The Fixing the 401(k) Approach in Action

I was pleasantly surprised to read a recent article in BusinessWeek praising IBM's 401(k) plan and calling it "the new gold standard."  Frankly, it has been quite some time since I've heard anyone find something praiseworthy to say about a 401(k) plan.  In fact, if many of the critics (and the media) are to be believed, the 401(k) plan should be put out to pasture for good. 

Despite my criticism of the retirement plan industry and most plans I come across (hey, I didn't come up with the title of my book by accident), I've always maintained that a 401(k) plan is an excellent vehicle for retirement saving.  Unfortunately, it's the implementation of these plans, especially in the under $50 million plan space, that leaves most of them lacking. 

The responsibility for poor 401(k) implementation, in my opinion, lies primarily with plan fiduciaries who have failed in their duty to make well-informed decisions, either by lack of knowledge or just plain indifference.  My book, in large part, was designed specifically to empower these key decision-makers,  who have an enormous legal (and I would argue societal) responsibility to properly oversee these plans.

As I read through the article, I was pleased to see how much of the Fixing the 401(k) SM approach IBM is currently using.  To revisit, there are four key components (or what I call "pillars") to the Fixing the 401(k) SM approach, including:

  1. Effective Plan Design - The plan should be designed in such a way that both plan participation  and participant contributions are increased progressively over time.  Automatic enrollment, automatic deferral increases, and default investments are key elements of a well-designed plan.

  2. Cost Containment - All plan service providers are required to fully disclose their compensation (in percentages and dollars) and fiduciaries focus on reducing and re-structuring as many costs as possible on a fixed basis in order to control these expenses as the plan grows over time.  The use of passive investments, such as index funds, and fixed, per participant charges for administration and recordkeeping should be maximized.

  3. Successful Investment Experiences - The plan should be designed in a way that helps participants utilize the plan effectively and make prudent investment decisions.  To limit poor decision-making, the vast majority of participants should utilize professionally managed, custom portfolios.

  4. Fiduciary Protection - The oversight of the plan should be organized and structured in such a way that fiduciaries are empowered to make well-informed, prudent decisions and have limited personal liability. 

Here are a few quotes from the article that clearly highlight elements of the Fixing the 401(k) SM approach:

"IBM takes a very paternalistic and serious attitude in terms of the quality and the cost to participants," says Ted Benna, chief operating officer of pension consultant Malvern Benefits and the man considered to be the father of the 401(k)."

"Advice is helpful, however, only if the plan is structured right. Studies show that many 401(k) participants make bad decisions, and that defined-contribution plans such as 401(k)s underperform compared with the defined-benefit variety. So IBM leveraged its money-management expertise to assemble the best investments at the best prices....We try to negotiate as well as we can to wring every penny out of costs," says Ray Kanner, chief investment officer of IBM's retirement funds."

"We try to negotiate as well as we can to wring every penny out of costs," says Ray Kanner, chief investment officer of IBM's retirement funds."

"The plan also nudges participants toward better choices than they may have made on their own. Behavioral finance research by academics Richard H. Thaler of the University of Chicago Booth School of Business and Shlomo Benartzi of UCLA Anderson School of Management demonstrated the merits of putting the 401(k) on automatic pilot. One feature, auto-enrollment, pulls workers into retirement plans unless they opt out. Another, auto-escalation, increases contributions along with raises in pay—again, unless they opt out. In studies, these tricks substantially increase 401(k) participation and savings. IBM also offers automatic rebalancing, meaning employees' portfolios are automatically reset to the asset allocation they want over time."

"Custom target-date funds are another feature IBM uses to serve employees who don't like to manage their own money. Target-date funds are portfolios that set asset allocation based on how close a participant is to retirement; the funds then ratchet down risk (by decreasing equity exposure, for example) as the retirement date draws nearer. Such funds got a lot of flak after some off-the-shelf products with target dates of 2010 plummeted in the market downturn. IBM, like some other companies with billion-dollar 401(k) plans, has created its own customized target-date funds. Those funds mix indexed portfolios, which are at the core of IBM's plan offerings, and active portfolios. To hedge against inflation, plan managers threw in Treasury Inflation-Protected Securities and alternative assets such as commodities and real estate."

I disagree with the author's contention that "IBM's creation isn't revolutionary in design or implementation" because very few companies have taken such a progressive and thought-leading approach.  Otherwise, the author would not be arguing that IBM has "reinvented" the 401(k).

And while not every plan has the enormous pricing power that IBM's wields, every plan (whether large or small), can implement the Fixing the 401(k) SM approach and have a "gold standard" plan just like IBM.