standard of living in retirement. They would have found it necessary to work much later into their lives than they had planned, or to accept sharp reductions in living standards upon reaching retirement. The situation of the baby boomers has been made much worse by the economic and financial collapse of the last two years. Ironically, the sharpest decline in wealth took place in an asset that many were led to believe was completely safe, their house. Real house prices have fallen by more than 30 percent from their peak in 2006 and will almost certainly fall at least another 10-15 percent before hitting bottom.3 The plunge in house prices has been especially devastating both because it was by far the largest source of wealth for most baby boomers, and also because the high leverage in housing. The fact that housing is highly leveraged is of course a huge advantage to homeowners in times when prices are rising. If a homeowner can buy a $200,000 house with a 20 percent down payment, and the house subsequently increases 50 percent in value, the homeowner gets a very high return, earning $100,000 on a down payment of just $40,000. However, leverage also poses enormous risks. In this case, if the home price falls by 20 percent, then the homeowner has lost 100 percent of her equity. This is exactly the sort of situation confronting tens of millions of baby boomers at the edge of retirement. They just witnessed the destruction of most or all of the equity in their home. Our analysis of the SCF indicates that almost one fourth of late baby boomers who own homes have so little equity that they will need to bring cash to settle their mortgage at their closing. In a somewhat more pessimistic scenario, almost 40 percent of the home owning households in this cohort will need to bring cash to a closing. The collapse in the housing equity of the baby boom cohort in the last two years will have enormous implications for their well-being in retirement. Instead of having a home largely paid off by the time they reach their retirement years, many baby boomers will be in the same situation as first time home buyers, looking at large mortgages requiring decades to pay down. Furthermore, the loss of equity in their current homes will make it far more difficult for baby boomers to move into homes that may be more suitable for their needs in retirement. Millions of middle class baby boomers will find it difficult to raise the money needed to make a down payment on a new home. While the focus of pension and retirement policy has usually been pensions and Social Security, it is important to recognize the role of housing wealth for two reason. First, the massive loss of housing wealth due to the collapse of the housing bubble is likely to be a factor that has an enduring impact on the living standards of the baby boom cohorts in their retirement years. The other reason why Congress should recognize the importance of housing wealth is that this pillar of retirement income is not as secure as it has often been treated. In other words, the risks associated with housing wealth have generally not been fully considered in evaluating the security of retirement income. While it is reasonable to hope that the economy

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will not see the same sort of nationwide housing bubble for many decades into the future, if ever, there will nonetheless be a substantial element of risk associated with homeownership, since there will always be substantial fluctuations in local housing markets. This means that workers who have much of their wealth in their home already face substantial risks to their retirement income even before considering their financial investments. Here also the baby boom cohort has received a very unpleasant surprise in the last two years as stock market has plunged by more than 40 percent from its peak in November of 2007.4 While the data does not yet allow us to determine exactly how badly the baby boom cohorts have been hit by this decline, it is virtually certain that they felt the biggest impact, simply because they had the most wealth to lose. The Fed‘s data show that at the end of 2007, more than 70 percent of the assets in defined contribution pension plans were held either directly or indirectly in the stock market.5 The baby boomers‘ losses on their stockholdings will compound the losses incurred on their homes. Of course most baby boomers had managed to accumulate relatively little by way of stock wealth even prior to the market collapse of the last year and half. In 2004, the median household headed by someone between the ages of 55 to 64 had accumulated less than $100,000 in financial assets of all forms, including holdings of stock and mutual funds. Median financial wealth for this age group had fallen to just over $60,000 in 2009 following the collapse of the stock market. The younger 45 to 54 cohort had median financial wealth of just $40,000 in 2004. This had fallen to less than $30,000 in 2009. To summarize, our system of retirement income security was completely unprepared for the sort of financial earthquake set in motion by the collapse the of the housing bubble and its secondary impact on the stock market. Older workers were already inadequately prepared for retirement even prior to these events. The events of the last two years now put most of the baby boom cohorts facing retirement with very little to depend on other than their Social Security and Medicare benefits. While a full picture of retirement income would also incorporate estimates of the income that these workers will receive from defined benefit pensions, the vast majority of workers in these age cohorts will receive little or nothing from traditional defined benefit pension plans. Defined benefit plans have been rapidly declining in importance for the last quarter century. This pace of decline is increasing with the downturn as many companies that still have defined benefit plans lay off workers and others freeze benefit levels to conserve cash.

OTHER PROBLEMS WITH THE DEFINED CONTRIBUTION PENSION SYSTEM The prior discussion highlights the problem of risk for which the current defined contribution system was completely inadequate. I will just briefly note some of the other problems that have been frequently raised in prior years.

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Inadequate Coverage In spite of efforts to simplify the process for employers, most businesses still do not offer workers the opportunity to contribute to a pension at their workplace. Almost half of private sector workers are not currently contributing to a pension plan at their workplace. The primary reason that workers do not contribute because their employer does not offer the option. The Bureau of Labor Statistics reported a take up rate of 83 percent in their most recent survey.6 The lack of coverage is overwhelmingly a small business issue. Two thirds of the workers employed in firms with more than 100 workers are contributing to a pension. Just one-third of the workers in workers employing less than 50 workers are contributing to a pension.

Lack of Portability In the modern economy, workers change jobs frequently either by choice or necessity. When workers leave a job with a pension, they generally cannot simply role over their accumulated funds into a plan operated by their new employer (if there is one). While recent legislation has sought to promote rollovers into IRAs, it is still too early to know how effective these rules will be. Until we have a fully portable pension system, changing jobs still provides an opportunity for leakage of funds from retirement accounts.

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High Fees While some pension plans are very efficient, many plans charge annual fees in excess of 1.5 percentage points. These fees can substantially reduce retirement savings. For example, a 1.0 percentage point difference in fees can reduce retirement accumulations by almost 20 percent over a thirty five year period. Private insurance companies will charge between 10 percent and 20 percent of the value of an accumulation to convert it into an annuity. This further reduces workers‘ retirement income.

PRINCIPLES FOR A NEW PENSION SYSTEM The events of the last two years have brought home the extent to which the current pension system exposes workers to risk both in the value of their pension and also their housing wealth. The federal government has the ability to shield workers from this risk, at very little cost to taxpayers. Before discussing principles for expanding retirement security, it is important to note the security that the government already does provide through Social Security and Medicare. With the collapse of retirement savings over the last two years, as well as the plunge in housing equity, the baby boom cohorts will be hugely dependent on these two social welfare programs. It is therefore more essential than ever that Congress maintain the integrity of these

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programs and ensure that the baby boom cohorts can at least count on the benefits that they have been promised. The main lesson of the last two years is that, in addition to the problems stemming from inadequate coverage and high costs, the current pension system subjects workers to far more risk than has been generally recognized. The government can solve all three problems by allowing workers the option to contribute to a government run pension system that would provide a modest guaranteed rate of return. The system would be a universal system like Social Security, however it would be voluntary. To try to maintain high rates of enrollment, there can be a default contribution from all workers of 3 percent, up to a modest level, such as $1,000 a year. Workers could be allowed to contribute some additional amount, for example an additional $1,000 per year, that would also earn them the same guaranteed rate of return. The system should also be structured to encourage workers to take their payouts in the form of annuities, except in the case of life threatening illness. For example, a nationwide system could easily offer free annuitization, while charging a modest penalty (e.g. 10 percent) to workers who take their money out of the account in a lump sum. Ideally, there would be tax subsidies for low and moderate income workers that would make it easier for them to put aside 3.0 percent, or more, of their wages. However, if budget limitations make subsidies impractical, there is no reason that Congress could not move ahead to establish a structure and consider adding subsidies at some future date. The guaranteed return should be set at a level that is consistent with a long-term average return on a conservatively invested portfolio. Such a guarantee should pose little new risk to the government. As recent events have shown, in extreme cases, the government will step in to protect savings, as it did when it opted to guarantee money market funds, even where it has no legal obligation to make such a commitment. Guaranteeing a modest rate of return over a long period of time should present very little additional risk to the government. The funds in this system would be kept strictly separate from the general budget. The investment would be carried through by a private contractor in a manner similar to the way in which the Federal Employees Thrift Saving Plan current invests the savings of federal employees. Even a modest contribution could make a large difference in the retirement security of most workers. For example, at a 3 percent rate of return, a worker who saved $1,000 a year for 35 years would be able to get an annuity of $4,200 a year at age 65. This would be 14 percent of the wage of a worker who earned $30,000 a year during their working lifetime. Such a sum would be a substantial supplement to their Social Security benefits. A contribution of $2,000 a year would be sufficient to provide an annuity that is almost equal to 30 percent of this worker‘s earnings during their working career. The formulas for this sort of plan can be altered in any number of ways, but the point is that Congress can enormously increase the retirement security of tens of millions of workers simply by making a system with a defined rate of return available to them. This could be done at no cost to the taxpayers.

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CONCLUSION The events of the last two years have shown how exposed workers‘ retirement income is to market risk. The collapse of the housing bubble has called attention to the fact that the value of not only their pensions, but also their homes, fluctuate with the market, while their homes are an even more important asset for most workers. While fully restoring the lost wealth of the baby boom cohorts may not prove feasible, Congress can take effective steps to create a better retirement system for future generations. This can be done at no cost to taxpayers, simply by having the government assume market risk by averaging returns over time. There are no economic or administrative obstacles to going this route, it is simple a question of political will.

End Notes 1

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We used the 2004 SCF, because the micro data from the 2007 is not yet available. This analysis, by my colleague David Rosnick and myself, will soon be available on the website of the Center for Economic and Policy Research, www.cepr.net. 2 These calculations exclude wealth in defined benefit pensions. 3 This is based on data from the Case-Shiller 20 City index. The peak level was reached in May of 2006. Most data is from November of 2008. These data are based on sales prices, which means that they reflect contracts that were typically signed 6 to 8 weeks earlier. This means that the most recent data is close to 5 months out of date at present. With prices in the index falling at a rate of more than 2 percent monthly, house prices may already be close to 10 percent lower than the level indicated in the November data. 4 This refers to the decline as measured by the S&P 500, which is a much broader measure than the Dow Jones Industrial Average. 5 This is taken form the Flow of Funds Table, L.118c, lines 12 plus 13, divided by line 1, available at http://www.federalreserve.gov/releases/z1/Current/z1r-6.pdf. 6 Bureau of Labor Statistics, ―Employee Benefits in the United States, 2008,‖ available at http://www.bls.gov/news.release/pdf/ebs2.pdf.

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Chapter 6

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - HUTCHESON TESTIMONY Matthew D. Hutcheson

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INTRODUCTION It is widely accepted that 401(k) and similar arrangements are the way most Americans will invest for retirement. Therefore, it is incumbent upon us all to be absolutely certain there are no unnecessary obstacles (whether intentional or unintentional) to its long-term success. The 401(k) concept is excellent. It has always had great potential, but that potential was sacrificed on Wall Street‘s altar of greed, corruption, and the 401(k) industry‘s harmful business model. It is not too late for the 401(k), but that will require a complete and unequivocal shift in public thinking. In other words, the public—including elected representatives, and regulators— must cast off the marketing-induced stupor that has befallen them. It is with a deeply felt commitment to the success of our private retirement system that this statement is shared with the Committee. There are reasons the 401(k) is failing. If those reasons are understood and acted upon, the 401(k) can be saved. This statement will explain those reasons and what is required to correct and restore the viability of the 401(k) for generations to come. If all six of the steps described herein are not implemented, the 401(k) system will be doomed to mediocrity – and, more likely, continuing failure.

Step 1: Elevate Stature of 401(k) to the Original Level Contemplated by Statute ―Give a dog a good name and he’ll live up to it.‖1

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While the 401(k) as a concept is excellent, the way the plan has been interpreted, marketed, delivered, implemented and operated is not. The 401(k) is suffering because many people inside and outside of the 401(k) and financial services industry view its purpose incorrectly. It is seen as a financial product, not a delicate retirement-incomegenerating system deserving of fiduciary protections and care. Many believe that 401(k) plans are nothing more than financial planning or simple savings tools. That is incorrect. 401(k) plans are true retirement plans, with all the attendant obligations and implications. They must be viewed and operated as such for the system to begin to restore the public trust. From a statutory perspective, a 401(k) plan is as much a retirement plan as a traditional pension plan. Until the 401(k) plan, and the system that it operates within is elevated to the intended stature of a ―pension benefit plan‖ under ERISA section 3(3) (which is why 401(k) plans are reported as a pension benefit plan on form 5500), society and the 401(k) and financial services industry will continue to view the 401(k) as being of ―lesser‖ importance and stature. Behavior and attitudes toward the 401(k) will follow accordingly. The 401(k) needs a fine reputation to live up to, and that can only happen if all Americans begin viewing it not as just another financial product, more like E*Trade than ERISA, but as an income-producing mechanism, as correctly stated under ERISA, with the ability to financially undergird society as it ages.

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Step 2: Create the Right Types of Safe Harbors and Incentives ―Faced with this statutory and regulatory riddle, the Department of Labor (―DOL‖) and now, Congress, support various investment advice schemes that allow plan sponsors to seek fiduciary relief under ERISA section 404(c). Although these schemes have the potential to resolve the ERISA section 404(c) dilemma, their structural flaws only create more problems— for example, they allow investment advisors to self-deal and operate despite conflicts of interest. And so the riddle of ERISA section 404(c) continues.‖2

The conventional 401(k) system is not founded solely upon principles that will yield favorable results for participants and beneficiaries. Ironically, there are regulatory incentives to produce mediocre or poor results. Nothing has produced more chaos and confusion in the 401(k) system than Department of Labor section 2550.404c-1, commonly referred to as ―404(c).‖ 404(c) is not just one of many problems with the 401(k) system. It‘s the problem. We wouldn‘t let our loved ones get on an airplane that does not strictly adhere to principles of aeronautical science and physics. And we certainly wouldn‘t knowingly let our loved ones ride in an airplane with a missing wing or a visibly cracked fuselage. That airplane will surely fall short of its destination; and that fact would be obvious long before takeoff. Yet we have a system that permits our loved ones to do just that with 401(k) plans operating within the meaning of Department of Labor regulation 404(c). In many cases, participants merely guess about which funds to invest in, and they often guess wrong. It is commonplace for incomplete or sub-optimal portfolios to be randomly selected. Without even realizing it, participants choose the wrong funds, or the wrong combination of funds, or the most expensive funds–thereby unnecessarily sacrificing years of potential retirement income. To

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continue the analogy, they choose a portfolio that is not ―flight-worthy.‖ Sadly, they will discover that reality far too late in life, and find that their only option is to work harder and longer – perhaps well into their 70‘s or even beyond. Section 404(c) was not originally meant for 401(k) plans anyway. It was intended for Defined Benefit Plans with after-tax mandatory employee contribution requirements or the precursor to the 401(k) – the Thrift Savings plans that some employers sponsored in addition to a traditional Defined Benefit Plan. Since the benefits provided under a traditional Defined Benefit Plan were protected by employer funding and the PBGC, it mattered far less if a participant made poor decisions with their after-tax mandatory or Thrift Savings account. The number of participants affected by 404(c) prior to the creation of the 401(k) is not known – but likely insignificant. Perhaps most 401(k) participants today participate in a plan with a section 404(c) provision. The drafters of ERISA could not have foreseen how 404(c) would damage a system that did not yet exist. ERISA section 404(c) existed prior to the 401(k), and its corrosive effects could not have been known. In 1991, final regulations under 404(c) were issued by the Department of Labor as a provision that 401(k) plans could utilize. That regulation was ill-conceived. By issuing those regulations, the Department of Labor consigned the 401(k) to mediocrity or worse. It should have been clear that 404(c) should be the exception, not the rule – as there were pre-existing laws in place that gave participants the right to a well diversified, prudent portfolio. The application of 404(c) to 401(k) plans opened the floodgates to the chaos in speculation and deviation from sound economic and financial principles – placing the burden of ―flight-worthiness‖ on the passenger and taking it away from trained professionals at the airline or the FAA, as it were. If trust in the 401(k) system is to be restored, the strangle-hold of 404(c) must be broken. That will prevent participants from making incorrect decisions based on emotion, ignorance, greed, or all of the above. It will place investment decision-making back where it belongs – with prudent fiduciaries. If 404(c) is allowed to remain, it should require a beneficiary waiver before a participant may choose to disregard the portfolios put in place by professional fiduciaries because the result will almost certainly be less favorable for both the participant and the beneficiary. If both agree, so be it. However, a prudent portfolio constructed by an investment fiduciary should be the standard established by law, and it should be accompanied by a safe harbor. Congress should consider clarifying for the courts that complying with 404(c) requires affirmative proof that all of its requirements have been satisfied. That of course is impossible, because there is no way to determine whether plan participants are ―informed.‖ It is the ―informed‖ requirement that gives 404(c) legitimacy, not the offering of a broad selection of funds. The Courts have missed that point entirely. Since it is impossible to know who is truly informed and who is not, even after extensive efforts to provide investor education, 404(c) is simply not viable in a system where the overwhelming population of American workers persists in its failure to grasp the elementary differences between a stock and a bond.3 Again, 404(c) could perhaps be the exception, but it is a mistake of massive proportions to have permitted it to become the rule. ―Many Americans, alas, know little about stocks, bonds, and retirement. This is the conclusion reached by none other than the companies and organizations that would benefit most from a system of private accounts. The Vanguard Group, the National Association of

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Matthew D. Hutcheson Securities Dealers, the Securities Industry Association, the Investment Protection Trust, Merrill Lynch, Money magazine, and the Securities and Exchange Commission have all done studies or issued reports that reach the same general conclusion. To make matters worse, much of the research over the past five years has focused on the knowledge of individuals who already own stock and are thus presumably more familiar with the workings of financial markets; the research has still found severe financial illiteracy.‖4

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Beyond the requirement that participants be ―informed,‖ virtually everyone in the 401(k) industry knows that only a tiny fraction of any plan actually complies with the long list of requirements. Section 404(c) is a waste of time, money, and it is also the cause of many billions of dollars wasted each year that otherwise would have been legitimately earned by professionally constructed and managed portfolios. When employers see a safer route (less fiduciary risk) that also has the promise of better results, the system will begin to heal and public trust will be restored. An employer that sponsors a 401(k) plan should be assured by a clear, unequivocal statutory safe harbor for appointing a professional independent fiduciary, acting pursuant to sections 3(21) or 3(38) of ERISA, or both. That will do more to protect the plan sponsor from fiduciary risk than anything else, and it is consistent with the duty of loyalty in a way that participants do not currently enjoy. Such a safe harbor would reduce or eliminate conflicts of interest. Results would improve through professional application of sound economic and financial principles. No longer would America‘s employers have to wear two hats and grapple with divided loyalties to their shareholders and their 401(k) plan participants. Such a safe harbor would restore order to the system. Creating better safe harbors and other incentives that give plan sponsors confidence and a sense of security for having done the right thing the right way will wean the 401(k) from concepts that have only confused and frustrated an otherwise excellent program with potential for long-term success.

Step 3: Participants Have a Right to Know the Expected Return of Their Portfolio ―If [investment] returns could not be expected from the investment of scarce capital, all investment would immediately cease, and corporations would no longer be able to produce their sellable goods and services. The truth is that we invest, not with an eye to making speculative gains, but because we have an expectation of a specific return over time.‖5

Every week, thousands of enrollment meetings are held in the lunch-rooms of corporate America. Those enrollment meetings seek to explain to participants why they should enroll in their company‘s 401(k), and which investment options are available to them. That is fine, with one exception. Most of the paperwork and enrollment materials will provide participants with useless information about the type of investor they are. Participants will take a 5 minute quiz, and that quiz will tell the participant that they are a ―conservative‖ investor, or a ―moderate‖ investor, or perhaps an ―aggressive‖ investor. Perhaps a particular list of funds with suggested ratios for which to allocate new contribution dollars will be associated with each investor type.

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.

There are two fundamental flaws with that approach. First, whether a participant has a conservative or an aggressive investor profile is dependent on emotion; how much market volatility they can stomach. A participant‘s tolerance for market turbulence is not static. It can change day-to-day. For example, if a participant with an aggressive profile gets in a car accident, their profile may immediately switch to conservative. That is an emotional profile that does not tie well to the economics of prudent, long-term investing. Second, the emotion of identifying an investor profile does not help the participant understand the interplay between new funding (ongoing contributions/deposits to the plan) and future retirement income streams that can be expected (not to be misunderstood as ―guaranteed.‖) Therefore, the most important thing a participant needs to know is not their emotionally determined ability to endure market turbulence, but rather the long-term economic output of the participant‘s portfolio. This is called the ―expected return.‖ Knowing that, a participant cannot truly understand how much money they should be contributing to the plan, when coupled with any employer generosity, if any, to achieve a future income- replacement goal. The expected return is the most fundamental concept of investing because if those with capital to invest could not expect a return, that capital would be invested elsewhere – or not at all. The concept of expected return is perplexingly absent in the current 401(k) system and is not understood by participants or fiduciaries. That misunderstanding can easily be corrected. It should be mandated by law that all participants be told what the expected return is for the actual portfolio they are in. That way, the one thing that participants can control – the amount they contribute to the plan – is a decision made in light of the expected return of the portfolio they will invest in so their decision is both informed and founded upon a process that is likely to yield favorable results. Participants may not be able to afford what they wish they could contribute based on the expected return of their portfolio. For example their portfolio may have an expected return of 5%, and to comfortably retire they may learn that they will need to contribute twice as much as they can afford in order to get there. That is an understood reality of life that many face each day when purchasing goods and services. However, participants should at a minimum know the economic characteristics of their portfolio so they can choose to get more education in order to earn more, work longer, spend less on other things, or a combination thereof. Consider how different things would be if we stopped inducing emotional decisions in participants and began given them solid, reliable information based on modern principles of economics and finance.

Step 4: Transparency Our retirement savings system and its participants deserve protection. The bedrock of any mechanism as delicate as the 40 1(k) should be clarity and transparency. The debate over whether the cost of a 401(k) plan is reasonable is pointless without standardized transparency. Can something be determined reasonable if it cannot first be seen and understood in a comparative context?

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In the case of plans with known economic impact to participants, perhaps all fees and costs are deemed reasonable when compared to the industry as a whole, yet simultaneously excessive in light of the quality or value of services rendered to a specific plan. In other words, all 401(k) plans could eventually have fees that someone deems reasonable, but those same fees may be genuinely excessive at the same time – therefore it is not an either-or scenario.6 That conundrum cannot be resolved in an environment of opacity. Given the seriousness of the crisis we face, where an estimated $1 trillion in 401(k) assets has been lost in the past few months, we cannot accept anything less than full and absolute transparency – even if fees and other charges become very low by today‘s standard. In other words, there may come a time when fees are reasonable, non- excessive, and absolutely transparent. It is in times such as those, transparency will be no less important or necessary for the purpose of protecting trust in the system. Passage of HR 3185 or a fundamentally similar Bill will begin the process of restoring broken trust. Distilling disclosure of expenses into an understandable format will deliver value to participants, beneficiaries, and employers. The gross-to-net methodology, which means clearly showing gross returns on the investments in a 401(k) account and also showing the net returns that the participant gets to keep, makes the most sense. It reveals total investment returns, the net return to each participant, and by simple subtraction, the actual costs of delivering those net returns to each participant.7 Any other method obscures both returns and costs from the view of the participants, plan sponsors, and regulators alike. Grossto-net disclosure establishes true transparency, a pre-requisite to restoring trust in the 401(k). Transparency should also be required for new financial products that are developed in the future, such as fund-of-funds, lifestyle, and target date funds. Some of those may be well constructed. Some of them are not. Transparency is required to ensure fiduciaries and plan participants understand the difference.

Step 5: Retire-Ability Measurements As stated earlier, the 401(k) has not been managed to produce future retirement income. Rather, it has been managed like merely another of an array of ordinary financial products. Thus, the ability of conventional 401(k) plans to produce financially secure retirees is not a primary discussion item of fiduciaries and committee members in their meetings. Many factors go into creating a successful program, each having differing importance and weight at different stages of a participant‘s progression from entry into the workforce to retirement. Also, participants at different ages are affected differently by plan provisions or economic conditions. For example, younger participants with smaller account balances are most affected by matching or other employer contributions. Older participants with larger account balances are most impacted by fees and other charges. Employers and fiduciaries must understand what helps participants, what hurts them, and when those effects are most likely. If 401(k) plans are to thrive, employers and fiduciary committees must engage in regular proactive and thoughtful assessments of the ―retire-ability‖ qualities of their plan, while taking into account the demographics of the plan participants as a whole.

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Society requires more that ever a more astute body of fiduciaries who understand that improved future retirement income for individuals also enables an improved future economy for all. Higher retirement incomes can help stabilize the economy, sustain tax revenues necessary to deliver essential government services and provide economic opportunity for the rising generation. Employers must not fear the question, and then answer honestly, ―Will our employees be able to retire at their chosen time? If not, what can we do to improve their chances?‖

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SUMMARY 1. Return to Roots – Congress can make it unequivocally clear that plan sponsors need to understand 401(k) plans must not as mere financial planning tools, but rather the a pension benefit mechanism that produces retirement income that will be the financial undergirding mechanism of society. 2. Safe Harbors & Incentives – Congress can create meaningful safe harbors and incentives that give employers confidence to proceed in managing their 40 1(k) plans in accordance with modern principles of economics and finance – thus improving results. Congress can remove or suppress harmful elements of the conventional system, such as Department of Labor regulation 404(c). That regulation, 404(c), is the lead in the paint, the salmonella in the peanuts, the goose in the jet engine of the retirement system. Fix it, and you will fix the root cause of the problems that plague the 401(k). 3. Expected Returns – Congress can require that participants be given the expected return (economic characteristic) of the portfolio in which their funds are invested. Unlike knowing the expected return of a portfolio, the emotional risk profile most 401(k) participants are given to help them choose investments is not useful in calculating future retirement income nor is it helpful in making appropriate portfolio changes. The expected return is already required by case law to be known and understood by fiduciaries. That same information should also be made known to participants. 4. Pass HR 3185 – Congress can pass HR 3185 or its fundamental equivalent to clarify plan expenses by a simple gross-to-net calculation in order to help employers and plan participants make better decisions, and also to restore trust and confidence in the system. No system as important as the 401(k) should have any lingering questions about fee or expense transparency. Thus, the passage of HR 3185 or its equivalent is at a minimum, urgent. 5. Retire-Ability Measures – Congress can encourage employers to look beyond the robotic fund selecting process that has become synonymous with being a 40 1(k) committee member and to look more deeply at how their plans are designed to produce financially secure retirees. And participants can be provided tools to assess their projected retirement dates and expected income levels.

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CONCLUSION There are problems with how the 401(k) has been delivered; that goes without saying. That does not mean we need to accept what has not worked and protect the status quo. No one is suggesting that employers guarantee benefits. It is proposed, rather, that 401(k) plans be managed like the retirement-income-producing mechanism they were always intended to be. It is because the benefits delivered by a 401(k) are not guaranteed that we should demonstrate particular care and compassion. Participants are entirely vulnerable, and deserve better protections. Protecting the interests of participants will require a sweeping shift in thinking toward a system that enables (1) A fiduciary level of care; (2) Improved safe harbors and incentives; (3) Disclosure of expected investment returns; (4) Transparency via actual grossto-net disclosure; and (5) Measurements of each participant‘s ability to retire at targeted dates and income levels. The benefits of these five reforms to the 401(k) system will reach more than fifty million working Americans. Without this shift in thinking and behavior, including abandoning the misused 404(c) provisions, the 401(k) will fail to deliver on its original promise. There is hope for the 401(k) to rebuild savings and regain the trust of American workers, but it must be operated as ERISA originally contemplated; like a ―pension benefit‖ plan.

End Notes 1

Attributed to Dale Carnegie Chicago-Kent Law Review. ERISA Section 404(c) and investment advice: What is an Employer or Plan Sponsor to do? Stefanie Kastrinsky. Page 3 May 16, 2005. 3 Dave Mastio, ―Lessons our 401(k)s Taught us. How much do Americans know about investing for retirement? What investors don‘t know.‖ http://www.hoover.org/publications/policyreview/3552047.html 4 Ibid 5 ―Investment Risk vs. Unprincipled Speculation‖ Journal of Pension Benefits ©Wolters Kluwer Law and Business. Volume 16, Number 2, Winter 2009. Page 76. 6 See 9th Meigs question for further explanation about the relationship between ―reasonable‖ and ―excessive‖ fees and expenses. http://www.401khelpcenter.com/401k/meigs mdh interview.html 7 See ―Gross-to-Net‖ proposed fee and expense disclosure reporting grid. http://www.dol.gov/ebsa/pdf/IF408b2.pdf. See also http://advisor.morningstar.com/articles/article.asp?s=0&docId=15714&pgNo=2

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Chapter 7

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - JOHN BOGLE, BEFORE THE COMMITTEE ON EDUCATION AND LABOR, U.S. HOUSE OF REPRESENTATIVES

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John C. Bogle

Our nation‘s system of retirement security is imperiled, headed for a serious train wreck. That wreck is not merely waiting to happen; we are running on a dangerous track that is leading directly to a serious crash that will disable major parts of our retirement system. Federal support—which, in today‘s world, is already being tapped at unprecedented levels— seems to be the only short-term remedy. But long-term reforms in our retirement funding system, if only we have the wisdom and courage to implement them, can move us to a better path toward retirement security for the nation‘s workers. One of the causes of the coming crisis—but hardly the only cause—is the collapse of our stock market, erasing some $8 trillion in market value from its $17 trillion capitalization at the market‘s high in October 2007, less than 18 months ago. However, this stunning loss of wealth reflects, in important part, a growing and substantial overvaluation of stocks during the late 1990s and early 2000s, ―phantom wealth‖ which proved unjustified by corporate intrinsic value. (I‘ll discuss this subject in greater depth later in my statement.) But four other causes must not be ignored. One is the inadequacy of national savings being directed into retirement plans. ―Thrift‖ has been out in America; ―instant gratification‖ in our consumer-driven economy has been in. As a nation, we are not saving nearly enough to meet our future retirement needs. Too few citizens have chosen to establish personal retirement accounts, and even those who have established them are funding them inadequately and only sporadically. Further, our corporations have been funding their pension plans on the mistaken assumption that stocks would produce future returns at the generous levels of the past, raising their prospective return assumptions even as the market reached valuations that were far above historical norms.2 And the pension plans of our state and local

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governments seem to be in the worst financial condition of all. (Because of poor transparency, inadequate disclosure, and non- standardized financial reporting, we really don‘t know the dimension of the shortfall.) Second is the plethora of unsound, unwise, and often speculative investment choices made not only by individuals responsible for managing their own tax-sheltered retirement investment programs (such as individual retirement accounts and defined-contribution pension plans such as 401(k) thrift plans provided by corporations and 403(b) savings plans provided by non-profit institutions), but also professionally managed defined benefit plans, largely created in earlier days by our nation‘s larger corporations and by our state and local governments. Third, conflicts of interest are rife throughout our financial system. Both the managers of mutual funds held in corporate 401(k) plans and the money managers of corporate pension plans face a potential conflict when they hold the shares of the corporations that are their clients. It is not beyond imagination that when a manager votes proxy shares against a company management‘s recommendation, it might not sit well with company executives who select the plan‘s provider of investment advice. (There is a debate about the extent to which those conflicts have actually materialized.) In trade union plans, actual conflicts of interest among union leaders, union workers, investment advisers, and money managers have been documented in the press and in court. In defined benefit plans, corporate senior officers face an obvious short-term conflict between minimizing pension costs in order to maximize the earnings growth that market participants demand, and incurring larger pension costs by making timely and adequate contributions to their companies‘ pension plans in order to assure long-term security for the pension benefits they have promised to their workers. Fourth, our financial system is a greedy system, consuming far too large a share of the returns created by our business and economic system. Corporations generate earnings for the owners of their stocks, pay dividends, and reinvest what‘s left in the business. In the aggregate, over the past century, the returns generated by our businesses have grown at an annual rate of about 9½ percent per year, including about 4½ percent from dividend yields and 5 percent from earnings growth. Similarly, corporate and government bonds pay interest, and the aggregate return on bonds averaged about 5 percent during the same period. But these are the gross returns generated by the corporations that dominate our system of competitive capitalism (and by government borrowings). Investors who hold these financial instruments, either directly or through the collective investment programs provided by mutual funds and defined benefit pension plans, receive their returns only after the cost of acquiring them and then trading them back and forth among one another. While some of this activity is necessary to provide the liquidity that has been the hallmark of U.S. financial markets, it has grown into an orgy of speculation that pits one manager against another, and one investor (or speculator) against another—a ―paper economy‖ that has, predictably, come to threaten the real economy where our citizens save and invest. It must be obvious that our present economic crisis was, by and large, foisted on Main Street by Wall Street—the mostly innocent public taken to the cleaners, as it were, by the mostly greedy financiers.

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EXTRACTING VALUE FROM SOCIETY I‘ve written about our absurd and counterproductive financial sector at length. Writing in the Journal of Portfolio Management in its Winter 2008 issue, here are some of the things that I said about the costs of our financial system: ― . . . mutual fund expenses, plus all those fees paid to hedge fund and pension fund managers, to trust companies and to insurance companies, plus their trading costs and investment banking fees . . . totaled about $528 billion in 2007. These enormous costs seriously undermine the odds in favor of success for citizens who are accumulating savings for retirement. Alas, the investor feeds at the bottom of the costly food chain of investing, paid only after all the agency costs of investing are deducted from the markets‘ returns . . . Once a profession in which business was subservient, the field of money management has largely become a business in which the profession is subservient. Harvard Business School Professor Rakesh Khurana is right when he defines the standard of conduct for a true professional with these words: ‗I will create value for society, rather than extract it.‘ And yet money management, by definition, extracts value from the returns earned by our business enterprises.‖ These views are not only mine, and they have applied for a long time. Hear Nobel laureate economist James Tobin, presciently writing in 1984: ― . . . we are throwing more and more of our resources into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to their social productivity, a ‗paper economy‘ facilitating speculation which is short-sighted and inefficient.‖ In his remarks, Tobin cited the eminent British economist John Maynard Keynes. But he failed to cite Keynes‘s profound warning: ―When enterprise becomes a mere bubble on a whirlpool of speculation, the consequences may be dire . . . when the capital development of a country becomes a by-product of the activities of a casino . . . the job (of capitalism) will be ill-done.‖ That job is indeed being ill-done today. Business enterprise has taken a back seat to financial speculation. The multiple failings of our flawed financial sector are jeopardizing, not only the retirement security of our nation‘s savers but the economy in which our entire society participates.

OUR RETIREMENT SYSTEM TODAY The present crisis in worker retirement security is well within our capacity to measure. It is not a pretty picture:

Defined Benefit Plans Until the early 1990s, investment risk and the longevity risk of pensioners (the risk of outliving one‘s resources) were borne by the defined benefit (DB) plans of our corporations and state and local governments, the pervasive approach to retirement savings outside of the huge DB plan we call Social Security. But in the face of a major shift away from DB plans in favor of defined contribution (DC) plans, DB growth has essentially halted. Assets of

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corporate pension plans have declined from $2.1 trillion as far back as 1999 to an estimated $1.9 trillion as 2009 began. These plans are now severely underfunded. For the companies in the Standard & Poor‘s 500 Index, pension plan assets to cover future payments to retirees has tumbled from a surplus of some $270 billion in 1999 to a deficit of $376 billion at the end of 2008. Largely because of the stock market‘s sharp decline, assets of state and local plans have also tumbled, from a high of $3.3 trillion early in 2007 to an estimated $2.5 trillion last year.

The Pension Benefit Guaranty Corporation This federal agency, responsible for guaranteeing the pension benefits of failing corporate sponsors is itself faltering, with a $14 billion deficit in December 2007. Yet early in 2008— just before the worst of the stock market‘s collapse—the agency made the odd decision to raise its allocation to diversified equity investments to 45 percent of its assets, and add another 10 percent to ―alternative investments,‖ including real estate and private equity, essentially doubling the PBGC‘s equity participation at what turned out to be the worst possible moment.

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Defined Contribution Plans DC plans are gradually replacing DB plans, a massive transfer from business enterprises to their employees of both investment risk (and return) and the longevity risk of retirement funding. While DC plans have been available to provide the benefits of tax-deferral for retirement savings for well over a half-century,3 it has only been with the rise of employer thrift plans such as 401(k)s and 403(b)s, beginning in 1978, that they have been widely used to accumulate retirement savings. The growth in DC plans has been remarkable. Assets totaled $500 billion in 1985; $1 trillion in 1991; $4.5 trillion in 2007. With the market crash, assets are now estimated at $3.5 trillion. The 401(k) and 403(b) plans dominate this total, with respective shares of 67 percent and 16 percent or 83 percent of the DC total.

Individual Retirement Accounts IRA assets presently total about $3.2 trillion, down from $4.7 trillion in 2007. Mutual funds (now some $1.5 trillion) continue to represent the largest single portion of these investments. Yet with some 47 million households participating in IRAs, the median balance is but $55,000, which at, say, a 4 percent average income yield, would provide but $2,200 per year in retirement income per household, a nice but far from adequate, increment.

FOCUSING ON 401(K) RETIREMENT PLANS Defined contribution pension plans, as noted above, have gradually come to dominate the private retirement savings market, and that domination seems certain to increase. Further,

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there is some evidence that DC plans are poised to become a growing factor in the public plan market. (The federal employees‘ Thrift Savings Plan, with assets of about $180 billion, has operated as a defined contribution plan since its inception in 1986.) Even as 401(k) plans have come to dominate the DC market, so mutual fund shares have come to dominate the 40 1(k) market. Assets of mutual funds in DC plans have grown from a mere $35 billion in 1990 (9 percent of the total) to an estimated $1.8 trillion in 2008 (51 percent). Given the plight in which our defined benefit plans find themselves, and the large (and, to some degree, unpredictable) bite that funding costs take out of corporate earnings, it is small wonder that what began as a gradual shift became a massive movement to defined contribution plans. (Think of General Motors, for example, as a huge pension plan now with perhaps $75 billion of assets—and likely even larger liabilities—surrounded by a far smaller automobile business, operated by a company with a current stock market capitalization of just $1.3 billion.) I would argue the shift from DB plans to DC plans is not only an inevitable move, but a move in the right direction in providing worker retirement security. In this era of global competition, U.S. corporations must compete with non-U.S. corporations with far lower labor costs. So this massive transfer of the two great risks of retirement plan savings—investment risk and longevity risk—from corporate balance sheets to individual households will relieve pressure on corporate earnings, even as it will require our families to take responsibility for their own retirement savings. A further benefit is that investments in DC plans can be tailored to the specific individual requirements of each family—reflecting its prospective wealth, its risk tolerance, the age of its bread-winner(s), and its other assets (including Social Security). DB plans, on the other hand, are inevitably focused on the average demographics and salaries of the firm‘s work force in the aggregate. The 401(k) plan, then, is an idea whose time has come. That’s the good news. We‘re moving our retirement savings system to a new paradigm, one that will ultimately efficiently serve both our nation‘s employers—corporations and governments alike—and our nation‘s families. Now for the bad news: our existing DC system is failing investors. Despite its worthy objectives, the deeply flawed implementation of DC plans has subtracted—and subtracted substantially—from the inherent value of this new system. Given the responsibility to look after their own investments, participants have acted contrary to their own best interests. Let‘s think about what has gone wrong.4

A DEEPLY FLAWED SYSTEM I now present my analysis of the major flaws that continue to exist in our 401(k) system. We need radical reforms to mitigate these flaws, in order to give employees the fair shake that must be the goal if we are to serve the national public interest and the interest of investors.

Inadequate Savings The modest median balances so far accumulated in 401(k) plans make their promise a mere shadow of reality. At the end of 2008, the median 401(k) balance is estimated at just

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$15,000 per participant. Indeed, even projecting this balance for a middle-aged employee with future growth engendered over the passage of time by assumed higher salaries and real investment returns, that figure might rise to some $300,000 at retirement age (if the assumptions are correct). While that hypothetical accumulation may look substantial, however, it would be adequate to replace less than 30 percent of pre-retirement income, a help but hardly a panacea. (The target suggested by most analysts is around 70 percent, including Social Security.) Part of the reason for today‘s modest accumulations are the inadequate participant and corporate contributions made to the plans. Typically, the combined contribution comes to less than 10 percent of compensation, while most experts consider 15 percent of compensation as the appropriate target. Over a working lifetime of, say, 40 years, an average employee, contributing 15 percent of salary, receiving periodic raises, and earning a real market return of 5 percent per year, would accumulate $630,000. An employee contributing 10 percent would accumulate just $420,000. If those assumptions are realized, this would represent a handsome accumulation, but substantial obstacles—especially the flexibility given to participants to withdraw capital, as described below—are likely to preclude their achievement.

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Excess Flexibility 401(k) plans, designed to fund retirement income, are too often used for purposes that subtract directly from that goal. One such subtraction arises from the ability of employees to borrow from their plans, and nearly 20 percent of participants do exactly that. Even when— and if—these loans are repaid, investment returns (assuming that they are positive over time) would be reduced during the time that the loans are outstanding, a dead-weight loss in the substantial savings that might otherwise have been accumulated at retirement. Even worse is the dead-weight loss—in this case, largely permanent—engendered when participants ―cash out‖ their 401(k) plans when they change jobs. The evidence suggests that 60 percent of all participants in DC plans who move from one job to another cash out at least a portion of their plan assets, using that money for purposes other than retirement savings. To understand the baneful effect of borrowings and cash-outs, just imagine in what shape our beleaguered Social Security System would find itself if the contributions of workers and their companies were reduced by borrowings and cash outs, flowing into current consumption rather than into future retirement pay. It is not a pretty picture to contemplate.

Inappropriate Asset Allocation One reason that 401(k) investors have accumulated such disappointing balances is due to unfortunate decisions in the allocation of assets between stocks and bonds.5 While virtually all investment experts recommend a large allocation to stocks for young investors and an increasing bond allocation as participants draw closer to retirement, a large segment of 401(k) participants fails to heed that advice. Nearly 20 percent of 401(k) investors in their 20s own zero equities in their retirement plan, holding, instead, outsized allocations of money market and stable value funds, options

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which are unlikely to keep pace with inflation as the years go by. On the other end of the spectrum, more than 30 percent of 401(k) investors in their 60s have more than 80 percent of their assets in equity funds. Such an aggressive allocation likely resulted in a decline of 30 percent or more in their 401(k) balances during the present bear market, imperiling their retirement funds precisely when the members of this age group are preparing to draw upon it. Company stock is another source of unwise asset allocation decisions, as many investors fail to observe the time-honored principle of diversification. In plans in which company stock is an investment option, the average participant invests more than 20 percent of his or her account balance in company stock, an unacceptable concentration of risk.

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Excessive Costs As noted earlier, excessive investment costs are the principal cause of the inadequate long-term returns earned by both stock funds and bond funds. The average equity fund carries an annual expense ratio of about 1.3 percent per year, or about 0.80 percent when weighted by fund assets. But that is only part of the cost. Mutual funds also incur substantial transaction costs, reflecting the rapid turnover of their investment portfolios. Last year, the average actively managed fund had a turnover rate of an astonishing 96 percent. Even if weighted by asset size, the turnover rate is still a shocking—if slightly less shocking—65 percent. Admittedly, the costs of this portfolio turnover cannot be measured with precision. But it is reasonable to assume that trading activity by funds adds costs of 0.5 percent to 1.0 percent to the expense ratio. So the all-in-costs of fund investing (excluding sales loads, which are generally waived for large retirement accounts) can run from, say 1.5 percent to 2.3 percent per year. (By contrast, low-cost market index funds—which I‘ll discuss later—have expense ratios as low as 0.10 percent, with transaction costs that are close to zero.) In investing, costs truly matter, and they matter even more when related to real (after inflation) returns. If the future real investment return on a balanced retirement account were, say, 4 percent per year (5 percent nominal return for bonds, 8 percent for stocks, less 2.5 percent inflation), an annual cost of 2.0 percent would consume fully 50 percent of that annual return. Even worse, over an investment lifetime of, say, 50 years, those same costs would consume nearly 75 percent of the potential wealth accumulation. It is an ugly picture. Given the centrality of low costs to the accumulation of adequate retirement savings, then, costs must be disclosed to participants. But the disclosure must include the all-in costs of investing, not merely the expense ratios. (I confess to being skeptical about applying costaccounting processes to the allocation of fund expenses among investment costs, administrative costs, marketing costs, and record-keeping costs. What‘s important to plan participants is the amount of total costs incurred, not the allocation of those costs among the various functions as determined by accountants and fund managers who have vested interests in the outcome.)

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Failure to Deal with Longevity Risk Even as most 401(k) plan participants have failed to deal adequately with investment risk, so they (and their employers and the fund sponsors) have also failed to deal adequately with longevity risk. It must be obvious that at some point in an investment lifetime, most plan participants would be well-served by having at least some portion of their retirement savings provide income that they cannot outlive. But despite the fact that the 401(k) plan has now been around for three full decades, systematic approaches to annuitizing payments are rare and often too complex to implement. Further, nearly all annuities carry grossly excessive expenses, often because of high selling and marketing costs. Truly low-cost annuities remain conspicuous by their absence from DC retirement plan choices. (TIAA-CREF, operating at rock-bottom cost and providing ease and flexibility for clients using its annuity program, has done a good job in resolving both the complexity issue and the cost issue.)

THE NEW DEFINED CONTRIBUTION PLANS

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Given the widespread failures in the existing DC plan structure, and in 401(k) plans in particular, it is time for reform, reform that serves, not fund managers and our greedy financial system, but plan participants and their beneficiaries. We ought to carefully consider changes that move us to a retirement plan system that is simpler, more rational and less expensive, one that will be increasingly and inevitably focused on DC plans. Our Social Security System and, at least for a while, our state and local government systems would continue to provide the DB backup as a ―safety net‖ for all participating U.S. citizens:

1. Simplify the DC system Offer a single DC plan for tax-deferred retirement savings available to all of our citizens (with a maximum annual contribution limit), consolidating today‘s complex amalgam of traditional DC plans, IRAs, Roth IRAs, 401(k) plans, 403(b) plans, the federal Thrift Savings Plan. I envision the creation of an independent Federal Retirement Board to oversee both the employer-sponsors and the plan providers, assuring that the interests of plan participants are the first priority. This new system would remain in the private sector (as today), with asset managers and recordkeepers competing in costs and in services. (But such a board might also create a public sector DC plan for wage-earners who were unable to enter the private system or whose initial assets were too modest to be acceptable in that system.)

2. Get Real about Stock Market Return and Risk Financial markets, it hardly need be said today, can be volatile and unpredictable. But common stocks remain a perfectly viable—and necessary—investment option for long-term retirement savings. Yet stock returns have been oversold by Wall Street‘s salesmen and by the mutual fund industry‘s giant marketing apparatus. In their own financial interests, they

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ignored the fact that the great bull market we enjoyed during the final 25 years of the 20th century was in large part an illusion, creating what I call ―phantom returns‖ that would not recur. Think about it: From 1926 to 1974, the average annual real (inflation-adjusted) return on stocks was 6.1 percent. But during the following quarter-century, stock returns soared, an explosion borne, not of the return provided by corporations in the form of dividend yields and earnings growth, but of soaring price-to-earnings ratios, what I define as speculative return. This higher market valuation reflected investor enthusiasm (and greed), and produced an extra speculative return of 5.7 percent annually, spread over 20 full years, an event without precedent. This speculative return almost doubled the market‘s investment return (created by dividend yields and earnings growth), bringing the market‘s total real return to nearly 12 percent per year. From these speculative heights, the market had little recourse but to return to normalcy, by providing far lower returns in subsequent years. And in fact, the real return on stocks since the turn of the century in 1999 has been minus 7 percent per year, composed of a negative investment return of -1 percent and a negative speculative return of another -6 percent, as price-earnings multiples retreated to (or below) historical norms. The message here is that investors in their ignorance, and financial sector marketers with their heavy incentives to sell, well, ―products,‖ failed to make the necessary distinction between the returns earned by business (earnings and dividends) and the returns earned by, well, irrational exuberance and greed. Today, we realize that much of the value and wealth we saw reflected on our quarterly 401(k) statements was indeed phantom wealth. But as yesteryear‘s stewards of our investment management firms became modern-day salesmen of investment products, they had every incentive to disregard the fact that this wealth could not be sustained. Our marketers (and our investors) failed to recognize that only the fundamental (investment) returns apply as time goes by. As a result, we misled ourselves about the realities that lay ahead, to say nothing of the risks associated with equity investing.

3. Owning the Stock Market—and the Bond Market Investors seem to largely ignore the close link between lower costs and higher returns— what I call (after Justice Brandeis) ―The Relentless Rules of Humble Arithmetic.‖ Plan participants and employers also ignore this essential truism: As a group, we investors are all ―indexers.‖ That is, all of the equity owners of U.S. stocks together own the entire U.S. stock market. So our collective gross return inevitably equals the return of the stock market itself. And because providers of financial services are largely smart, ambitious, aggressive, innovative, entrepreneurial, and, at least to some extent, greedy, it is in their own financial interest to have plan sponsors and participants ignore that reality. Our financial system pits one investor against another, buyer vs. seller. Each time a share of stock changes hands (and today‘s daily volume totals some 10 billion shares), one investor is (relatively) enriched; the investor on the other side of the trade is (relatively) impoverished. But, as noted earlier, this is no zero-sum game. The financial system—the traders, the brokers, the investment bankers, the money managers, the middlemen, ―Wall Street,‖ as it were—takes a cut of all this frenzied activity, leaving investors as a group inevitably playing a loser’s game. As bets are exchanged back and forth, our attempts to beat the market, and the

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attempts of our institutional money managers to do so, then, enrich only the croupiers, a clear analogy to our racetracks, our gambling casinos, and our state lotteries. So, if we want to encourage and maximize the retirement savings of our citizens, we must drive the money changers—or at least most of them—out of the temples of finance. If we investors collectively own the markets, but individually compete to beat our fellow market participants, we lose. But if we abandon our inevitably futile attempts to obtain an edge over other market participants and all simply hold our share of the market portfolio, we win. (Please re-read those two sentences!) Truth told, it is as simple as that. So our Federal Retirement Board should not only foster the use of broad-market index funds in the new DC system (and offer them in its own ―fall back‖ system described earlier) but approve only private providers who offer their index funds at minimum costs.

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4. Asset Allocation—Balancing Risk and Return The balancing of returns and risk is the quintessential task of intelligent investing, and that task too would be the province of the Federal Retirement Board. If the wisest, most experienced minds in our investment community and our academic community believe—as they do—that the need for risk aversion increases with age; that market timing is a fool‘s game (and is obviously not possible for investors as a group); and that predicting stock market returns has a very high margin for error, then something akin to roughly matching the bond index fund percentage with each participant‘s age with the remainder committed to the stock index fund, is the strategy that most likely to serve most plan participants with the most effectiveness. Under extenuating—and very limited—circumstances participants could have the ability to opt-out of that allocation. This allocation pattern is clearly accepted by most fund industry marketers, in the choice of the bond/stock allocations of their increasingly popular ―target retirement funds.‖ However, too many of these fund sponsors apparently have found it a competitive necessity to hold stock positions that are significantly higher than the pure age-based equivalents described earlier. I don‘t believe competitive pressure should be allowed to establish the allocation standard, and would leave those decisions to the new Federal Retirement Board. I also don‘t believe that past returns on stocks that include, from time to time, substantial phantom returns—borne of swings from fear to greed to hope, back and forth—are a sound basis for establishing appropriate asset allocations for plan participants. Our market strategists, in my view, too often deceive themselves by their slavish reliance on past returns, rather than focusing on what returns may lie ahead, based on the projected discounted future cash flows that, however far from certainty, represent the intrinsic values of U.S. business in the aggregate. Once we spread the risk of investing—and eliminate the risk of picking individual stocks, of picking market sectors, of picking money managers, leaving only market risk, which cannot be avoided—to investors as a group, we‘ve accomplished the inevitably worthwhile goal: a financial system that is based on the wisdom of long-term investing, eschewing the fallacy of the short-term speculation that is so deeply entrenched in our markets today. Such a strategy effectively guarantees that all DC plan participants will garner their fair share of whatever returns our stock and bond markets are generous enough to bestow on us (or, for

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that matter, mean-spirited enough to inflict on us). Compared to today‘s loser‘s game, that would be a signal accomplishment. Under the present system, some of us will outlive our retirement savings and depend on our families. Others will go to their rewards with large savings barely yet tapped, benefiting their heirs. But like investment risk, longevity risk can be pooled. So as the years left to accumulate assets dwindle down, and as the years of living on the returns from those assets begin, we need to institutionalize, as it were, a planned program of conversion of our retirement plan assets into annuities. This could be a gradual process; it could be applied only to plan participants with assets above a certain level; and it could be accomplished by the availability of annuities created by private enterprise and offered at minimum cost, again with providers overseen by the proposed Federal Retirement Board (just as the federal Thrift Savings Plan has its own board and management, and operates as a private enterprise).

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5. Mutuality, Investment Risk, and Longevity Risk The pooling of the savings of retirement plan investors in this new DC environment is the only way to maximize the returns of these investors as a group. A widely diversified, allmarket strategy, a rational (if inevitably imperfect) asset allocation, and low costs, delivered by a private system in which investors automatically and regularly save from their own incomes, aided where possible by matching contributions of their employers, and proving an annuity-like mechanism to minimize longevity risks is the optimal system to assure maximum retirement plan security for our nation‘s families. There remains the task of bypassing Wall Street‘s croupiers, an essential part of the necessary reform. Surely our Federal Retirement Board would want to evaluate the possible need for the providers of DC retirement plan service to be mutual in structure; that is, management companies that are owned by their fund shareholders, and operated on an ―atcost‖ basis; and annuity providers that are similarly structured. The arithmetic is there, and the sole mutual fund firm that is organized under such a mutual structure has performed with remarkable effectiveness.6 Of course that‘s my view! But this critical analysis of the structure of the mutual fund industry is not mine alone. Listen to Warren Buffett. ―[Mutual fund] independent directors . . . [have] been absolutely pathetic . . . [They follow] a zombie-like process that makes a mockery of stewardship . . . ‗[I]independent‘ directors, over more than six decades, have failed miserably.‖ Then, hear this from another investor, one who has not only produced one of the most impressive investment records of the modern era but who has an impeccable reputation for character and intellectual integrity, David F. Swensen, Chief Investment Officer of Yale University: ―The fundamental market failure in the mutual fund industry involves the interaction between sophisticated, profit-seeking providers of financial services and naïve, return-seeking consumers of investment products. The drive for profits by Wall Street and the mutual fund industry overwhelms the concept of fiduciary responsibility, leading to an all too predictable outcome: . . . the powerful financial services industry exploits vulnerable individual investors . . . The ownership structure of a fund management company plays a role in determining the likelihood of investor success. Mutual fund investors face the greatest challenge with investment management companies that provide returns to public

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shareholders or that funnel profits to a corporate parent—situations that place the conflict between profit generation and fiduciary responsibility in high relief. When a fund‘s management subsidiary reports to a multi-line financial services company, the scope for abuse of investor capital broadens dramatically . . . Investors fare best with funds managed by not-for-profit organizations, because the management firm focuses exclusively on serving investor interests. No profit motive conflicts with the manager‘s fiduciary responsibility. No profit margin interferes with investor returns. No outside corporate interest clashes with portfolio management choices. Not-for-profit firms place investor interests front and center . . . ultimately, a passive index fund managed by a not-for-profit investment management organization represents the combination most likely to satisfy investor aspirations.‖

WHAT WOULD AN IDEAL RETIREMENT PLAN SYSTEM LOOK LIKE?

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It is easy to summarize the ideal system for retirement savings that I‘ve outlined in this Statement. 1. Social Security would remain in its present form, offering basic retirement security for our citizens at minimum investment risk. (However, policymakers must promptly deal with its longer-run deficits.) 2. For those who have the financial ability to save for retirement, there would be a single DC structure, dominated by low-cost—even mutual—providers, inevitably focused on all-market index funds investing for the long term, and overseen by a newly-created Federal Retirement Board that would establish sound principles of asset allocation and diversification in order to assure appropriate investment risk for each participant. 3. Longevity risk would be mitigated by creating simple low-cost annuities as a mandatory offering in these plans, with some portion of each participant‘s balance going into this option upon retirement. (Participants should have the ability to opt-out of this alternative.) 4. We should extend the existing ERISA requirement that plan sponsors meet a standard of fiduciary duty to encompass plan providers as well. (In fact, I believe that a federal standard of fiduciary duty for all money managers should also be enacted.) It may not be—indeed, it is not—a system free of flaws. But it is a radical improvement, borne of common sense and elemental arithmetic, over the present system, which is driven by the interest of Wall Street rather than Main Street. And, with the independent Federal Retirement Board, we have the means to correct flaws that may develop over time, and assure that the interests of workers and their retirement security remain paramount.

End Notes 1 2

The opinions expressed in this speech do not necessarily represent the views of Vanguard‘s present management. For example, in 1981, when the yield on long-term U.S. Treasury bonds was 13 ½ percent, corporations assumed that future returns on their pension plans would average 6 percent. At the end of 2007, despite the sharp

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decline in the Treasury bond yield to 4.8 percent, the assumed future return soared to 8½ percent. Even without the large losses incurred in the 2008 bear market, it seems highly unlikely that such a return will be realized. 3 I have been investing 15 percent of my annual compensation in the DC plan of the company (and its predecessor) that has employed me since July 1951, when I first entered the work force. I can therefore give my personal assurance that tax-deferred defined contribution pension plans, added to regularly, reasonably allocated among stocks and bonds, highly diversified, and managed at low cost, compounded over a long period, are capable of providing wealth accumulations that are little short of miraculous. 4 I recognize that the Pension Protection Act of 2006 provided important improvements to the original 401(k) paradigm, as described in Appendix A, attached. 5 These data are derived from a Research Perspective dated December 2008, published by the Investment Company Institute, the association that represents mutual fund management companies, collecting data, providing research, and engaging in lobbying activities. 6 I‘m only slightly embarrassed to be referring here to Vanguard, the firm I founded 35 years ago. (My modest annual retainer is unrelated to our asset size or growth.) Even a glance at Vanguard‘s leadership in providing superior investment returns, in operating by far at the lowest costs in the field, in earning shareholder confidence, and in developing returns and positive cash flows into our mutual funds (even in the face of huge outflows from our rivals during 2008) suggests that such a structure has well-served its shareholders.

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Chapter 8

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - MILLER STATEMENT

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George Miller WASHINGTON, D.C. – Below are the prepared remarks of U.S. Rep. George Miller (DCA), chairman of the House Education and Labor Committee, for a committee hearing on ―Strengthening Worker Retirement Security." The Education and Labor Committee meets today to explore shortcomings in our nation‘s retirement system and look at solutions so that Americans can enjoy a safe and secure retirement. The current economic crisis has exposed deep flaws in our nation‘s retirement system. These flaws were mostly hidden when the market was doing well. Since the beginning of this crisis, trillions of dollars have evaporated from workers‘ 401(k) accounts. Millions of workers have seen a significant portion of their retirement balance vanish in just a few short months. The committee heard testimony last year that the decline has forced many workers to consider postponing retirement or rejoining the workforce if they have already retired. For many retirees coping with rising costs for health care and other basic expenses, this loss in income is simply devastating. For too many Americans, 401(k) plans have become little more than a high stakes crap shoot. If you didn‘t take your retirement savings out of the market before the crash, you are likely to take years to recoup your losses, if at all. As a result, we are realizing that Wall Street‘s guarantees of predictable benefits and peace of mind throughout retirement was nothing more than a hollow promise. And, many more are questioning whether our nation‘s retirement system as a whole is sufficient to ensure retirement security. Workers and retirees have historically depended on three sources of income during retirement – from defined contribution plans, defined benefit plans and other savings, and Social Security.

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One leg of our retirement system is Social Security, and this program has never looked better. When you consider the trillions that employees have lost in retirement investments, thank goodness we didn‘t get suckered into gambling Social Security funds at the Wall Street casino. Another leg is traditional pension plans. But over the last two decades, many companies have unceremoniously frozen or terminated pension plans. Defined contribution plans, including 401(k)s, and other savings make up the third leg of our nation‘s retirement system. However, the 401(k) is not the supplemental retirement plan as it was originally designed. In fact, more than two-thirds of workers with retirement plans rely solely on 401(k) type plans as their primary retirement vehicle. While 401(k)s are a fact of life, this committee has found that these plans in their current form do not and will not provide sufficient retirement security for the vast majority of Americans. That is why in the short term, we must preserve and strengthen 401(k)s. Hidden fees and conflicts of interest must be rooted out. And, 401(k)s need to be run in the interest of account holders, not the financial services industry. Wall Street middle men live off the billions they generate from 401(k)s by imposing hidden and excessive fees that swallow up workers money. Over a lifetime of work, these hidden fees can take an enormous bite out of workers accounts. Last Congress, I proposed a bill that would require simple and straightforward disclosure of 401(k) fees. Wall Street opposed it. The ferocity of Wall Street‘s response to simple fee disclosure leads me to believe that they do not want 401(k) account holders find out the billions they skim from Americans‘ hard-earned savings. I firmly believe that workers have the right to know exactly how much is taken from their accounts. Every penny contributed to a 401(k) is the worker‘s money and it should be used for the worker‘s retirement. In addition, as one of our witnesses will testify today, the interest of the investment managers selling retirement products to workers do not line up with the interests of account holders. Too often, the most marketed investment options are the worst for workers in terms of expense and performance. Finally, in the long term, we should ask ourselves whether our current system gives workers the ability to ensure a safe and secure retirement. Witnesses appearing today will discuss how the decades-old realignment of our retirement system is putting enormous stress on Americans‘ retirement security. Being able to save for retirement after a lifetime of hard work has always been a core tenet of the American Dream. Retirees ought to have financial security that allows them to focus on family and friends without sacrificing their standard of living. In the short-term, Congress must address ways to improve defined contribution plans. The 401(k) needs to be more transparent, fair, and operated on behalf of the account holder, not Wall Street firms.

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But, we must also ask the difficult questions about the state of our nation‘s retirement system as a whole and look to see whether we need to create a new leg of retirement security. I hope this marks the beginning of an open and frank discussion on where we are today and what we need to do as a country to create a retirement system that works for all Americans, not just the fortunate few. In the coming weeks and months, this committee and Mr. Andrews‘ subcommittee will be exploring all these issues. I look forward to today‘s testimony.

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Chapter 9

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - MUNNELL TESTIMONY

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Alicia H. Munnell Chairman Miller, Ranking Member McKeon, and members of the Committee, thank you for inviting me to testify this morning about the lessons we‘ve learned about our current 401(k) system in the wake of the financial crisis and ideas on how to strengthen our retirement security. My name is Alicia Munnell, and I am Director of the Center for Retirement Research at Boston College. The Center investigates anything that affects how much money people will have in retirement: we study public and private pensions, the Social Security system, and individual decisions about saving and work. Even before the financial crisis, we have been concerned about the ability of 401(k) plans to provide secure retirement income.1 They were not designed for that role. When 401(k) plans came on the scene in the early 1980s, they were viewed mainly as supplements to employer-funded pension and profitsharing plans. Since 401(k) participants were presumed to have their basic retirement income security needs covered by an employer-funded plan and Social Security, they were given substantial discretion over 401(k) choices. Today most workers with pension coverage have a 401(k) as their primary or only plan (see Figure 1). Yet 401 (k)s still operate under the old rules. Workers continue to have almost complete discretion over whether to participate, how much to contribute, how to invest, and how and when to withdraw the funds. Evidence indicates that people make mistakes at every step along the way. They don‘t join the plan, they don‘t contribute enough; they don‘t diversify their holdings; they over invest in company stock; they take out money when they switch jobs; and they don‘t annuitize at retirement.

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Source: Author‘s calculations based on the 2007 SCF.

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Figure 1. Percent of Workers with Pension Coverage by Type of Plan from SCF, 1983 and 2007

Policymakers came to recognize the challenges inherent in 40 1(k) plans – and building on studies by behavioral economists that demonstrated the major role that inertia plays in how workers participate and invest – enacted the Pension Protection Act of 2006 (PPA).2 The PPA encouraged automatic enrollment, fostered automatic increases in deferral rates, and broadened default investment options. This legislation has been helpful, but it is not a ―cure all‖ for 401(k)s. And the PPA did not address the challenges that participants will face on the decumulation side, as they try to figure out the best way to draw down their assets in retirement. The most telling failure of 401(k) plans is the modest balances that participants have accumulated. Based on reports from Vanguard and the new 2007 Survey of Consumer Finances (SCF), median 401(k) holdings for people 55-64 were only about $60,000 in 2007 when the stock market was at its peak.3 A more complete – and more worrisome – picture of how risky retirement has become is captured in our National Retirement Risk Index, which projects the percent of households that will not be able to maintain their standard of living in retirement. This Index shows that the share of households unprepared for retirement jumped from 31 percent in 1983 to 44 percent in 2006. And the number rises to 61 percent explicitly factoring in health care expenses (see Figure 2). My conclusion was that exclusive reliance on 401(k) plans was a catastrophe in the making. But I thought the dimensions of the problem would not become clear for another 10 or 15 years when large numbers of people retired reliant solely on Social Security and 401(k)s. Instead, the financial crisis has accelerated a reexamination of our retirement income system. The financial crisis – and its impact in the real economy – has highlighted the fragility of 401(k) plans as the sole supplement to Social Security.

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Sources: Munnell, Golub-Sass, and Webb (2007); and Munnell et al. (2008).

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Figure 2. The National Retirement Risk Index, 1983-2006 and 2006 Explicitly Incorporating Health Care

Sources: Author‘s estimates based on U.S. Department of Labor (2006); newspaper articles; and personal communication with companies. Note: Most participation data are for plan year 2006 – the most recent Form 5500 data available. Figure 3. Cumulative Percentage of Private-Sector Defined Contribution Plan Participants Affected by Suspension of Employer Match, 2008-2009

401(k) balances have dropped in value by about thirty percent; people are losing their jobs, resulting in fewer contributions and more hardship withdrawals; and companies under pressure are suspending their matching contributions.

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Between October 9, 2007, the peak of the stock market, and October 9, 2008, the Wilshire 5000 declined by 42 percent.4 Participants in 401(k) plans approaching retirement held about two-thirds of their balances in equities.5 As a result, the market value of assets in 401(k)s/IRAs tumbled by about 30 percent (see Table 1). That decline means that the median 40 1(k) holdings for a person 55-64 went from around $60,000 in 2007 to roughly $42,000 at the end of 2008.6 The financial crisis has also severely damaged the real economy. Roughly 3.6 million people have lost their jobs.7 People without jobs cannot contribute to 401(k) plans. And those with jobs increasingly are turning to their 401(k) plans for help. Hardship withdrawals (to cover the purchase of a primary residence, educational expenses, medical expenses, or general financial pressures) – while still at relatively low levels – have ticked up. According to data from Fidelity and Vanguard, to date roughly 2 percent of participants have made a hardship withdrawal.8 My sense is that many more will tap their 401(k) before the recession is over. Finally, as the recession gains momentum, companies under severe earnings pressure have announced a suspension of their 401(k) matches. This response mirrored what happened in the wake of the 2001 recession when many large companies stopped matching employee contributions. Once again the automobile companies led the way with Ford and General Motors suspending the match for their salaried employees. But suspensions have also occurred at Kodak, FedEx, US Steel and many other companies. We track these announcements and estimate to date that about 1.6 percent of 401(k) participants have lost their 401(k) match (see Figure 3). The seriousness of the current suspensions depends on whether more firms follow suit and whether the suspensions are a temporary or permanent phenomenon. If, as was the case in the wake of the 2001 recession, the suspensions are temporary, the effects will probably be modest. On the other hand, if these suspensions lead to a permanent decline of the employer match, significantly fewer people will participate – especially among the lower paid – and people will end up with noticeably less retirement income. Table 1. Equity Declines October 9, 2007 – October 9, 2008 in Retirement Plans, Trillions of Dollars Type of Plan Defined contribution plans IRAs Private defined contribution plans Federal government plana Defined benefit plans Private defined benefit plans State and local plans Total

10/9/2007 $4.7 2.0 2.6 0.2 4.2 1.8 2.4 8.8

10/9/2008 $2.7 1.1 1.5 0.1 2.4 1.0 1.4 5.1

Decline $2.0 0.8 1.1 0.1 1.7 0.7 1.0 3.7

Source: Author‘s updates based on Munnell and Muldoon (2008). Note: Figures may not add to totals due to rounding. Also, this figure varies slightly from that in Munnell and Muldoon (2008) due to changes in the way the Flow of Funds estimates equity holdings and the valuations of firms‘ market value. Further details can be found in U.S. Board of Governors of the Federal Reserve System (2008). a The federal government holdings are those in the Thrift Savings Plan.

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Some older workers can absorb the shock of the financial crisis by working longer. And working longer should be an important component of responding to the crisis and for strengthening our retirement income system.

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Even before the financial collapse, we have argued that people need to work longer.9 The reason is that the retirement system is contracting and people are living longer. At any given age, Social Security benefits will replace a smaller fraction of pre-retirement earnings than in the past because 1) the Full Retirement Age is moving from 65 to 67, which is equivalent to an across-the-board cut; 2) Medicare premiums, which are automatically deducted from Social Security benefits, are slated to increase sharply; and 3) the taxation of Social Security benefits under the personal income tax will move further down the income distribution, as the exemption amounts in the tax code are not indexed to wage growth or inflation (see Figure 4). In addition, as noted above, balances in 401(k) plans are modest, and people save virtually nothing outside of employer-sponsored plans. While the retirement system is contracting, life expectancy is increasing. For men, life expectancy at 65 was 14.7 years in 1980 and is expected to be 17.5 years in 2030.10 For women, the comparable numbers are 18.7 years and 21.1 years. Older workers, whose 401(k) balances have been decimated by the financial crisis, have three options: they can save more, they can live on less in retirement, or they can work longer. Saving enough to offset the impact of the financial collapse is virtually impossible.11 Reducing an already modest retirement income further is undesirable. So the only real option is to keep working. And that is apparently what many have decided to do. The employment statistics are dramatic. A greater percentage of men age 55 and older are working today than at the peak of the expansion in late 2007 (see Figure 5). This pattern is in sharp contrast to that of younger workers, where the employment rate is over 4 percentage points lower than at the cyclical peak.

Source: Author‘s updates based on Munnell (2003). Figure 4. Social Security Replacement Rates for Average Earner Retiring at Age 65, 2002 and 2030

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Note: Data are seasonally adjusted. ―Today‖ covers the period from December 2007-January 2009. Sources: Author‘s updates based on Munnell, Muldoon, and Sass (2009). Figure 5. Change in Employment to Population Ratio, Men Aged 25-54 and 55 and Older, Recent Recessions and Today

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Working longer is a powerful antidote to both the immediate crisis and the long-run contraction of the retirement income system. It directly increases current income; it avoids the actuarial reduction in Social Security benefits; it allows people to contribute more to their 401(k) plans; and it shortens the period of retirement. Working longer alone, however, will not ensure security for older Americans. To avoid a repeat of the current crisis, we also need to shore up our retirement income system. This task requires avoiding further reductions in Social Security and introducing a new tier of retirement income. The collapse of 401(k) plans during the recent financial crisis has highlighted the importance of Social Security as the backbone of our retirement income system. While Social Security faces a shortfall over the next 75 years because of the aging of the population, it has been almost totally unaffected by our current economic woes. The Social Security Administration continues to send out monthly checks, which while modest, are a predictable source of income that people can count on. Moreover, these benefits are a really special type of income because they are adjusted each year for changes in the cost of living and they continue for as long as the recipient lives. As discussed above, Social Security will replace less of pre-retirement earnings in the future than it has in the past. Any further reductions would put millions of future retirees at risk. My view is that, with little else to rely on, Americans will be willing to pay higher taxes to maintain this extremely successful program. Stabilizing Social Security is not enough, however. We also need to consider a new tier of retirement income. This tier would help bolster retirement security both for low-wage workers facing declining Social Security replacement rates and for middle- and upper- wage workers who increasingly rely on 40 1(k) plans as their only supplement to Social Security (see Figure 6).

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Source: Author‘s illustration.

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Figure 6. Additional Tier of Funded, Privately-Managed Retirement Saving

The goal of this additional tier would be to replace about 20 percent of pre-retirement income. To accomplish the goal, participation should be mandatory, participants should have no access to money before retirement, and benefits should be paid as annuities. The system should be funded and reside as much as possible in the private sector. As we have just learned, funded and pay-as-you-go systems are subject to different kinds of risks, so such an approach would allow us to diversify the risks. Moving beyond principles is difficult. The challenge hinges on the tradeoff between lifetime returns and the required contribution. Equities offer a higher return, but they also bring greater risk, as we have just seen. Relying on equities therefore creates two types of problems. First, replacement rates will vary dramatically depending on the performance of the stock market over the period when the participant is working and accumulating assets. Some cohorts of retirees will get a lot, and others will end up with little. Second, as the recent financial crisis highlights, values can drop precipitously just as participants are approaching retirement. A sharp drop in retirement balances upsets people‘s plans, even if the drops merely offset a lifetime of high returns. The net result is inadequate retirement saving. The natural response is to think about trying to protect people by offering guarantees. The problem is that low rates of guarantee – 2 percent or 3 percent inflation-adjusted – would have done nothing to protect workers over the last 84 years. The reason is that no retiring cohort would have earned less than 3.8 percent on a portfolio of equities, so low guarantees would never have kicked in. Only high guarantees – like 6 percent – would have had any impact, but standard finance theory says such guarantees are not possible, as long as the guarantor shares the market‘s aversion to risk. Perhaps the best we can do is a tier modeled on the Federal Thrift Savings Plan with sensible target date funds. Such an approach would avoid unnecessary risks, such as investing in a single stock or holding too large a share in equities just prior to retirement. But it would be nice to think a little more about guarantees and risk sharing.

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In any case, the message that I want to leave is that we need more organized retirement saving. A declining Social Security system and fragile 401(k) plans will not be enough for future retirees.

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REFERENCES Choi, James, J., David Laibson & Brigitte, C. Madrian. (2004). Plan Design and 401(k) Savings Outcomes. Working Paper 10486. Cambridge, MA: National Bureau of Economic Research. Fidelity Investments. (2007). Building Futures Volume VIII: A Report on Corporate Defined Contribution Plans. Boston, MA. Fidelity Investments. (2009). ―Fidelity Reports on 2008 Trends in 401(k) Plans.‖ Press Release. Boston, MA. Madrian, Brigitte, C. & Dennis, F. Shea. (2001). ―The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior.‖ The Quarterly Journal of Economics 116(4). Munnell, Alicia H. (2003), ―The Declining Role of Social Security,‖ Just the Facts on Retirement Issues. Chestnut Hill, MA: Center for Retirement Research at Boston College. Munnell, Alicia H., Francesca Golub-Sass & Anthony Webb. (2007). ―What Moves the National Retirement Risk Index? A Look Back and an Update.‖ Issue in Brief 7- 1. Chestnut Hill, MA: Center for Retirement Research at Boston College. Munnell, Alicia H. & Dan Muldoon. (2008). ―Are Retirement Savings Too Exposed to Market Risk?‖ Issue in Brief 8-16. Chestnut Hill, MA: Center for Retirement Research at Boston College. Munnell, Alicia H., Dan Muldoon & Steven A. Sass. (2009). ―Recessions and Older Workers.‖ Issue in Brief 9-2. Chestnut Hill, MA: Center for Retirement Research at Boston College. Munnell, Alicia H., Mauricio Soto, Anthony Webb, Francesca Golub-Sass, & Dan Muldoon. (2008). ―Health Care Costs Drive Up the National Retirement Risk Index.‖ Issue in Brief 8-3. Chestnut Hill, MA: Center for Retirement Research at Boston College. Munnell, Alicia H. & Steven A. Sass. (2008). Working Longer: The Solution to the Retirement Income Challenge. Washington, DC: Brookings Institution Press. Munnell, Alicia H. and Annika Sundén. 2004. Coming up Short: The Challenge of 401(k) Plans. Washington, D.C.: Brookings Institution Press. U.S. Board of Governors of the Federal Reserve System. Survey of Consumer Finances. 1983-2007. Washington, DC. —2008. Flow of Funds Accounts of the United States. (December 11 Release). Washington, DC. U.S. Bureau of Labor Statistics. (2009). The Employment Situation: January 2009. Washington, DC. U.S. Department of Labor. (2006). Form 5500 Data. U.S. Social Security Administration. (2008). Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds. Washington, DC: U.S. Government Printing Office.

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Vanguard. (2008). How America Saves 2008: A Report on Vanguard 2007 Defined Contribution Plan Data. Valley Forge, PA. Vanguard Center for Retirement Research. (2009) (forthcoming). ―2008 Hardship Withdrawals.‖ Valley Forge, PA. Wilshire Associates. (2008). Dow Jones Wilshire 5000 (Full Cap) Price Levels Since Inception. Available at: http://www.wilshire.com/Indexes/calculator/csv/w5kppidd.csv.

End Notes 1

Munnell and Sundén (2004). See, for example, Madrian and Shea (2001) and Choi, Laibson and Madrian (2004). 3 Vanguard (2008); and U.S. Board of Governors of the Federal Reserve System (2007). Focusing on only 401(k) balances understates accumulations because participants often roll money into Individual Retirement Accounts (IRAs). According to the 2007 SCF, median 401(k)/IRA balances for working individuals age 55-64 were $78,000. 4 As a result, the value of equities in pension accounts declined by almost $4.0 trillion (Munnell and Muldoon 2008). Individuals were sheltered from the immediate impact of the $1.7 trillion of losses in defined benefit plans. But they did experience a direct hit on the $2.0 trillion in losses that occurred in 401(k)s and IRAs. 5 Fidelity Investments (2007); and Vanguard (2008). 6 Author‘s calculations based on U.S. Board of Governors of the Federal Reserve System (2007); and Wilshire Associates (2008). 7 U.S. Bureau of Labor Statistics (2009). 8 Fidelity (2009); and Vanguard Center for Retirement Research (2009). 9 Munnell and Sass (2008). 10 U.S. Social Security Administration (2008). 11 For example, a person with eight years to retirement who had been on track to get 50 percent of his retirement income from financial assets would have to raise his saving rate from 6 percent to 21 percent to make up for the drop in the stock market.

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2

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In: Strengthening the Retirement System Beyond Social Security ISBN: 978-1-60741-752-1 Editor: Kala E. Upshaw © 2010 Nova Science Publishers, Inc.

Chapter 10

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - PSCA STATEMENT

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House Committee on Education and Labor The Profit Sharing/401k Council of America (PSCA), commends Chairman Miller for convening a series of hearing to examine the employer provided retirement plan system. PS CA, a national non-profit association of 1,200 companies and their six million employees, advocates increased retirement security through profit sharing, 401(k), and related defined contribution programs to federal policymakers. It makes practical assistance available to its members on profit sharing and 401(k) plan design, administration, investment, compliance, and communication issues. Established in 1947, PSCA is based on the principle that defined contribution partnership in the workplace fits today‘s reality. PSCA's services are tailored to meet the needs of both large and small companies, with members ranging in size from Fortune 100 firms to small entrepreneurial businesses.

THE MARKET CRISIS MUST BE ADDRESSED 401(k) plan participants, working in partnership with employers, can successfully manage normal market risks and cycles and accumulate ample assets for retirement. However, they cannot succeed without efficient and transparent capital markets. The drop in 401(k) account balances in 2008 was not caused by a defect in the 401(k) system or by ignorant participants. These plans are caught in the same financial crisis that has paralyzed business and financial organizations throughout the world. 401(k) participants have suffered along with everyone else. Inadequate enforcement, misguided policy, reckless conduct, and unethical behavior in the capital markets are the problem, not 401(k) plans. We urge the Committee, and Congress, to direct their efforts to ensuring that a similar market collapse never again occurs. 401(k) participants, as well as all other investors, will then be able to move confidently forward, knowing that saving and investing for the long term will pay off as expected.

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The Department of Labor reports that in 2006, the latest year available, participants and employers contributed over $250 billion to 40 1(k) type plans. The plans continue to improve, benefitting from a regulatory structure that permits flexible plan design and innovation. Automatic enrollment and target date funds were rare five years ago, but they are quickly becoming dominant plan design features. PSCA urges Congress to fix the markets and continue to work together with plan sponsors and providers to continually improve the very successful 401(k) system Contrary to several published reports, real current data indicates that 401(k) participants are remaining resolute. They are not stopping contributions or increasing their loan activity. Hardship withdrawals have increased slightly, but the percentage of participants taking a hardship distribution remains well below two percent1.

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DEFINED CONTRIBUTION PLANS WORK FOR EMPLOYEES, EMPLOYERS, AND AMERICA Employers offer either a defined benefit or defined contribution, and sometimes both types, of retirement plan to their workers, depending on their own business needs. According to the Investment Company Institute, Americans held $15.9 trillion in retirement assets as of September 30, 2008, the latest available date.2 On June 30, 2008, retirement assets totaled $16.9 trillion and they were $18 trillion on September 30, 2007. Government plans held $3.9 trillion. Private sector defined benefit plans held $2.3 trillion. Defined contribution plans held $4.0 trillion in employment based defined contribution plans, including $2.7 trillion in 40 1(k) plans, and $4.1 trillion in IRAs. Employer-based savings are the source of half of IRA assets. Ninety-five percent of new IRA contributions are rollovers, overwhelmingly from employer plans. Annuities held $1.5 trillion. There are questions about the ability of the defined contribution system to produce adequate savings as it becomes the dominant form of employer provided retirement plan. Some claim America is facing a retirement savings crisis. To answer this question, a baseline for comparison is required. The Congressional Research Service reports that in 2007, 22.8% of individuals age 65 and older received any income from a private sector retirement plan. The median annual income from this source was $7,200.3 This income stream represents a lump-sum value of $90,000, assuming the purchase of a single-life annuity at an 8% discount rate. Individuals age 65-69 had higher median annual income from a private sector retirement plan, $9,700 ($121,250 lump sum value), but only 19.6% of those age 65 or older received any income from this source. Overall, however, the elderly are not impoverished. In 2007, 9.7% of Americans 65 and older had family incomes below the federal poverty rate, the lowest rate for any population group. How will the next generation of retirees fare compared to current retirees? We hear about a negative savings rate in America, with some noting that Americans are saving less now than during the Great Depression. Intuitively, something must be wrong with this statistic as the total amount set aside for retirement has almost tripled in 12 years.4 A 2005 analysis by the Center for Retirement Research sheds considerable light on the matter. They discovered that the NIPA (National Income and Products Account) personal savings rate for the working-age population was significantly higher than the overall rate, which was

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then 1.8%. Working-age Americans were saving 4.4% of income, consisting almost exclusively of savings in employment-based plans. This does not include business savings, which, of course, are owned by individuals. Those 65 and older were ―dissaving‖ at negative 12% because they were spending their retirement assets, which are not considered income. The report accurately predicted that, as baby-boomers begin to retire, they will consume more than their income and the savings rate as currently defined would go even lower.5 A recent paper from the AARP Public Policy Institute includes the following finding:

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―While the personal saving rate has declined steadily for the past 20 years, aggregate household net worth, including pension, 401(k), IRA, and housing wealth have increased dramatically. As an indicator of the adequacy of retirement assets, the personal savings rate, despite being cited regularly in the media, is not very useful because it excludes capital gains, which are far more important to changes in net worth than annual personal saving. The change in household net worth, and not the saving rate, should be used to indicate changes in 6 retirement preparation. ‖

The Congressional Research Service reports that married households in which the head or spouse was employed and the head was age 45-54 held median retirement account assets of $103,200 in 2004. Similar unmarried households held $32,000. An identical married household headed by an individual age 55 and older held median retirement account assets of $119,500 in 2004.7 While some workers have enjoyed a full working career under a defined contribution plan such a as profit sharing plan, 401(k)-type plans in which the employee decides how much to save have existed for only slightly over twenty years, and most participants have participated in them for a much shorter period of time. The typical participant in 2000 had only participated in the plan for a little over seven years.8 Policymakers must be wary of statistics citing average 401(k) balances and balances of those approaching retirement because they have not saved over their full working career and some balances belong to brand new participants. For example, a recent Investment Company Institute report stated that at the end of 2006, the average 401(k) balance was $61,346 and the median balance was $18,986.9 The median age of the participants in the study was 44 and the median tenure in their current 401(k) plan was eight years. But when the study looked at individuals who were active participants in a 401(k) plan from 1999 to 2006 (including one of the worst bear markets since the Depression) the average 401(k) balance at the end of 2006 was $121,202 and the median balance was $66,650. Long-tenured (30 years with the same employer) individuals in their sixties who participated in a 401(k) plan during the 1999-2006 period had an average account balance of $193,701 at the end of 2006. The study does not reflect that many individuals and households have multiple 401(k)-type accounts or assets rolled over into an IRA. In their April 2007 paper, The Rise of 401(k) Plans, Lifetime Earnings, and Wealth at Retirement, James Poterba, Steven Venti, and David A. Wise reported the following: ―Our projections suggest that the average (over all persons) present value of real DB benefits at age 65 achieved a maximum in 2003, when this value was $72,637 (in year 2000 dollars), and then began to decline. The projections also suggest that by 2010 the average level of 401(k) assets at age 65 will exceed the average present value of DB

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benefits at age 65. Thereafter the value of 401(k) assets grows rapidly, attaining levels much greater than the historical maximum present value of DB benefits. If equity returns between 2006 and 2040 are comparable to those observed historically, by 2040 average projected 401(k) assets of all persons age 65 will be over six times larger than the maximum level of DB benefits for a 65 year old achieved in 2003 (in year 2000 dollars). Even if equity returns average 300 basis points below their historical value, we project that average 401(k) assets in 2040 would be 3.7 times as large as the value of DB benefits in 2003. These analyses consider changes in the aggregate level of pension assets. Although the projections indicate that the average level of retirement assets will grow very substantially over the next three or four decades, it is also clear that the accumulation of assets in 401(k)like plans will vary across households. Whether a person has a 401(k) plan is strongly related to income. Low-income employees are much less likely than higher-income employees to be covered by a 401(k) or similar type of tax-deferred personal account plan.‖

The Congressional Research Service estimates that a married household that contributes ten percent of earnings to a retirement plan for 30 years will be able to replace fifty-three percent of pre-retirement income. If they save for forty years, they will replace ninety-two percent of income.10 A ten percent savings rate is realistic given average contribution rates of seven percent and average employer contributions of three percent. These estimates do not consider Social Security payments The lesson is clear – long-term participation in a 401(k) plan will result in the accumulation of assets adequate to provide a secure retirement. These statistics mean little if a worker is not saving for retirement. One fact is abundantly clear – whether a worker saves for retirement is overwhelmingly determined by whether or not a worker is offered a retirement plan at work. In 2008, sixty-one percent of private sector workers had access to a retirement plan at work and fifty-one percent participated. Seventyone percent of full-time workers had access and sixty percent participated. Seventy-nine percent of workers in establishments employing 100 or more workers had access and sixtyseven percent participated. Only forty-five percent of workers in establishments of less than 100 workers had access to a plan and thirty-seven percent participated, but for establishments with between 50 and 100 workers, fifty-eight percent had access and 45 percent participated.11 These participation rates are at a single point in time. They are not indicative of whether or not a non-participant or their household will choose to participate in a 40 1(k) plan for a substantial period of a working career.

DB AND DC PLANS – UNDERSTANDING THE RISKS AND REWARDS Defined benefit plans and defined contribution plans are very different, and each plan has strengths and weaknesses. A traditional defined benefit plan pays a benefit at retirement that is based on a formula that considers years of service and compensation, (usually compensation in the last few years of employment). The employer assumes the investment risk for funding the plan and, accordingly, benefits from high investment returns. In a defined contribution plan, the employer commits to a certain contribution level and the employee is impacted by investment gains and losses. Proper investment strategies, such

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as diversification and age-based asset allocations, can greatly reduce investment risk. Target date funds and managed accounts permit a participant to delegate these actions to experts. A risk-averse participant can usually invest in a very conservative, but low-yielding investment. All DC plan participants can independently annuitize their retirement assets if they wish to do so. Many observers view the different impact of investment risk to claim, incorrectly, that DB plans are risk- free. DB plans are ―back-loaded‖ - the final benefit is strongly determined by earnings in the final years of employment and years of service. Older employees and longterm employees benefit most under a DB plan. Individuals who are involuntarily separated, and those who leave voluntarily, loose a major portion of their future benefit. Traditional DB plans are not portable to a new employer. A second major risk is that the employer will decide to terminate the plan. In both cases, the employee is left only with their accrued vested benefit, usually payable many years in the future. If the sponsoring employer becomes bankrupt, benefits may be further reduced to the PBGC guaranty level. Some defined benefit plans limit payments to a fixed annual amount, resulting in default and inflation risk. Finally, a DB plan benefit ends when the participant (or perhaps a spouse) dies. Those who die early subsidize long-lived participants and there is no opportunity to pass on wealth. Both types of plans have risks for participants. The primary difference is that in the DC plan system the individual can take responsibility for managing risk. In DB plans, most of the risk is beyond the control of the individual.

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OPPORTUNITIES FOR IMPROVEMENT What does all these data tell us? First, the employer provided defined contribution system has demonstrated that it can provide asset accumulation adequate for a secure retirement for participants at all income levels. The participation rate when offered a plan is encouraging, but can be improved. There are two areas in which to concentrate our efforts - lower-paid workers and small business plan coverage. We also need to increase participation by AfricanAmericans and some ethnic groups, as revealed by some recent studies. Small business owners need simplicity and meaningful benefits for themselves to compensate for the costs of providing a plan to their workers. The growth of automatic enrollment plans will substantially increase retirement plan participation by lower and middle-income workers that are most likely to be induced to save by this type of plan design. Ninety percent of workers that are automatically enrolled choose not to opt out of the plan.12 A 2005 ICI/EBRI study projects that a lowest quartile worker reaching age 65 between 2030 and 2039 who participates in an automatic enrollment program with a 6% salary deferral (with no regard for an employer match) and investment in a lifecycle fund will have 401(k) assets adequate for 52% income replacement at retirement, not including social security that provides another 52% income replacement under today‘s structure. 13 The important automatic enrollment provisions in the Pension Protection Act are already producing results. In the latest PSCA survey of 2006 plan year experience, 35.6% of plans have automatic enrollment, compared to 23.6% in 2006, 16.9% in 2005, 10.5% in 2004, and 8.4% in 2003. 53.2% of plans with 5,000 or more participants reported utilizing automatic

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enrollment in our survey. A Hewitt survey indicated that 36% of respondents offered automatic enrollment in 2007, up from 24% in 2006. Fifty-five percent of the other respondents are ―very likely or somewhat likely‖ to offer automatic enrollment in 2007.14 More than 300 Vanguard plans had adopted automatic enrollment by year-end 2007, triple the number of plans that had the feature in 2005. Large plans have been more likely to implement automatic enrollment designs. In 2007, Vanguard plans with automatic enrollment accounted for 15% of plans but one-third of total participants. In the aftermath of the PPA, two-thirds of automatic enrollment plans have implemented automatic annual savings rate increases, up from just one-third in 2005.15

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401(K) FEES IN THE ERISA FRAMEWORK Numerous aspects of ERISA (the Employee Retirement Income Security Act of 1974) safeguard participants‘ interests and 401(k) assets. Plan assets must generally be held in a trust that is separate from the employer‘s assets. The fiduciary of the trust (normally the employer or committee within the employer) must operate the trust for the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan. In other words, the fiduciary has a duty under ERISA to ensure that any expenses of operating the plan, to the extent they are paid with plan assets, are reasonable. To comply with ERISA, plan administrators must ensure that the price of services is reasonable at the time the plan contracts for the services and over time. For example, assetbased fees should be monitored as plan assets grow to ensure that fee levels continue to be reasonable for services with relatively fixed costs such as plan administration and perparticipant recordkeeping. The plan administrator should be fully informed of all the services included in a bundled arrangement to make this assessment. Many plan administrators prefer reviewing costs in an aggregate or ―bundled‖ manner. As long as they are fully informed of the services being provided, they can compare and evaluate whether the overall fees are reasonable without being required to analyze each fee on an itemized basis. For example, if a person buys a car, they don‘t need to know the price of the engine if it were sold separately. They do need to know the horsepower and warranty. Small business in particular may prefer the simplicity of a bundled fee arrangement. It is important to understand the realities of fees in 401(k) plans. There are significant recordkeeping, administrative, and compliance costs related to an employer provided plan that do not exist for individual retail investors. Nevertheless, because of economies of scale and the fiduciary‘s role in selecting investments and monitoring fees, the vast majority of participants in ERISA plans have access to capital markets at lower cost through their plans than the participants could obtain in the retail markets. The Investment Company Institute reports that the average overall investment fee for stock mutual funds is 1.5% and that 401(k) investors pay half that amount.16 The level of fees paid among all ERISA plan participants will vary considerably, however, based on variables that include plan size (in dollars invested and/or number of participants), average participant account balances, asset mix, and the types of investments and the level of services being provided. Larger, older plans typically experience the lowest cost. Employer provided plans

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are often the only avenue of mutual fund investment available to lower- paid individuals who have great difficulty accumulating the minimum amounts necessary to begin investing in a mutual fund or to make subsequent investments. Finally, to the degree an employer provides a matching contribution, and most plans do, the plan participant is receiving an extraordinarily high rate of return on their investment that a retail product does not provide. A study by CEM Benchmarking Inc. of 88 US defined contribution plans with total assets of $512 billion (ranging from $4 million to over $10 billion per plan) and 8.3 million participants (ranging from fewer than 1,000 to over 100,000 per plan) found that total costs ranged from 6 to 154 basis points (bps) or 0.06 to 1.54 percent of plan assets in 2005. Total costs varied with overall plan size. Plans with assets in excess of $10 billion averaged 28 bps while plans between $0.5 billion and $2.0 billion averaged 52 bps. In a separate analysis conducted for PSCA, CEM reported that, in 2005, its private sector corporate plans had total average costs of 33.4 bps and median costs of 29.8 bps. Other surveys have found similar costs. HR Investment Consultants is a consulting firm providing a wide range of services to employers offering participant-directed retirement plans. It publishes the 401(k) Averages Book that contains plan fee benchmarking data. The 2008 Ninth Edition of the book reveals that average total plan costs ranged from 161 bps for plans with 25 participants to 96 bps for plans with 5,000 participants. The Committee on the Investment of Employee Benefit Assets (CEIBA), whose more than 120 members manage $1.5 trillion in defined benefit and defined contribution plan assets on behalf of 16 million (defined benefit and defined contribution) plan participants and beneficiaries, found in a 2005 survey of members that plan costs paid by defined contribution plan participants averaged 29 bps.

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PRINCIPLES OF REFORM PSCA supports effective and efficient disclosure efforts. The following principles should be embodied in any effort to enhance fee disclosure in employer-provided retirement plans. Sponsors and Participants’ Information Needs Are Markedly Different. Any new disclosure regime must recognize that plan sponsors (employers) and plan participants (employees) have markedly different disclosure needs. Overloading Participants with Unduly Detailed Information Can Be Counterproductive. Overly detailed and voluminous information may impair rather than enhance a participant‘s decision-making. New Disclosure Requirements Will Carry Costs for Participants and So Must Be Fully Justified. Participants will likely bear the costs of any new disclosure requirements so such new requirements must be justified in terms of providing a material benefit to plan participants‘ participation and investment decisions. New Disclosure Requirements Should Not Require the Disclosure of Component Costs That Are Costly to Determine, Largely Arbitrary, and Unnecessary to Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

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House Committee on Education and Labor Determine Overall Fee Reasonableness. Bundled service providers should disclose the included services in detail. However, a requirement to ―unbundle‖ bundled services and provide individual costs in many detailed categories would be arbitrary and is not particularly helpful and would lead to information that is not meaningful. It also raises significant concerns as to how a service provider would disclose component costs for services if they were not offered outside a bundled contract. These costs will ultimately be passed on to plan participants through higher administrative fees. The increased burden for small businesses could inhibit new plan growth. Information About Fees Must Be Provided Along with Other Information Participants Need to Make Sound Investment Decisions. Participants need to know about fees and other costs associated with investing in the plan, but not in isolation. Fee information should appear in context with other key facts that participants should consider in making sound investment decisions. These facts include each plan investment option's historical performance, relative risks, investment objectives, and the identity of its adviser or manager. Disclosure Should Facilitate Comparison But Sponsors Need Flexibility Regarding Format. Disclosure should facilitate comparison among investment options, although employers should retain flexibility as to the appropriate format for workers.

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Participants Should Receive Information at Enrollment and Have Ongoing Access. Participants should receive fee and other key investment option information at enrollment and be informed periodically about fees.

HR 3185 PSCA supports legislation that will effectively improve fee transparency for sponsors and participants. HR 3185, as reported by the Committee on April 16, 2008, reflects many of our principles and is a significant improvement over the original legislation. In addition to numerous minor adjustments to ensure that HR 3185 reflects the complexity of the retirement plan system, PSCA recommends three key changes. First, the legislation needs to include a ―matching proposal‖ that specifies that the fiduciary duty to determine that fees are reasonable is limited in scope to the fees required to be disclosed under the legislation. The Committee agreed to examine this issue when Representative Kline offered and withdrew an implementing amendment during the 2008 mark-up. Second, Congress should abandon the ―unbundling‘ requirement in the bill and permit both models to compete in the marketplace. Bundled providers should provide a detailed description of the services they offer so that plan fiduciaries can determine that the aggregate fee is reasonable. Finally, the index fund requirement in the revised bill remains problematic. For additional information, contact Ed Ferrigno 202-863-7272 or [email protected].

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End Notes 1

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Fidelity Reports on 2008 Trends in 401(k) Plans, Fidelity Investments, January 28, 2009, and Update on Participant Activity Amid Market Volatility, Vanguard Center for Retirement Research, February 19, 2009. 2 The U.S. Retirement Market, Third Quarter 2008, Investment Company Institute, February 2009. 3 Income and Poverty Among Older Americans in 2007, Congressional Research Service, October 3, 2008. 4 The U.S. Retirement Market, Second Quarter 2008, Investment Company Institute, December 2008. 5 How Much are Workers Saving?, Alicia Munnell, Francesca Golub-Sass, and Andrew Varani, Center for Retirement Research at Boston College, October 2005. 6 A New Perspective on ―Saving‖ for Retirement, AARP Public Policy Institute, February 2009. 7 Retirement Savings: How Much Will Workers Have When They Retire?, CRS Report For Congress, January 29, 2007. 8 Rise of 401(k) Plans, Lifetime Earnings and Wealth at Retirement, James Poterba, Steven F. Venti, and David A. Wise, NBER Working Paper 13091, May 2007. 9 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2006, Investment Company Institute, August, 2007. 10 Retirement Savings: How Much Will Workers Have When They Retire?, CRS Report For Congress, January 29, 2007. 11 Employee Benefits in the United States, March 2008, Bureau of Labor Statistics, August 7, 2008. 12 Hewitt Study Reveals Impact of Automatic Enrollment on Employees’ Retirement Savings Habits, Hewitt Associates, October 25, 2006. 13 The Influence of Automatic Enrollment, Catch-Up, and IRA Contributions on 401(k) Accumulations at Retirement, EBRI Issue Brief no. 238, July 2005. 14 Survey Findings: Hot Topics in Retirement 2007, Hewitt Associates 15 How America Saves 2008, Vanguard 16 The Economics of Providing 401(k) Plans: Services, Fees, and Expenses, 2006, Investment Company Institute, September 2007.

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Chapter 11

STRENGTHENING WORKER RETIREMENT SECURITY HEARING - STEVENS TESTIMONY

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Paul Schott Stevens

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Paul Schott Stevens

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Paul Schott Stevens

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Paul Schott Stevens

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Paul Schott Stevens

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Paul Schott Stevens

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Paul Schott Stevens

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CHAPTER SOURCES

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The following chapters have been previously published: Chapter 1 – This is an edited, excerpted and augmented edition of a United States Congressional Research Service publication, Report Order Code RL34678, dated January 29, 2009. Chapter 2 – This is an edited, excerpted and augmented edition of a United States Government Accountability Office (GAO), Report to Congressional Committees. Publication GAO-08-774, dated July 2008. Chapter 3 - These remarks were delivered as Statement of Peter R. Orszag, before the Committee on Education and Labor, U.S. House of Representatives, dated April 18, 2008. Chapter 4 – These remarks were delivered as Statement of Dean Baker, Co-Director of the Center for Economic Policy Research (CEPR), before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009. Chapter 5 - These remarks were delivered as Statement of Matthew D. Hutcheson, Independent Pension Fiduciary, before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009. Chapter 6 – These remarks were delivered as Statement of John C. Bogle, founder and former Cheif Executive of The Vangaurd Group, before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009. Chapter 7 – These remarks were delivered as Statement of George Miller, (D-CA), Chairman of the House Education and Labor Committee, before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009. Chapter 8 – These remarks were delivered as Statement of Alicia M. Munnell, Director of the Center for Retirement Research at Boston College, before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009. Chapter 9 – These remarks were delivered as Statement of The Profit Sharing/401k Council of America (PSCA), before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009. Chapter 10 – These remarks were delivered as Statement of Paul Schott Stevens, President and CEO, Investment Company Institute, before the Committee on Education and Labor, U.S. House of Representatives, dated February 24, 2009.

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INDEX

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A AAA, 47 AARP, 117, 123 accountability, 34 accounting, 4, 49, 93 achievement, 92 actuarial, 50, 110 actuarial methods, 50 adjustment, 52 administration, 4, 9, 10, 11, 12, 13, 22, 41, 43, 44, 66, 115, 120 administrative, vii, 4, 35, 37, 41, 43, 61, 78, 93, 120, 122 administrators, 3, 6, 9, 15, 36, 120 aeronautical, 80 affiliates, 36 African-American, 119 afternoon, 47 age, 22, 26, 29, 43, 50, 51, 61, 64, 71, 75, 77, 91, 92, 93, 96, 109, 113, 116, 117, 119 aid, 8, 13, 27, 29, 31, 36, 60, 89, 120 aiding, 56, 59 alternative, 12, 14, 90, 98 alternatives, 3, 12, 13, 27, 44, 49, 63, 64 amalgam, 94 analysts, 49, 92 annual rate, 68, 88 annuities, 3, 6, 69, 77, 94, 97, 98, 111 anxiety, 60 appendix, 20, 40, 44 application, 81, 82 arithmetic, 97, 98

assessment, 120 assumptions, 87, 92 attitudes, 80 auditing, 20, 34, 43 authority, 18, 19, 20, 21, 23, 34, 39, 42, 43, 44 availability, 42, 97 average costs, 121 averaging, vii, 60, 78 aversion, 96, 111 awareness, 42 B baby boom, 73, 74, 75, 76, 78 back, 81, 88, 89, 90, 95, 96, 119 balance sheet, 91 bankers, 95 banking, 23, 89 bankruptcy, 35, 43, 66 banks, 22, 47 bargaining, 62 basis points, 118, 121 behavior, 61, 86, 115 benchmark, 11, 28, 44, 121 benefits, 2, 4, 6, 13, 15, 16, 20, 22, 23, 26, 32, 34, 38, 48, 55, 56, 60, 61, 62, 66, 69, 75, 77, 81, 86, 88, 90, 101, 109, 110, 111, 117, 118, 119, 120 Board of Governors, 71, 108, 112, 113 bond market, 96 bonds, 14, 27, 47, 48, 56, 63, 66, 81, 88, 92, 93, 98, 99 borrowing, 71

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Index

Boston, 105, 112, 123, 143 breaches, 29, 35, 42 breakdown, 8 brokerage, 6, 28, 44 bubble, 47, 73, 74, 75, 78, 89 Budget Committee, 48 budget deficit, 66 business model, 79 buyer, 95

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C CAP, 18, 35 capital gains, 117 capital markets, 115, 120 capitalism, 88, 89 case law, 85 cash flow, 96, 99 cast, 79 Census, 68 Census Bureau, 68 CEO, viii, 143 chaos, 80, 81 children, 61 citizens, 87, 88, 89, 94, 96, 98 classes, 10, 64 clients, 31, 63, 88, 94 cohort, 74, 75, 111 Columbia, 68 commodities, 52 communication, 41, 44, 107, 115 community, 36, 96 compassion, 86 compensation, 2, 6, 10, 11, 18, 21, 22, 30, 31, 33, 34, 35, 36, 37, 39, 43, 45, 69, 92, 99, 118 competition, 29, 59, 91 complement, 56, 58 complexity, 2, 34, 38, 94, 122 compliance, 3, 8, 12, 14, 21, 30, 34, 35, 38, 41, 42, 115, 120 components, 11 composition, 49 computing, 49

concentration, 93 confidence, 47, 82, 85, 99 conflict, 33, 36, 88, 98 confusion, 3, 21, 25, 30, 33, 34, 39, 80 Congress, 1, 3, 7, 17, 18, 19, 21, 34, 37, 38, 39, 45, 48, 55, 56, 57, 59, 61, 62, 63, 64, 65, 74, 76, 77, 78, 80, 81, 85, 102, 115, 116, 122, 123 Congressional Budget Office, 8, 15, 47, 48, 50, 51, 52 consultants, 30, 32, 33, 35, 45 consulting, 25, 31, 34, 36, 41, 121 consumers, 97 consumption, 92 contracts, 21, 30, 36, 38, 78, 120 control, 3, 11, 12, 21, 22, 43, 44, 83, 119 convergence, 44 conversion, 97 corporations, 82, 87, 88, 89, 91, 95, 98 corrosive, 81 corruption, 79 cost of living, 110 costs, vii, 5, 10, 12, 25, 31, 36, 38, 57, 59, 62, 66, 77, 84, 88, 89, 91, 93, 94, 95, 96, 97, 99, 101, 119, 120, 121, 122 costs of compliance, 38 counseling, 69 courts, 81 covering, 55, 58 credit, 43, 48 critical analysis, 97 CRS, 2, 4, 15, 123 currency, 52 Current Population Survey, 53, 68, 69 cycles, 64, 115 D data collection, 42 death, 43 debt, 47, 52 decision makers, 23

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Index

decisions, viii, 17, 18, 19, 20, 25, 26, 27, 28, 29, 31, 32, 36, 37, 39, 42, 43, 44, 45, 51, 81, 83, 85, 92, 93, 96, 105, 121, 122 deduction, 60, 67, 71 defaults, 47 deficits, 66, 90, 98 defined benefit pension, 75, 78, 88 defined-benefit, 48, 49 defined-contribution plans, 48, 49, 51, 52 definition, 25, 43, 89 delivery, 25, 30 demographics, 84, 91 Department of Commerce, 53 Department of Justice, 23 deposits, 83 destruction, 74 deviation, 81 disability, 43 Disability Insurance, 112 disclosure, vii, 1, 2, 7, 9, 10, 11, 12, 15, 21, 34, 36, 37, 38, 39, 84, 86, 88, 93, 102, 121 discount rate, 49, 116 discretionary, 43, 44, 67 disposition, 43 dissaving, 117 disseminate, 8, 14 distribution, 5, 40, 41, 49, 50, 64, 71, 109, 116 District of Columbia, 68 diversification, 27, 29, 51, 56, 64, 65, 70, 93, 98, 119 dividends, 88, 95 Dow Jones Industrial Average, 14, 78 draft, 39 duties, 2, 20, 21, 25, 27, 29, 30, 32, 34, 62 E earnings, 13, 22, 50, 51, 77, 88, 91, 95, 108, 109, 110, 118, 119 ears, 22 earthquake, 75 economic crisis, vii, 60, 88, 101

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economic cycle, 64 Economic Growth and Tax Relief Reconciliation Act, 43, 59, 65 economic stability, 61 economics, 83, 85 economies of scale, 62, 120 Education, v, vi, vii, viii, 1, 7, 15, 19, 40, 45, 53, 87, 101, 115, 143 educational institutions, 2, 59 elderly, 50, 116 e-mail, 41 emotion, 81, 83 emotional, 83, 85 Employee Retirement Income Security Act, vii, 2, 15, 17, 18, 19, 120 Employee Retirement Income Security Act (ERISA), 15 employees, 1, 2, 3, 14, 18, 20, 26, 40, 41, 43, 50, 56, 58, 59, 60, 61, 62, 63, 64, 65, 66, 67, 68, 69, 70, 71, 77, 85, 90, 91, 92, 102, 108, 115, 118, 119, 121 employment, 43, 53, 109, 116, 117, 118, 119 encouragement, 63 enrollment, 6, 12, 14, 52, 56, 59, 61, 62, 63, 67, 68, 70, 71, 77, 82, 106, 116, 119, 122 enterprise, 61, 89, 97 enthusiasm, 95 environment, 50, 84, 97 EPR, 73 equities, 48, 49, 64, 66, 71, 92, 108, 111, 113 equity, 12, 51, 52, 60, 71, 73, 74, 76, 90, 93, 95, 108, 118 ERISA, vii, 2, 6, 7, 8, 14, 15, 17, 18, 19, 20, 21, 22, 23, 24, 25, 27, 29, 30, 31, 32, 33, 34, 36, 37, 39, 42, 43, 44, 45, 62, 64, 69, 70, 71, 80, 81, 82, 86, 98, 120 ethnic groups, 119 evolution, 56, 59 examinations, 35 execution, 6, 44 exercise, 3, 11, 12, 21, 22, 43, 56, 62

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Index

expertise, 29, 31 exposure, 52, 64 eye, 82

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F FAA, 81 failure, 35, 79, 81, 97, 106 fairness, 56, 61 family, 91, 102, 116 family income, 116 fear, 85, 96 federal budget, 66 Federal Bureau of Investigation, 23 federal government, 59, 66, 76, 108 Federal Register, 15 Federal Reserve, 48, 49, 52, 53, 71, 73, 108, 112, 113 Federal Reserve Board, 53, 73 fees, vii, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 24, 25, 27, 28, 29, 30, 31, 33, 35, 36, 37, 38, 39, 44, 76, 84, 86, 89, 102, 120, 122 fiduciary issue, 24, 37, 39 fiduciary responsibilities, 25, 39, 42 finance, 33, 83, 85, 96, 111 financial crisis, 105, 106, 108, 109, 110, 111, 115 financial institutions, 22 financial markets, 47, 48, 49, 51, 58, 82, 88 financial planning, 6, 59, 80, 85 financial sector, 89, 95 financial system, 88, 89, 94, 95, 96 financing, 48, 56 firms, 38, 52, 61, 76, 95, 98, 102, 108, 115 fixed costs, 120 flexibility, 66, 92, 94, 122 flight, 81 float, 36 Flow of Funds Accounts, 52, 71, 112 fluctuations, 52, 75 focusing, 59, 66, 96 food, 89 Ford, 108

fragility, 106 fraud, 36 funding, 44, 48, 49, 58, 81, 83, 87, 90, 91, 118 funds, 3, 5, 8, 10, 14, 15, 18, 21, 23, 27, 28, 29, 30, 32, 35, 39, 44, 48, 49, 51, 52, 59, 62, 63, 64, 70, 75, 76, 77, 80, 81, 82, 84, 85, 88, 90, 91, 92, 93, 96, 98, 99, 102, 105, 111, 116, 119, 120 G gambling, 96, 102 General Motors, 91, 108 generation, 85, 98, 116 global competition, 91 goals, 20, 29, 30, 60, 61 goods and services, 49, 66, 82, 83, 89 government, 2, 8, 14, 18, 20, 21, 22, 34, 37, 43, 49, 59, 66, 76, 77, 78, 85, 88, 89, 91, 94, 108 Government Accountability Office, 53, 143 Great Depression, 68, 116 greed, 79, 81, 95, 96 groups, 3, 26, 42, 56, 61, 63, 119 growth, 55, 58, 60, 66, 88, 89, 90, 92, 95, 99, 109, 119, 122 guidance, 18, 21, 22, 23, 29, 30, 33, 34, 38, 63, 64, 69 guidelines, 1, 29 H handling, 65 hands, 95 hanging, 76 harm, 21, 39 health, vii, 60, 65, 101, 106 health insurance, 60 hearing, 38, 101, 115 hedge funds, 52 higher education, 65 higher-income, 118 hiring, 29, 31, 32, 49

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Index

Hispanic, 70 historical trends, 60 home value, 58 homeowners, 74 horizon, 14 House, v, vi, viii, 7, 15, 19, 45, 48, 52, 68, 87, 101, 115, 143 household, 73, 74, 75, 90, 117, 118 households, vii, 1, 49, 50, 51, 74, 90, 91, 106, 117, 118 housing, 47, 73, 74, 75, 76, 78, 117 human, 33, 41 human resources, 33, 41

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I id, 50 identity, 6, 8, 10, 11, 14, 122 illiteracy, 82 illusion, 95 imagination, 88 implementation, 91 incentives, 30, 56, 59, 61, 67, 80, 82, 85, 86, 95 income, vii, 1, 8, 12, 14, 15, 16, 19, 22, 27, 43, 49, 50, 52, 55, 56, 57, 58, 60, 61, 63, 64, 67, 69, 70, 73, 74, 75, 76, 77, 78, 80, 83, 84, 85, 86, 90, 92, 94, 101, 105, 106, 108, 109, 110, 111, 113, 117, 118, 119 income distribution, 50, 109 income replacement, 119 income tax, 50, 109 incomes, 85, 97, 116 indication, 40 individual retirement account, 58, 67, 69, 88 industry, viii, 17, 18, 20, 21, 24, 25, 26, 27, 28, 29, 31, 32, 33, 38, 40, 41, 42, 43, 44, 56, 60, 63, 70, 79, 80, 82, 84, 94, 96, 97, 102 inertia, 106 inflation, 9, 64, 93, 95, 109, 111, 119 innovation, 56, 59, 116 Inspector General, 23

installment payments, 71 institutions, 2, 22, 47, 59, 88 instruments, 48, 88 insurance, 3, 6, 22, 23, 30, 45, 60, 76, 89 insurance companies, 6, 22, 76, 89 integrity, 4, 76, 97 interaction, 97 interbank market, 47 interest rates, 47, 48 intermediaries, 10 internal controls, 35 Internal Revenue Code, 8, 15, 22, 23, 43, 61 Internal Revenue Service, 1, 23 interview, 86 interviews, viii, 17, 20, 42 intrinsic, 87, 96 intrinsic value, 87, 96 invasive, 66 investigative, 23, 35 investment bank, 89, 95 investment capital, 56, 66 investors, 10, 60, 62, 71, 86, 91, 92, 93, 95, 96, 97, 115, 120 IRA, 61, 65, 67, 68, 71, 90, 113, 116, 117, 123 IRS, 1, 6, 63 isolation, 122 J job creation, 61 job mobility, 61 jobs, 58, 66, 76, 92, 105, 107, 108 judge, 57 K Keynes, 89 L labor, 51, 91 labor force, 51

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Index

labor force participation, 51 law, 3, 6, 9, 19, 26, 32, 37, 38, 65, 81, 83, 85 leadership, 99 leakage, 65, 76 learning, 42 leg, 102, 103 legislation, vii, 1, 19, 38, 73, 76, 106, 122 lending, 43, 47 life expectancy, 71, 109 lifecycle, 14, 27, 44, 63, 64, 70,119 lifestyle, 28, 59, 84 lifetime, 73, 77, 92, 93, 94, 102, 111 likelihood, 61, 97 limitations, 7, 20, 40, 77 liquidity, 29, 65, 88 literacy, 67 living standards, 74 loans, 3, 7, 18, 26, 35, 47, 65, 71, 92 lobbying, 99 local government, 2, 49, 59, 88, 89, 94 long period, 77, 99 longevity, 89, 90, 91, 94, 97 losses, 8, 14, 15, 16, 18, 21, 39, 47, 75, 99, 101, 113, 118 lotteries, 96 lower prices, 64 lower-income, 63 low-income, 70 loyalty, 33, 62, 82 M management, 6, 9, 10, 12, 20, 25, 26, 27, 31, 36, 43, 88, 89, 95, 97, 98, 99 market, vii, 8, 13, 14, 28, 47, 48, 49, 50, 51, 52, 55, 57, 58, 59, 60, 66, 67, 68, 73, 75, 77, 78, 83, 87, 88, 90, 91, 92, 93, 95, 96, 97, 98, 99, 101, 106, 108, 111, 113, 115 market capitalization, 91 market failure, 97 market value, 50, 87, 108 marketing, 5, 79, 93, 94

marketplace, 59, 122 markets, 47, 48, 49, 51, 58, 60, 68, 75, 82, 88, 89, 94, 96, 115, 116, 117, 120 mask, 33 measures, 34, 55, 58 media, 117 median, 27, 73, 74, 75, 90, 91, 106, 108, 113, 116, 117, 121 Medicare, 75, 76, 109 membership, 42 men, 102, 109 middle class, 74 middle-aged, 92 minority, 63 misunderstanding, 83 mobility, 61 models, 122 momentum, 108 money, 22, 28, 43, 48, 62, 65, 74, 77, 82, 83, 88, 89, 92, 95, 96, 98, 102, 105, 111, 113 morning, 105 mortgage, 47, 73, 74 motion, 75 movement, 91 multiples, 95 mutual funds, 3, 5, 10, 14, 15, 28, 44, 49, 62, 75, 88, 91, 99, 120 N nation, vii, 55, 57, 87, 88, 89, 91, 97, 101, 102, 103 National Association of State Retirement Administrators, 49 national saving, 87 natural, 111 negotiating, 33 New York, 52 newsletters, 31, 41 next generation, 116 NIPA, 116 NO, 68 non-profit, 88, 115

Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,

Index

normal, 115 norms, 87, 95 not-for-profit, 98 O objectivity, 36 obligation, 31, 32, 44, 64, 77 obligations, vii, 17, 18, 19, 20, 21, 25, 26, 27, 28, 30, 31, 32, 33, 34, 35, 37, 38, 39, 40, 41, 42, 44, 48, 55, 56, 57, 62, 80 Offices of Congressional Relations and Public Affairs, 40 online, 4, 40, 41, 59, 62 opacity, 47, 84 outsourcing, 41 oversight, 18, 21, 24, 25, 30, 33, 34, 39, 42, 56, 57, 62 ownership, 56, 64, 66, 97 ownership structure, 97

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P partnership, 115 passive, 98 pay off, 115 pay-as-you-go, 111 payroll, 60, 67, 71 PBGC, 6, 81, 90, 119 peanuts, 85 peer group, 28 penalties, 62 penalty, 37, 65, 77 pension, vii, viii, 1, 2, 15, 16, 17, 19, 21, 23, 27, 28, 29, 30, 32, 33, 35, 38, 41, 43, 45, 48, 49, 50, 51, 52, 74, 75, 76, 77, 80, 85, 86, 87, 88, 89, 90, 91, 98, 99, 102, 105, 113, 117, 118 Pension Benefit Guaranty Corporation, 6, 23, 90 pension plans, vii, 1, 19, 21, 43, 48, 49, 50, 51, 52, 75, 76, 87, 88, 90, 98, 99, 102 pension system, 48, 76, 77 pensioners, 89

151

pensions, 42, 47, 48, 50, 66, 74, 75, 78, 105 periodic, 62, 92 permit, 11, 12, 64, 119, 122 personal communication, 107 physics, 80 plague, 85 planning, 6, 29, 59, 62, 80, 85 play, 2, 55, 57, 58 policy makers, 40 policymakers, vii, 1, 57, 60, 65, 98, 115 poor, 80, 81, 88 population, 20, 41, 43, 44, 50, 81, 110, 116 population group, 116 portability, 59, 65 portfolio, 7, 29, 44, 49, 70, 77, 81, 83, 85, 93, 96, 98, 111 portfolios, 51, 52, 70, 80, 81, 82, 93 poverty, 116 poverty rate, 116 power, 62 PPA, 56, 63, 64, 70, 106, 120 pre-existing, 81 premiums, 109 present value, 117 press, 88 pressure, 91, 96, 107, 108 price changes, 51 prices, 48, 49, 50, 52, 60, 64, 74, 78 private, viii, 17, 23, 48, 52, 55, 56, 59, 60, 66, 68, 76, 77, 79, 81, 89, 90, 94, 96, 97, 105, 111, 116, 118, 121 private sector, 23, 59, 66, 76, 94, 111, 116, 118, 121 private-sector, 48, 55, 59, 68 proactive, 84 production, 66, 89 productivity, 66, 89 profit, 30, 40, 56, 58, 61, 88, 97, 105, 115, 117 profit margin, 30, 98 profits, 26, 48, 69, 97 program, 20, 26, 37, 48, 82, 84, 94, 97, 102, 110, 119 property, 43, 44, 62

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152

Index

protection, 8, 14, 63, 83 proxy, 88 prudence, 31, 62 public, 18, 21, 34, 36, 37, 38, 48, 49, 50, 79, 80, 82, 88, 91, 94, 98, 105 public interest, 91 public pension, 49, 50 public sector, 94 Q qualifications, 27, 31 quality of service, 27, 31 quartile, 67, 119 questioning, 101 questionnaire, 41, 42

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R random, 40 range, 20, 25, 27, 32, 41, 64, 121 rate of return, 2, 12, 14, 77, 121 real estate, 49, 90 reality, 81, 83, 91, 95, 115 recession, 108 record keeping, 4, 9, 12, 25, 27, 31, 33, 36 reforms, 61, 63, 67, 86, 87, 91 regional, 24, 35, 37 regular, 7, 60, 84 regulation, 27, 29, 33, 34, 36, 38, 39, 43, 44, 80, 81, 85 regulations, 3, 6, 7, 15, 18, 20, 21, 22, 26, 34, 36, 37, 38, 42, 44, 45, 63, 64, 81 regulators, 79, 84 regulatory oversight, 57 relationship,8, 10, 36, 48, 65, 86 relatives, 22 relevance, 52 reliability, 40 replacement rate, 110, 111 reputation, 80, 97 resolution, 23 resources, 29, 33, 35, 41, 49, 55, 62, 89

responsibilities, 2, 18, 21, 23, 25, 34, 39, 42, 45 restitution, 35 retail, 10, 44, 62, 64, 120, 121 retirees, vii, 3, 57, 58, 60, 62, 71, 84, 85, 90, 101, 110, 111, 112, 116 retirement age, 51, 64, 92 returns, vii, 1, 14, 27, 28, 35, 49, 60, 66, 67, 78, 82, 84, 86, 87, 88, 89, 92, 93, 94, 95, 96, 97, 98, 99, 111, 118 revenue, 25, 33, 36 rewards, 89, 97 risk, vii, 11, 12, 14, 21, 27, 28, 29, 39, 44, 47, 52, 55, 57, 59, 64, 66, 67, 75, 76, 77, 78, 82, 85, 89, 90, 91, 93, 94, 96, 97, 98, 110, 111, 118, 119 risk aversion, 96 risk profile, 85 risk sharing, 111 risks, 29, 51, 52, 74, 91, 95, 97, 111, 115, 119, 122 road map, 64 robotic, 85 rolling, 71 rust, 112 S safeguard, 55, 57, 120 safety, 57, 66, 94 salaries, 91, 92 salary, 22, 61, 68, 69, 92, 119 sales, 5, 9, 12, 13, 35, 38, 78, 93 sample, 8, 31, 44, 67 sampling, 8, 14, 40, 41 saving rate, 113, 117 savings, vii, 19, 27, 36, 37, 55, 56, 57, 58, 59, 60, 61, 62, 63, 64, 65, 67, 68, 69, 70, 71, 76, 77, 80, 83, 86, 87, 88, 89, 90, 91, 92, 93, 94, 96, 97, 98, 101, 102, 116, 117, 118, 120 savings account, 71 savings rate, 63, 68, 116, 117, 118, 120 Secretary of the Treasury, 9, 48

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153

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Index

securities, 14, 25, 27, 30, 43, 44, 47, 49 Securities and Exchange Commission, 5, 23, 82 security, vii, 2, 7, 11, 17, 19, 39, 47, 55, 57, 60, 63, 66, 67, 73, 74, 75, 76, 77, 82, 87, 88, 89, 91, 97, 98, 101, 102, 103, 105, 110, 115, 119 selecting, 12, 14, 18, 20, 22, 25, 27, 29, 31, 32, 45, 64, 85, 120 Self, 28 seller, 95 Senate, 15, 45 sensitivity, 41 sentences, 96 separation, 71 series, 42, 58, 115 service provider, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 14, 15, 18, 19, 20, 21, 22, 25, 27, 30, 31, 32, 33, 34, 35, 36, 37, 38, 39, 42, 43, 45, 59, 63, 122 services, 3, 4, 6, 7, 8, 9, 10, 12, 14, 19, 21, 22, 25, 27, 29, 30, 31, 32, 33, 34, 35, 36, 38, 39, 41, 43, 45, 49, 59, 62, 63, 64, 66, 69, 70, 80, 82, 83, 84, 85, 89, 94, 95, 97, 102, 115, 120, 121, 122 severe stress, 51 shape, 30, 92 shareholders, 49, 82, 97, 98, 99 shares, 5, 10, 15, 50, 88, 90, 91, 95, 111 sharing, 21, 25, 30, 33, 34, 36, 39, 40, 56, 58, 61, 105, 111, 115, 117 shock, 109 short-term, 36, 44, 47, 87, 88, 96, 102 small firms, 61 smoothing, 50 Social Security, i, iii, vii, 50, 57, 58, 66, 74, 75, 76, 77, 89, 91, 92, 94, 98, 101, 102, 105, 106, 109, 110, 112, 113, 118, 119 social welfare, 76 Special Committee on Aging, 45 specialization, 39 spectrum, 93 speculation, 81, 88, 89, 96 speech, 98

sponsor, 3, 10, 13, 14, 18, 19, 20, 21, 23, 25, 26, 27, 29, 30, 31, 32, 33, 38, 41, 42, 43, 44, 45, 48, 59, 82 spouse, 69, 117, 119 stability, 28, 61 stabilize, 85 stages, 84 stakeholders, 42 standard of living, 74, 102, 106 standards, 20, 23, 43, 64, 69, 74 statistics, 58, 61, 109, 117, 118 statutory, 19, 21, 34, 36, 38, 39, 80, 82 stock, 28, 44, 48, 51, 52, 56, 59, 60, 64, 65, 71, 73, 75, 81, 82, 87, 90, 91, 93, 94, 95, 96, 105, 106, 108, 111, 113, 120 stock price, 48, 52, 60 strategies, 42, 64, 118 stress, 47, 102 stupor, 79 subgroups, 52 subscribers, 41, 42 subsidies, 77 subtraction, 84, 92 suffering, 80 summaries, 7 Sun, 112, 113 supplemental, 102 supplements, 105 supply, 8 surplus, 90 surprise, 75 suspensions, 108 T tax collection, 50 tax credits, 56, 59 tax incentives, 67 taxation, 109 taxes, 7, 8, 110 tax-exempt, 2, 56, 59 taxpayers, vii, 66, 76, 77, 78 telephone, 25, 31, 42 tenure, 61, 117

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154

Index

testimony, viii, 38, 48, 73, 101, 103 theft, 23 thinking, 79, 86 third party, 10, 35 threatening, 77 timetable, 62 timing, 96 tolerance, 64, 83, 91 total costs, 93, 121 tracking, 25 trade, 6, 88, 95 trading, 38, 88, 89, 93 training, 34 transaction costs, 93 transactions, 3, 5, 12, 13, 22, 35, 37, 43, 45 transfer, 90, 91 transparency, 2, 37, 83, 84, 85, 88, 122 transparent, 38, 55, 84, 102, 115 Treasury, 9, 47, 48, 98 truism, 95 trust, 3, 4, 23, 25, 31, 43, 69, 80, 81, 82, 84, 85, 86, 89, 120 trust fund, 25 trusts, 3, 16, 44 turbulence, 83 turnover, 93 U U.S. Treasury, 98 uncertainty, 61 United States, 19, 41, 52, 68, 71, 73, 78, 112, 123, 143 universe, 40, 41

variability, 42 variables, 120 variation, 68 vehicles, 44, 60, 62, 63, 69 volatility, 60, 83 W wages, 45, 61, 66, 77 wealth, vii, 49, 73, 74, 75, 76, 78, 87, 91, 93, 95, 99, 117, 119 wear, 82 weathering, 49 weight loss, 92 welfare, 76 well-being, 74 wisdom, 87, 96 withdrawal, 59, 71, 108 witnesses, 102 women, 109 workers, vii, 2, 17, 19, 21, 23, 38, 39, 49, 51, 52, 55, 56, 57, 58, 59, 60, 61, 62, 63, 64, 65, 66, 67, 68, 69, 70, 73, 75, 76, 77, 78, 81, 86, 87, 88, 92, 98, 101, 102, 105, 106, 109, 110, 111, 117, 118, 119, 122 workforce, vii, 29, 44, 84, 101 working groups, 42 workplace, 55, 58, 62, 63, 67, 69, 71, 76, 115 writing, 36, 73, 89 Y yield, 2, 80, 83, 90, 98

V Valley Forge, 113 values, 48, 49, 50, 58, 96, 111

Strengthening The Retirement System Beyond Social Security, Nova Science Publishers, Incorporated, 2009. ProQuest Ebook Central,