401(k) Perspective: What Does the Future Hold?

By Ted Benna
Creator of the 401(k); Author of Ted's Table

In This Story What Shapes the 401(k) Market What the Vocal Minority Wants The Employer's Role in the Future The Answer How Employees Cope with Choice Employer Liability 401(k)s, 10 Years from Now

What will the 401(k) plan of the future be like? The plan's creator, Ted Benna, thinks individual investors should have more control over the money and employers less.

The following article concludes a three-part series that we asked Ted to write for us in preparation for the 20th anniversary of the first 401(k) plan on Jan. 1, 2001. In it, Ted shares his views about where he thinks 401(k)s are heading and why. This piece expresses Ted's opinion of how the 401(k) market will change over the next decade. We realize that many of our readers may have different opinions and we welcome comments from all readers, whether they agree or disagree with Ted's view.

minute: read this article at a glance.

Technical Terms Employee Retirement Income Security Act (ERISA) Fiduciary Rollover 404(c) regulations

What factors are shaping the 401(k) market?

The products and services available to 401(k) participants today have evolved during the past 20 years largely through market pressure from participants — what participants want strongly influences plan sponsor buying decisions. As a result, the products and services available to participants today are governed largely by the open marketplace rather than government regulation. For example, the average plan contains eight to 10 investment options even though only three are necessary to comply with the Department of Labor's Section 404(c) regulations.

Other major changes during the past five years that have resulted from investor demand include:

• Increased access to information;
• The ability to conduct transactions 24 hours a day, seven days a week, 365 days a year; and
• Increased investment education support.

The latest major product enhancement is the addition of actual investment advice. Virtually all participants will have access to investment advice within the next couple of years because participants want more than just educational material.

The fact that participants have largely driven change shouldn't be surprising since most of the money in these plans is contributed by participants. The pace of change will not slow and it will continue to be influenced largely by participants. Those who disagree with me on this point state that most participants are content with the way 401(k) plans are currently structured. I agree that at least 80 percent of participants are either content or indifferent, but that is only part of the story. Change has historically been driven by the 20 percent who are more knowledgeable and who take the initiative. Why have we moved from two funds to eight or more funds? It wasn't because the vast majority of participants wanted additional options, it was the 20 percent wanting more funds who successfully pushed the market in this direction. And, this will continue to be the case in the future.

What do those 20 percent who cause change want?

The two big words are choice and control. Participants who have access to unlimited investment alternatives through individual retirement accounts (IRAs) and other personal investments want the same flexibility with their 401(k). Someone who is able to select from thousands of alternatives when investing $2,000 outside of a 401(k) has difficulty understanding why he or she is limited to only 10 alternatives when investing a much larger amount inside of a 401(k). Participants have been told that investing for retirement is their responsibility, and this makes it very difficult to understand why there are barriers to what they can invest in.

The pace of change will not slow and it will continue to be influenced largely by participants. — Ted Benna, creator of the 401(k).

I received a question via this site from a participant several months ago that was a typical example of participant frustration. The writer works for a Fortune 500 company that offers 16 funds and company stock. She asked why ex-employees who may select from thousands of funds via an IRA rollover are treated better than active employees who are limited to 16 and what she could do about it. As account balances continue to grow, an increasing number of participants will push for this greater flexibility.

The second issue is control. Employees have been told by their employers, service providers and the media that planning for retirement, including how to invest their retirement savings, is their own responsibility. Employees have generally taken this message to heart by seriously considering how they are investing their retirement savings. When they receive a notice from their employer telling them their money is being moved from one set of funds to another because of a change in the 401(k) plan, they are initially surprised, then annoyed. I am frequently asked by participants who have received these announcements whether the employer can legally force them to change funds. Yes, employers may legally force participants to move their money from one set of funds to another but doing so is inconsistent with what employees have been told. This inconsistency is becoming increasing uncomfortable for both employers and employees. Employees suddenly find out when they are forced to move their money that they don't really have control. In some instances, this practice has led to lawsuits.

What will the employer's role be in the future?

Today, employers assume the responsibility and the liability for how employees invest their money by selecting the investment choices that will be offered to their employees. I have come to the conclusion that this structure puts employers in a high-risk business where they can never win — only lose big-time.

For starters, I believe that the fiduciary standard contained in the Employee Retirement Income Security Act (ERISA) is unworkable. ERISA requires employers to act solely in the best interest of participants. This was a workable standard back in 1974 when ERISA was enacted because retirement plans were primarily employer-funded and the employer assumed the investment risk with defined-benefit pension plans. This standard breaks down when plans are primarily employee-funded and the employee assumes the investment risk. It is impossible for an employer with thousands of employees to know what is in the best interest of each employee.

This "sole benefit" fiduciary standard is also routinely violated when participants are forced to move their money from one set of investments to another, such as during an acquisition or change of service provider. The main benefit objective during most mergers is to get all employees into the same benefit program. This typically results in transferring the 401(k) account balances for the employees at the acquired entity into the buyer's plan. The investments held by employees of the acquired entity are commonly sold and the money is reinvested in the investments offered by the buyer's plan. The major factor driving this decision is administrative simplicity rather than the sole best interest of participants. In my opinion, a strong case can be made in such a situation that there has been an ERISA violation. Regardless of the skill that is employed during the fund selection process, including the use of an independent consultant, there is a strong possibility that one or more of the new funds will not perform as well during the first year following the change as the funds that were replaced. This opens the door for a potential lawsuit in which an attorney representing the participants can claim the fiduciary standards of ERISA were violated because the decision to change investments was not made for the sole benefit of participants. The employer must prove that the decision was made considering the sole best interest of the participants. Citing administrative reasons why this was best for participants is not likely to solve the problem because the suit would involve investment rather than administrative issues.

Selecting investment options, monitoring performance, and replacing managers are time-consuming and rather expensive. No matter how much skill is employed, there are always participants who are unhappy and want different choices.

What is the answer?

Employers should stop being investment gatekeepers. Choice and control should truly be passed to participants. Employees should have the same flexibility when they are investing their 401(k) money as they have when investing any other money — they should never be forced to move their money from one set of investments to another — after all, it is their money. Participants should be able to establish investment relationships that continue for a lifetime regardless of where they are employed or even whether they are employed. Currently, participants make what they intend to be long-term investment decisions, but these can be disrupted when they change jobs or retire, if their employer is sold, or when their employer decides to change service providers.

How will participants who are used to a limited number of options cope with a broad selection?

In my opinion, moving to an open environment where employees have unlimited choice and control will substantially reduce an employer's liability, particularly if participants have access to an independent investment advisor to help them make their investment selections. — Ted Benna, creator of the 401(k).

Moving to an open environment where participants have an unlimited number of alternatives is not what most participants want but it is where the market is heading. The transition must be made by considering the needs of all participants rather than just those who will continue to push the market toward more choice.

The answer I propose is for the independent investment advisors, such as mPower, publisher of this Web site, to build portfolios that will make it easier for participants who don't want to sort through thousands of funds. These premixed portfolios will consist of funds that are picked, monitored and replaced, when appropriate, by an independent advisor that does not have any financial stake in how participants invest their money. The independent advisor would be able to select from the entire universe of funds when creating these preallocated investment portfolios.

What will this do to the employer's liability?

In my opinion, moving to an open environment where employees have unlimited choice and control will substantially reduce an employer's liability, particularly if participants have access to an independent investment advisor to help them make their investment selections. I strongly believe the highest possible risk an employer can take is to force employees to change their investments, especially when the change is not due to subpar investment performance.

There are approximately 300,000 401(k) plans in existence today and more than 90 percent of them cover fewer than 100 participants each. Most of these employers are not equipped to assume responsibility for deciding what investment alternatives will be offered to their participants. The decision makers in these companies may possess some outstanding business skills but picking and overseeing 401(k) investments is not necessarily one of them. In addition, these individuals usually have many other responsibilities that are far more pressing.

How will 401(k)s work 10 years from now?

Related Reading Your Company Was Acquired! What Happens to Your 401(k) Money? Follow the 401(k) Money Trail: Where it Begins, Where it Ends 401(k) Perspective: Where Did the Plan Come From? 401(k) Perspective: The First 20 Years

Participants will decide where and how to invest their money. They will be able to choose from a number of service providers that offer a wide variety of alternatives. These providers will offer products ranging from traditional retail funds to low-cost institutionally priced investment options and individual stock. Some providers will receive a fee for service and will be financially independent, while others will continue to receive compensation that is asset-based.

An employee's contributions will be deposited directly to the 401(k) account the same day that payroll is run, similar to how an employee's net pay is deposited directly to the bank account the employee selects. This will eliminate the payroll reconciliation process that exists today, with the result that the employee's contributions will be invested immediately. The employee will deal directly with the organization he or she selects. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

401(k) Perspective: What Does the Future Hold?

By Ted Benna
Creator of the 401(k); Author of Ted's Table

In This Story What Shapes the 401(k) Market What the Vocal Minority Wants The Employer's Role in the Future The Answer How Employees Cope with Choice Employer Liability 401(k)s, 10 Years from Now

What will the 401(k) plan of the future be like? The plan's creator, Ted Benna, thinks individual investors should have more control over the money and employers less.

The following article concludes a three-part series that we asked Ted to write for us in preparation for the 20th anniversary of the first 401(k) plan on Jan. 1, 2001. In it, Ted shares his views about where he thinks 401(k)s are heading and why. This piece expresses Ted's opinion of how the 401(k) market will change over the next decade. We realize that many of our readers may have different opinions and we welcome comments from all readers, whether they agree or disagree with Ted's view.

minute: read this article at a glance.

Technical Terms Employee Retirement Income Security Act (ERISA) Fiduciary Rollover 404(c) regulations

What factors are shaping the 401(k) market?

The products and services available to 401(k) participants today have evolved during the past 20 years largely through market pressure from participants — what participants want strongly influences plan sponsor buying decisions. As a result, the products and services available to participants today are governed largely by the open marketplace rather than government regulation. For example, the average plan contains eight to 10 investment options even though only three are necessary to comply with the Department of Labor's Section 404(c) regulations.

Other major changes during the past five years that have resulted from investor demand include:

• Increased access to information;
• The ability to conduct transactions 24 hours a day, seven days a week, 365 days a year; and
• Increased investment education support.

The latest major product enhancement is the addition of actual investment advice. Virtually all participants will have access to investment advice within the next couple of years because participants want more than just educational material.

The fact that participants have largely driven change shouldn't be surprising since most of the money in these plans is contributed by participants. The pace of change will not slow and it will continue to be influenced largely by participants. Those who disagree with me on this point state that most participants are content with the way 401(k) plans are currently structured. I agree that at least 80 percent of participants are either content or indifferent, but that is only part of the story. Change has historically been driven by the 20 percent who are more knowledgeable and who take the initiative. Why have we moved from two funds to eight or more funds? It wasn't because the vast majority of participants wanted additional options, it was the 20 percent wanting more funds who successfully pushed the market in this direction. And, this will continue to be the case in the future.

What do those 20 percent who cause change want?

The two big words are choice and control. Participants who have access to unlimited investment alternatives through individual retirement accounts (IRAs) and other personal investments want the same flexibility with their 401(k). Someone who is able to select from thousands of alternatives when investing $2,000 outside of a 401(k) has difficulty understanding why he or she is limited to only 10 alternatives when investing a much larger amount inside of a 401(k). Participants have been told that investing for retirement is their responsibility, and this makes it very difficult to understand why there are barriers to what they can invest in.

The pace of change will not slow and it will continue to be influenced largely by participants. — Ted Benna, creator of the 401(k).

I received a question via this site from a participant several months ago that was a typical example of participant frustration. The writer works for a Fortune 500 company that offers 16 funds and company stock. She asked why ex-employees who may select from thousands of funds via an IRA rollover are treated better than active employees who are limited to 16 and what she could do about it. As account balances continue to grow, an increasing number of participants will push for this greater flexibility.

The second issue is control. Employees have been told by their employers, service providers and the media that planning for retirement, including how to invest their retirement savings, is their own responsibility. Employees have generally taken this message to heart by seriously considering how they are investing their retirement savings. When they receive a notice from their employer telling them their money is being moved from one set of funds to another because of a change in the 401(k) plan, they are initially surprised, then annoyed. I am frequently asked by participants who have received these announcements whether the employer can legally force them to change funds. Yes, employers may legally force participants to move their money from one set of funds to another but doing so is inconsistent with what employees have been told. This inconsistency is becoming increasing uncomfortable for both employers and employees. Employees suddenly find out when they are forced to move their money that they don't really have control. In some instances, this practice has led to lawsuits.

What will the employer's role be in the future?

Today, employers assume the responsibility and the liability for how employees invest their money by selecting the investment choices that will be offered to their employees. I have come to the conclusion that this structure puts employers in a high-risk business where they can never win — only lose big-time.

For starters, I believe that the fiduciary standard contained in the Employee Retirement Income Security Act (ERISA) is unworkable. ERISA requires employers to act solely in the best interest of participants. This was a workable standard back in 1974 when ERISA was enacted because retirement plans were primarily employer-funded and the employer assumed the investment risk with defined-benefit pension plans. This standard breaks down when plans are primarily employee-funded and the employee assumes the investment risk. It is impossible for an employer with thousands of employees to know what is in the best interest of each employee.

This "sole benefit" fiduciary standard is also routinely violated when participants are forced to move their money from one set of investments to another, such as during an acquisition or change of service provider. The main benefit objective during most mergers is to get all employees into the same benefit program. This typically results in transferring the 401(k) account balances for the employees at the acquired entity into the buyer's plan. The investments held by employees of the acquired entity are commonly sold and the money is reinvested in the investments offered by the buyer's plan. The major factor driving this decision is administrative simplicity rather than the sole best interest of participants. In my opinion, a strong case can be made in such a situation that there has been an ERISA violation. Regardless of the skill that is employed during the fund selection process, including the use of an independent consultant, there is a strong possibility that one or more of the new funds will not perform as well during the first year following the change as the funds that were replaced. This opens the door for a potential lawsuit in which an attorney representing the participants can claim the fiduciary standards of ERISA were violated because the decision to change investments was not made for the sole benefit of participants. The employer must prove that the decision was made considering the sole best interest of the participants. Citing administrative reasons why this was best for participants is not likely to solve the problem because the suit would involve investment rather than administrative issues.

Selecting investment options, monitoring performance, and replacing managers are time-consuming and rather expensive. No matter how much skill is employed, there are always participants who are unhappy and want different choices.

What is the answer?

Employers should stop being investment gatekeepers. Choice and control should truly be passed to participants. Employees should have the same flexibility when they are investing their 401(k) money as they have when investing any other money — they should never be forced to move their money from one set of investments to another — after all, it is their money. Participants should be able to establish investment relationships that continue for a lifetime regardless of where they are employed or even whether they are employed. Currently, participants make what they intend to be long-term investment decisions, but these can be disrupted when they change jobs or retire, if their employer is sold, or when their employer decides to change service providers.

How will participants who are used to a limited number of options cope with a broad selection?

In my opinion, moving to an open environment where employees have unlimited choice and control will substantially reduce an employer's liability, particularly if participants have access to an independent investment advisor to help them make their investment selections. — Ted Benna, creator of the 401(k).

Moving to an open environment where participants have an unlimited number of alternatives is not what most participants want but it is where the market is heading. The transition must be made by considering the needs of all participants rather than just those who will continue to push the market toward more choice.

The answer I propose is for the independent investment advisors, such as mPower, publisher of this Web site, to build portfolios that will make it easier for participants who don't want to sort through thousands of funds. These premixed portfolios will consist of funds that are picked, monitored and replaced, when appropriate, by an independent advisor that does not have any financial stake in how participants invest their money. The independent advisor would be able to select from the entire universe of funds when creating these preallocated investment portfolios.

What will this do to the employer's liability?

In my opinion, moving to an open environment where employees have unlimited choice and control will substantially reduce an employer's liability, particularly if participants have access to an independent investment advisor to help them make their investment selections. I strongly believe the highest possible risk an employer can take is to force employees to change their investments, especially when the change is not due to subpar investment performance.

There are approximately 300,000 401(k) plans in existence today and more than 90 percent of them cover fewer than 100 participants each. Most of these employers are not equipped to assume responsibility for deciding what investment alternatives will be offered to their participants. The decision makers in these companies may possess some outstanding business skills but picking and overseeing 401(k) investments is not necessarily one of them. In addition, these individuals usually have many other responsibilities that are far more pressing.

How will 401(k)s work 10 years from now?

Related Reading Your Company Was Acquired! What Happens to Your 401(k) Money? Follow the 401(k) Money Trail: Where it Begins, Where it Ends 401(k) Perspective: Where Did the Plan Come From? 401(k) Perspective: The First 20 Years

Participants will decide where and how to invest their money. They will be able to choose from a number of service providers that offer a wide variety of alternatives. These providers will offer products ranging from traditional retail funds to low-cost institutionally priced investment options and individual stock. Some providers will receive a fee for service and will be financially independent, while others will continue to receive compensation that is asset-based.

An employee's contributions will be deposited directly to the 401(k) account the same day that payroll is run, similar to how an employee's net pay is deposited directly to the bank account the employee selects. This will eliminate the payroll reconciliation process that exists today, with the result that the employee's contributions will be invested immediately. The employee will deal directly with the organization he or she selects. 

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.