Employee Investment Outcomes and the New Fiduciary Standard

When Section 401(k) became a permanent provision of the Internal Revenue Code in 1980, a seismic shift occurred in American workers’ preparation for retirement. The responsibility for contribution and investment decisions shifted from employers to employees.

Before 1980, companies that offered a retirement plan were required to fund them. That meant that the employer alone bore the contribution and investment responsibilities.

In those defined benefit plans, if the investment returns were less than expected, then the employer’s funding obligation increased, to offset the shortfall on investment returns. The employer was tasked with achieving sustainable investment outcomes to support their employees throughout their retirement years.

With the introduction of 401(k) plans, contributions became the responsibility of the employee. Moreover, they have had to decide an adequate savings rate and become investment savvy.

Employee-directed Retirement Investment Falls Short

Employees have, overall, not been up to these tasks. This shift to a 401(k) retirement world thus ushered in an era in which employees were inadequately prepared to face the tasks at hand.

Early on, participants had no guidance on the how much they should be saving for retirement or how those funds should be invested.

The Department of Labor has created numerous regulations over the past 36 years to ensure employees have the information and resources needed to make informed and educated decisions about their retirement savings.

Not surprisingly, insurance companies and financial services firms jumped into the void of information, and developed slide rules, websites, online calculators, glide path funds, target date funds, custom QDIAs, and a plethora of other tools and products to serve the fledging 401(k) investor.

The outcome of these endeavors has been disappointing, to say the least.  With the first generation of 401(k) participants approaching retirement, the reality of inadequate preparation of is beginning to set in.

Retirement Unpreparedness Meets New Fiduciary Duties

The average account balance for the typical participant lies far below the threshold needed for a sustainable retirement income. The education, tools, and resources provided by employers, their advisors, and the industry have left many ill-prepared for retirement. This void is being addressed by longer working careers, government intervention, and an opportunistic legal system. [is this common knowledge in the industry? If not, spell out what are you referring to here re the legal system]

Public school systems have been sued over failed outcomes by their students, but the courts have been reluctant to rule in favor of the parents and students in such cases. The potential liability would not be in the best interest of school systems and the public good.

While a standard of care is mandated by law and periodic achievement test can demonstrate some level of proficiency in the public education system, it is doubtful the 401(k) industry will be afforded the same latitude.

Against this background, we have the passage of the new fiduciary rule for investment advisors. It elevates the standard of care investment advisors must use to the highest level. No longer should the products and services simply be suitable; they must also be in the best interest of plan participants.

“In the best interest of plan participants” implies a quantifiable outcome. To protect themselves, and help their employees make wiser investment and saving decisions, employers would be well served to quantify the progress participants are making toward retirement.

Education alone is not enough. Tools and resources alone are not enough.

The new fiduciary rule is only the beginning of accountability standards employers and service providers can expect in the future. Plan sponsors need to ensure that they have appropriate, quantifiable measures in place, so they can demonstrate that participants have a path to achieving retirement readiness.

Defining and achieving sustainable outcomes mitigates the employer’s liability while improving productivity and employee morale.

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