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How to Fix the 401(k) Retirement System That Emerged by Accident

Michael Abbott’s 401(k) retirement plan is more transparent than most -- which isn’t a high bar to clear.

Abbott is a partner at Gardere Wynne Sewell LLP, a Houston law firm that charges employees a flat fee of about $100 annually to cover the cost of administering the accounts. Most U.S. workers have no idea what their plans cost them, because expenses usually are embedded in investment choices. Savers picking actively managed funds can carry more of the burden for their employers than those choosing index funds.

“The retirement system has been largely set up in a way that the fund companies have control,” Abbott said. “It was making it difficult to figure out exactly what was being paid.”

Change is starting to come as businesses like Abbott’s law firm and larger companies including Micron Technology Inc. are trying to make their 401(k)s more user-friendly and the fees more transparent. It’s among the ways employers as well as lawmakers and academics are redesigning 401(k)-type plans, which have become the main way that private-sector workers save for retirement.

Other proposed improvements focus on making the plans more like regular pensions, stemming early withdrawals from the accounts and lowering costs.

Brief Insert

Part of the problem with 401(k)s is that they weren’t intended for the burden they now support. They were sketched out in an 869-word insert in a much broader 1978 tax law as a supplement to defined-benefit pension plans, which were managed by employers and guaranteed monthly payments to retirees.

Instead, over the next three-plus decades, financial firms sold 401(k)s to employers as an inexpensive way to provide retirement benefits just as corporations were moving away from pensions altogether. Today workers left only with 401(k) plans have had to become skilled investors and hedge against unknowns such as their lifespan and market volatility.

Few people expect a return to traditional pensions so proposals tend to focus on making the current system work better. Here are some of the more interesting ideas and those gaining attention:

Hybrid Plans

State governments have suggested creating savings programs that combine the best features of 401(k)s and pensions to lower costs, provide retirees steadier income and reach workers whose employers don’t offer benefits. Known as hybrid plans, they could triple their share of the retirement market by 2020, according to a report by Global Wealth Allocation.

California passed a law in 2012 that would establish such a plan for private-sector workers, which would pool assets from employees’ paychecks and include a guaranteed rate of return. The state aims to start the plan in 2016, according to the office of state Senator Kevin de Leon, the main author of the bill.

Lawmakers in Connecticut, Maryland and Oregon are looking at similar proposals.

Thrift Savings

At the federal level, Senator Marco Rubio, a Florida Republican, said in May that workers whose employers don’t offer a retirement plan should be able to join the Thrift Savings Plan. The TSP is a low-cost, 401(k)-type plan available to federal employees, including those in Congress, which holds more than $400 billion in assets. The senator will continue to push for such reforms in 2015, spokesman Alex Conant said.

Rubio’s plan mirrors President Barack Obama’s MyRA program, scheduled to start at the end of the year, which allows Americans without access to retirement plans to open individual retirement accounts and invest in a government bond fund.

Senator Orrin Hatch, a Utah Republican who is poised to become chairman of the Senate Finance Committee in January, has a proposal that would encourage small businesses to offer 401(k)-type plans and let them pool assets with other employers to reduce costs. Hatch, in a December speech in Washington, said he would push for such changes in 2015.

Avoiding Leaks

Few laws on retirement security have advanced in Congress during Obama’s administration because much of the policy is rooted in U.S. tax law. Efforts to advance the broadest tax-code revamp since 1986 have stalled.

Once people are putting money in 401(k)s, attention turns to keeping it from leaking out. Many workers have tapped the accounts to pay bills since the financial crisis of 2008-2009 limited the liquidity they had in their homes. The Internal Revenue Service collected about $5.7 billion in 2011 from penalties for early withdrawals from accounts.

David Laibson, a Harvard University economics professor, suggests giving employees two savings accounts at work: a 401(k) only for retirement, and another whose funds could be withdrawn for emergencies or life events without penalty. The proposal would leverage automatic deductions from workers’ paychecks to promote savings, he said.

Plan Disparity

A separate camp of people would reduce rather than increase employers’ role in the system because of the wide discrepancies in how companies set up their 401(k)s.

“We have this patchwork retirement system that works well for some but not everyone by any means,” said John Rekenthaler, vice president of research at Morningstar Inc.

Regulations give employers discretion on 401(k) investment choices and fees as long as they are reasonable. They aren’t required to contribute to workers’ accounts, and if they do, they can stop their payments at will.

Rekenthaler proposes removing employers as the key architects of the plans. That’s a solution echoed by the Center for American Progress, a Washington-based group aligned with Democrats.

David Madland, managing director for economic policy at the center, would create a fund that isn’t run by employers and would follow workers from job to job. It would pool savings to smooth out uneven investment returns and provide lifetime payments like a pension.

The structure also would credit participants with at least a zero percent return in years where financial markets decline, and a maximum of 8 percent in top performing years. Any outperformance would be put in a reserve to cover losses in future years, Madland said.

Fees Debate

Fees are among the most contentious areas of debate among those seeking to redesign 401(k)s. Some of those advocating for lower costs have fought for changes through legal action. The U.S. Supreme Court is scheduled to decide next year on a case involving expenses in the plans.

Some companies, like Abbott’s law firm, have sought to simplify and reduce fees for workers by shifting to a per-participant charge for administrative expenses and by adding low-cost index funds as investment options. Employees at his firm pay about 35 basis points for administrative and investment costs for their 401(k) accounts, he said. A basis point is equal to .01 percentage point.

Micron Technology, a maker of computer-memory chips, switched to a per-participant cost of $60 for its 401(k) administrative expenses in April 2013, according to its filing with the U.S. Department of Labor.

The flat fee makes it easier for the Boise, Idaho-based company to control what it pays to manage the plan compared with the percent-of-assets structure usually charged, Daniel Francisco, a company spokesman, said in an e-mail.

The Illinois legislature passed a bill this month to establish a retirement savings program for people without a plan at work that would cap fees at 75 basis points.

The typical 401(k) plan has a total cost paid by workers of almost 1 percent, or 91 basis points, of assets for services including administration, investments and advice, according to the Investment Company Institute and BrightScope Inc.

Reduce Balances

Some pay as much as 2 percent, according to BrightScope, a San Diego-based firm that rates 401(k)s. A 1 percent difference in costs can reduce people’s balances by 28 percent, according to the Labor Department.

The Center for American Progress has gone so far as recommending labels on 401(k) investments that would be similar to those on cigarette packs or those that list the nutritional content of food products. They would show costs of a mutual fund in the plan compared with the average of low-cost competitors, Madland said.

Laurie Rowley, founder and president of the National Association of Retirement Plan Participants, supports the idea of better labeling.

“There are some real holes in the system,” Rowley said. “These are Americans’ lifetime savings. We need to give them the best shot.”

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