Among the finance-related proposals emerging in the presidential campaign, candidate Joe Biden has suggested various changes to America’s 401k retirement programs. He may wish to evaluate the 401k improvements listed below that I am suggesting based on my more than 30 years of working with hundreds of 401k plans.
Changes are needed because Americans aren’t saving enough for retirement. A recent study shows that 25% of American workers haven’t saved anything for retirement and 63% are not sure they are on the right track.
I have scored these 401k improvements from 1 to 10 (with 10 being a major impact) based on how I feel the change affects employees’ retirement readiness.
401k Improvements Biden Should Consider
1. Require the complete suite of “auto” features
Auto-enrollment, auto-escalation and auto-reenrollment work. Require all 401k plans to adopt the full suite of “auto” features beginning with auto-enrollment at 6%, annual auto-escalation of participant contributions by 1% up to a 12% maximum, and annual auto-reenrollment of every employee not in the plan.
Auto-reenrollment ensures plan participation rates in the low 90% range. Plan participants have the right to opt out of everything, but as we’ve learned, most don’t.
Impact score: 10. A set of 401k improvements that we know works!
2. Require a QDIA in every plan
Participants have shown, by how they invest, that they appreciate the do-it-for-me investment approach in 401k plans. Require every 401k plan to offer a target date or risk-based series of funds as a Qualified Default Investment Alternative (QDIA).
QDIAs are not required in 401k plans now, but plan sponsors who take advantage of offering them gain safe harbor protection on the investment of undesignated employee contributions. They work well in partnership with auto-enrollment and allow participants to begin saving and investing as soon as they are eligible.
Participants have accepted do-it-for-me investment solutions by not opting out of the QDIAs they are invested in when auto-enrolled. If their accounts remain invested in a QDIA until they retire, the benefits could be enormous.
Impact score: 8. If auto features are mandated, it would be smart to require QDIAs as well, since employee contributions will need to be invested appropriately.
3. Raise Roth 401k contribution limits
No state or federal tax revenue is lost here because Roth 401k contributions are after-tax. This change gives participants – including most of us who didn’t contribute enough early in our careers – a chance to catch up.
The existing $6,500 annual catch-up contribution for those age 50 and older falls woefully short of what is necessary to help participants catch up and build retirement-ready account balances.
Based on 2020 limits, consider allowing up to $19,500 in 401k pre-tax contributions, plus a maximum of $19,500 in Roth 401k contributions, plus another $13,000 in catch-up contributions ($6,500 of each type).
Impact score: 7. There doesn’t seem to be a downside to allowing a higher limit on Roth 401k contributions.
4. Allow unlimited after-tax contributions
No state or federal tax revenue is lost when after-tax contributions are made and there is no loss to taxing authorities when these balances are withdrawn because that is when earnings are taxed.
For this provision to be effective, these after-tax contributions will need to be exempt from discrimination testing.
This is another way to help American’s catch-up on their retirement savings.
Impact score: 5. Not everyone will be able to afford to make these after-tax contributions, but it is an easy way to help those who can.
5. Make every party with a signed contract a fiduciary
It’s time to stop playing games with who is and who isn’t a fiduciary and to what extent. Most employers are so confused about what is happening here that they have given up trying to understand the subject.
Here is a common-sense suggestion: If you have a signed contract with a qualified retirement plan sponsor to provide administrative, trust, custody, investment advisory, investment education, audit or any other services, you are a fiduciary for those services.
There is recent and ongoing litigation indicating that a third party administrator (TPA) and recordkeeper are fiduciaries for certain actions while the plan sponsor is not. Cyber fraud claims in the Abbott and Leventhal cases are laying a path to fiduciary responsibility for recordkeepers and TPAs that process fraudulent distributions of plan participant balances.
Common sense impact score: 10. This could be the most important of all 401k improvements. Why isn’t it the law right now?
6. Increase HSA contribution limits
Health Savings Accounts (HSAs) can play a significant role in retirement planning. Raising contribution limits could be one of the most important 401k improvements.
Contributions to HSAs are triple tax-free and can be used to pay all sorts of healthcare-related expenses while the individual is working or retired. Allowing American workers another avenue to accumulate retirement savings is important and providing a way to save for high healthcare expenses in retirement is huge.
In 2021, HSA contribution limits will be $3,600 for individuals and $7,200 for families with a catch-up contribution of $1,000 available to taxpayers who are 55 and older. Make the contribution limits the same as the 401k plan maximums which, for 2020, are $19,500 per individual with catch-up contributions allowed of $6,500 for those age 50 and older.
Impact score: Could be a 10, depending on how high contribution limits are raised. The impact of this change could be significant for many American workers, giving them a chance to accumulate savings to pay high healthcare expenses in retirement. Given where healthcare costs appear to be headed, something needs to be done to help retirees pay for them. Why not this?
7. Outlaw participant loans
When 401k plans were initially established, offering a 401k loan option was thought to be a way of motivating employees to enroll in a 401k plan. This feature is no longer needed to encourage participation. In fact, this is one provision that may harm participants more than help.
Very few participants have the ability to pay back a loan when they leave their employer (especially if they are terminated). Most don’t realize that they will be required to pay their loan back immediately if they leave. As a result, the majority default on their loans, permanently removing those funds from their retirement savings.
From a financial perspective, participant loans are one of the worst decisions any 401k plan participant can make. Administratively, many human resources departments spend much more time with loan issues than they would prefer and pay recordkeepers more to offer loans as an option. Very few employers are excited about being in the loan business.
Eliminate participant loans as soon as possible. Participants who need access to their 401k account balance during emergencies can apply for hardship withdrawals. The vast majority of plan participants who take out loans now are not doing so for hardship reasons.
Impact score: 5. Putting guardrails like this on 401k plans guides and protects participants and helps plug 401k account leakage.
8. Get all company stock out of 401k plans
Company stock has proved to be a poor investment for many 401k plan participants. Senior management is always conflicted when asked to provide advice and guidance about investing in company stock, especially at times when that advice would be most helpful to participants – like when the stock price is falling. And participants often overweight their allocation to company stock at the wrong times (when the stock price is high).
Impact score: 5. Fewer and fewer plans will offer company stock investment options as a result of recent court rulings. However, there is no reason to hold back from barring it as an investment option now.
9. Require use of R6 or similar share classes
All qualified 401k plans should be required to use mutual fund share classes that do not pay any soft dollar revenue to plan providers. These R6 or similar share classes already exist for many mutual funds and are being developed for many others.
Impact score: 7. Participants pay higher fees for mutual funds when share classes have soft dollar (12b-1 or sub-TA fees) attached to them. Using R6 or similar shares lowers the expense ratios of the funds allowing more of the fund’s earnings to be passed through to participants.
As candidate Biden considers changes to our private retirement system, I hope he considers these 401k improvements, all of which help working Americans become more retirement-ready. Even if none of these 401k improvements are implemented, employers can make many of them on their own right now.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or firstname.lastname@example.org.
Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in Socially Responsible Investment (SRI) strategies for retirement plans and is a pioneer in the field. LRPC currently has contracts in place to provide consulting services on nearly a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, a plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice, and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.