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Washington's Big New Retirement Proposal

John Rekenthaler

Trivial Pursuit
It is Sunday morning. The top five headlines in the Money section of CNN's website read:

"Super Bowl ticket prices heat up"
"Big game means traffic jam--for private jets"
"GoldieBlox makes Super Bowl history"
"Can stocks shake off January jitters?"
"How to lower your tax bill"

I scan the next 20 headlines, seeking something--anything --about Sen. Tom Harkin's proposal, released three days before, to revamp the heart of the nation's retirement-savings system, the 401(k) plan. Nothing.

On to the Retirement subsection. Its text:

"What is a 'myRA retirement account'?"
"Americans on Obama's myRA plan"
"Take retirement for a test drive"

I open Yahoo's Finance page. Then AOL's Finance page. No and no.

Strange. When PBS attacked 401(k)s last spring in its "Frontline" documentary, "The Retirement Gamble," all three websites brandished that story on their home pages. Now, when the chair of the Senate Pensions Committee puts together a proposal that addresses many, if not all, of the criticisms made in that "Frontline special," his announcement is met by ... silence.

The USA Retirement Funds Act
Make no mistake about it: Harkin's proposal, entitled the Universal, Secure, and Adaptable (USA) Retirement Funds Act of 2014, is a big idea. President Obama's myRA plan is a modest item that can be passed by executive fiat. The USA Retirement Funds Act, in contrast, is a large, ambitious bill that must be passed via the normal legislative process.

The bill would establish a nationally available 401(k) plan, populated with USA Retirement Funds. Unlike the president's myRA plan, which would offer the single option of U.S. government bonds, there would be many USA Retirement Funds, from many providers.

The USA Retirement Funds would function differently from either current 401(k) funds or the single myRA portfolio. Rather than accumulate a cash balance, USA Retirement Funds would create retirement income. That is, at the time of retirement, the investor would not have an asset. Instead, he would have a promised income stream, as with a traditional defined-benefit plan. The amount paid out by this portable, ersatz DB plan would be determined by the investor's contributions and by the performance of the selected USA Retirement Fund(s).

The USA Retirement Funds would be managed by private companies rather than the government. At this stage, there is no description of how these private companies are selected, but the press release states that it would be a relatively open field, so that any qualified money manager who wished to create a fund would be permitted to do so. (That would seem to be unrealistic, at least as initially presented, because a USA Retirement Funds system with 200 offerings would fail the primary test of being a simple solution.)

The plan would automatically enroll all employees into a fund (or funds), at a 6% contribution rate. As with current automatic-enrollment programs in 401(k) plans, employees could opt out or change the contribution rate. From the employee's perspective, then, the USA Retirement Funds Act is less far-reaching and intrusive than my hesitant suggestion last week that if the Social Security age is to be pushed higher, perhaps 401(k) participation should be made mandatory.

The intrusion is greater from the employer's perspective. All employers with 10 or more employees would be required to adopt the USA Retirement Funds plan or to modify their existing 401(k) schemes so that they operated via automatic enrollment and offered a retirement-income option. The former is now common, but the latter is certainly not.

The USA Retirement Funds plan would also be available to those who work for companies with fewer than 10 employees and to the self-employed. According to Sen. Harkin's press release, such employees "could simply sign up and make periodic contributions like they would with any other individual retirement plan." Thus, the release claims, the plan is truly universal.

As with current 401(k)s, the USA Retirement Plan would be overseen by the Department of Labor and subject to ERISA regulations. However, in contrast with current practice, plan sponsors who use the USA Retirement Plan system would be completely freed of their fiduciary responsibilities. All fiduciary duties would belong to the USA Retirement Plan fund, which would have a board of trustees that would act as the fund's fiduciaries.

That provision would be a major improvement for both employees and the employer. Currently, plan sponsors are the prime fiduciaries for 401(k) plans. They can hire consultants and other outside parties to help share the burden, but they cannot escape it; there is no way for a company to hand off its fiduciary responsibilities. The duties of plan selection and monitoring that are required for a fiduciary are not only a worry for the plan sponsor and a distraction from running their businesses but also are fixed costs that must be borne either out of the employer's own pockets or by the employees. Often it is the latter--which means significantly higher 401(k) costs for those who work at smaller companies.

The release suggests that the USA Retirement Plan's funds would come at a low cost. This surely would be the case, given the bargaining power of a single entity negotiating on behalf of what would quickly become a huge asset pool. As a possible example, the federal government now runs a 401(k)-like savings vehicle for federal employees, called the Federal Thrift Savings Plan. The funds in those plan, index funds run by Barclays, have an expense ratio of 0.025% annually--one 40th of 1 percentage point. That is far, far lower than the costs of any 401(k) plan today that is assembled with mutual funds.

Food for Thought
It seems unlikely that this bill will pass. The press conference consisted of Sen. Harkin, a union president, and an insurance executive. A Democrat, a key Democratic constituent, and a member from the industry that would gain new business from the bill's passage. No Republican co-sponsor, nobody representing plan sponsors, no general business organization. The battle lines would appear to be drawn.

That said, the bill certainly deserves a broader hearing. Today's 401(k)s are an accident--a loophole of an IRS tax code that permitted companies to set up tax-sheltered savings plan. Basing national policy on a tax dodge is, well, dodgy. It's about time that somebody in Washington took a big swing at the target.

Not everything in Harkin's bill strikes me as sound. For starters, I wouldn't make mandatory the retirement-income option, nor does it seem that manager selection has been well considered. But relieving plan sponsors of their fiduciary duties is an idea that is long overdue. So, too, is finding a way to give employees at small companies access to 401(k) plans that are as good as the plans at large companies.

In future columns, I'll develop some of the bill's better ideas, to see how they might practically be implemented to improve the current 401(k) system.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.