Lessons from a failed 401(k) plan
As many of you probably do, I read the Wall Street Journal as often as possible. Last week, I read an article detailing how West Virginia had recently switched back to a pension plan from a 401(k). I initially focused on the article because “401(k)” was in the title, but became more interested as I read about the issues that brought about the change of heart. Upon finishing the article I was both concerned for those adversely affected and reinforced in my belief of the importance of impartial, unbiased advice for participants.
Let’s start with a quick recap. The state of West Virginia switched to a 401(k) because like many employers they were facing continually increasing costs from their defined benefit (”db”) plan. When they decided to switch to a 401(k) they instituted a generous employer contribution of 7.5% vs. the most common private sector match of 50% on the dollar up to 6% of an individual’s salary. The plan offered stock and bond mutual funds, a money market fund, and an annuity. Seems like a pretty good set-up… right? Well, besides the fixed annuity part, but that’s a personal opinion.
So what went wrong and forced the state to switch back to a defined benefit plan?
First, the state actually lowered the amount employees were required to contribute to the plan (6% in the db plan and only 4.5% in the dc, or defined contribution, plan). A large employer match is great and certainly helps individuals prepare for retirement, but lowering the required contribution each individual had to make seems a bit odd to me.
Second, the plan had a fixed annuity option. I imagine there are situations where a fixed annuity makes sense for an individual. However, I struggle to think of a reason why almost 2/3 of plan assets should be invested in one, which according to the article was reached at one point during the plans existence. (If you want to learn more about annuities, check out our Primer on Annuities)
Now while I don’t understand why you would invest in a fixed annuity in a dc plan, I do understand how it happened. The story mentions that Valic (the company that offered the fixed annuity) sent in salespeople to talk about the annuity. In fact many of these salespeople were former educators and school employees. While I’m all for knowledgeable advisors working with participants to build appropriate investment plans, I have a problem with individuals who are “not authorized or directed to give investment advice” but who are “… only authorized to sell a fixed-annuity contract.” Inherently, this relationship is going to be rife with potential conflicts. First, a salesperson is incented to sell a product. Second, if you are a knowledge resource shouldn’t you be able to talk about other investments or the pension plan as a whole… especially in something as important as retirement investing?
So what does this mean?
I urge everyone who reads this post, no matter if you are a participant or employer, to do the research necessary to select appropriate investments. Or if you aren’t interested (or don’t think you have the knowledge) please consider using an advice provider. I’d love for it to be Smart401k, but would find it gratifying simply to know that you are taking control of your investments.
If you are an individual and want more information on Smart401k click here or contact one of our advisors who are authorized to provide advice. If you’re an employer and want to know more about how we can strengthen your plan and educate your employees click here to request more information.
If you have any questions or comments, feel free to post of comment to this article or call us at 1-877-627-8401.
Till next time…
Scott H
Full Disclosure: My knowledge about the situation is entirely contained with the WSJ article “When 401(k) Investing Goes Bad” that was published on Monday, August 4, 2008.
