Jeremy's Blog

401(k) Crypto Craze? Not So Fast!

 

Last week the U.S. Department of Labor (DOL) published compliance assistance tips for 401(k) plan investments in “cryptocurrencies”. This was not a glowing endorsement of cryptocurrency in 401(k) plans, rather they urged extreme caution to plan sponsors. They provided 5 specific reasons that they believe cryptocurrency presents significant risks and challenges to participants' retirement accounts and plan fiduciaries.

  1. Speculative and Volatile Investments – The Securities and Exchange Commission (SEC) to this point has cautioned that investment in a cryptocurrency is highly speculative. They also point out that cryptocurrencies have been subject to extreme price volatility, uncertainties related to valuing these types of assets, and incidents of theft and fraud among other reasons to be cautious.
  2. The Challenge for Plan Participants to Make Informed Investment Decisions – Cryptocurrencies are uniquely different from your typical retirement plan investments such as mutual funds, exchange traded funds (ETF's), & collective investment trusts (CIT's). They are also promoted as innovative and offering the opportunity for large gains, which can be quite attractive to plan participants. However, these are complex instruments that many expert investors have difficulty understanding and evaluating. Plan participants are much less likely to have the knowledge and expertise to properly evaluate and make informed decisions about investing in crypto. By including cryptocurrency as an investment option, plan fiduciaries are signaling to plan participants that they have approved this as a prudent option.
  3. Custodial and Recordkeeping Concerns – Cryptocurrency is usually held in a digital wallet; this is much different than the traditional trust or custodial accounts of traditional plan assets. There are some cases of people losing or forgetting their password which can result in losing the asset forever. The DOL also points out that other methods of holding crypto can be vulnerable to hackers and theft.
  4. Valuation Concerns – As noted under Speculative and Volatile Investments, there are concerns about the reliability and accuracy of crypto valuations. Experts are struggling to gather consensus on how to properly value cryptocurrency. To make matters worse, cryptocurrency market intermediaries may not use consistent accounting treatment and may not be subject to the same stringent reporting and data integrity requirements as it relates to pricing as other more traditional investment products.
  5. Evolving Regulatory Environment – With crypto being a relatively new investment product, regulations are consistently evolving making it a challenge to continue operating inside the regulatory framework. The DOL also stated that “Fiduciaries who are considering whether to include a cryptocurrency investment option will have to include in their analysis how regulatory requirements may apply to issuance, investments, trading, or other activities and how those regulatory requirements might affect investments by participants in the 401(k) plan.” That's quite a bit of additional work, time, and exposure for plan fiduciaries!

The most important section of the release was the last paragraph, which is crucial for plan fiduciaries to know before deciding to offer crypto in their plan. “Based on these and other concerns, EBSA expects to conduct an investigative program aimed at plans that offer participant investments in cryptocurrencies and related products, and to take appropriate action to protect the interests of plan participants and beneficiaries with respect to these investments. The plan fiduciaries responsible for overseeing such investment options or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks described above.” In short, offering crypto as an investment in your plan will put a bullseye on you for the DOL to target. At this point in time, I believe it is prudent for plan fiduciaries to resist offering cryptocurrency in their plans until some of the issues presented above are addressed and regulations become more favorable.

Cryptocurrencies, Digital Assets and other Blockchain related technology (such as Bitcoin, Ethereum, NFTs and others) are not securities, not regulated and not approved products offered by Cetera Advisor Networks LLC, and cryptocurrency or other blockchain related non-securities products cannot be recommended, offered, or held by the firm.

 

Thin(k)ing Smarter Blog #4 – How Much Should You Save

“How much should I be saving?” is one of the most frequent questions employees and plan sponsors ask me. It is also the most important variable that determines their ability to reach financial freedom in retirement. A common response I have to this question is MORE, you should be saving more. But let's dive into the numbers and see how much you should be striving to save to produce a high probability of reaching financial freedom in retirement.

It is important that we start the discussion by looking at what employees think they should be saving and how much they are saving. In the J.P. Morgan 2021 Defined Contribution Plan Participant Survey, three out of four plan participants surveyed believe they should be saving at least 10% of their salary to be financially secure in retirement; however, 65% said they haven't contributed the amount they believe they should in the past year. When looking at why they are not saving more, 41% indicated they were prioritizing paying off debt and another 28% said they were not earning enough. Based on the survey results, we know many participants think they should be saving at least 10%, but is 10% adequate to reach financial freedom in retirement?

We can't determine an appropriate savings rate until we identify an appropriate replacement rate. Replacement rate is the amount of gross, preretirement income a person will need to replace in retirement, to maintain their preretirement standard of living. In a simple example, if you are taxed at 20% and save 10% for retirement while working, your replacement rate would need to be 70% to maintain your current standard of living in retirement.

“How Much Should I Save for Retirement” the research paper by Massi De Santis and Marlena Lee attempts to identify replacement rates needed by income. What they found was that households in the lowest 25% based on income needed to replace more of their preretirement income (82%) than those in the top 25% of household income (58%). What they found was the lowest 25% of households who needed to replace 82% of their preretirement income had 59% of their replacement rate made up of social security and the remaining 23% coming from personal retirement savings. The top 25% of households needed to replace 58% of their preretirement income required personal retirement savings to account for 37% with social security only accounting for 21%. While households in the lowest 25% based on income had to replace more of their preretirement income, they needed to cover less of that with personal savings than households in the top 25%.

With income brackets showing the need to replace roughly 20%-40% of income from personal retirement savings. The researchers looked to determine the savings rate needed in correlation to their success probability.

 

Savings Rate

Success Probability

40% Replacement

20% Replacement

95%

16.8%

8.4%

90%

13.2%

6.6%

50%

5.2%

2.6%

 

If those surveyed who think they should save at least 10% save exactly 10%, and they only need to replace 20% of their income they have better than 95% chance of saving enough. However, if they need to replace 40% of their income, they need to have a savings rate of 16.8% to have a 95% level of confidence. Therefore, the amount you need to save is driven by the replacement rate you need to achieve. How much you should save is not the same for everyone, determine your replacement rate and solve for how much you need to save.

It is our duty as fiduciaries to understand why our employees may not be saving enough and implement a solution to help. Many employees say they aren't saving enough due to debt or their income or other reasons. Address those areas and savings will follow and you will also have very appreciative employees.

The hypothetical investment results are for illustrative purposes only and should not be deemed a representation of past or future results. Actual investment results may be more or less than those shown. This does not represent any specific product [and/or service].

 

Thin(k)ing Smarter Blog #3 – Do Your Statements Look Different?

                Many of you may not log into your retirement accounts more than a couple times a year, if even that often, and there isn't anything inherently wrong with that. However, many retirement plan participants do look at their quarterly statements when they come in the mail or via email. If you are one of those people, you may have noticed your statement may already include an additional section showing the lifetime income your account may provide you, or you certainly will before the end of the year. While I like what the government was trying to accomplish with this provision of the SECURE Act, there are some things to be aware of when you see this on your next statement.

                The idea of getting plan participants to think about their retirement account balance not as a lump sum but as a stream of income in retirement, is in my opinion, a very good thing. I look at this as the government's way of “pensionizing” (that's a word I just made up), a 401(k) account to help participants understand what they may expect their account balance to equal in terms of monthly or annual income. Pensions have long been easy to understand because it is a defined dollar amount to be received monthly. 401(k) plans have traditionally operated differently. It was once commonly recommended to save $1 million to retire, however everyone is different in terms of spending habits, additional accounts, etc., so the amount every individual needs, will vary.  

                Now while the impetus behind this rule was well intended, I have some small issues with the rules that govern the lifetime income disclosure. The age at which you are required to show participants beginning to take income is age 67, or if they are older than 67, you must show them taking income at whatever their current age over 67 is. This means if a participant plans on retiring at age 62, the income projection on their statement will be higher than what they would actually receive at age 62.  A person could easily be misled into over-estimating income at a retirement age that is below 67.

                The lifetime income disclosure will also provide two illustrations, one as a single life annuity and the other as a qualified joint spouse annuity (QJSA) with payment being equal to 100% of the monthly payment that is payable during the joint lives of the participant and spouse. The QJSA assumes every participant is married and their spouse is the same age as the participant. Now, we know that not everyone is married, and we know not all married spouses are the same age. These presumptions again can cause the projections to be inaccurate.

                Mortality assumptions on the new income disclosure is another topic I have a concern with. The rule requires the use of a unisex mortality table. Naturally, it is administratively much simpler to use a unisex mortality table, but that isn't real life. On average, women live longer than men, and insurance companies ask a lot of questions to get an understanding of a person's health, lifestyle, etc. to get a more accurate depiction of their individual risk of mortality. Using a unisex mortality table for these statements will likely result in women's monthly payments being higher and men's monthly payments being lower than what they could purchase in the open market.

                My last concern with this disclosure relates to the inflation assumptions or lack thereof in the lifetime income disclosure. Prior to the past year or so, inflation has been relatively low, however as we have seen recently, inflation can have a large effect on our purchasing power. By not including any sort of inflation adjustment, participants reading their income projections become overly optimistic about their ability to have adequate income in retirement. This may not rear its ugly head immediately in your retirement, but as inflation reduces your purchasing power in retirement, you may realize you need more income than you planned.

                All things considered, I do believe the lifetime income disclosure will be a positive thing for retirement plan participants. But it is important for participants to understand that information on the disclosures is a generalization, and that—while helpful-- there are limitations built into the calculations.  It is our job as retirement plan advisors and plan sponsors to help ensure that participants understand the numbers, and to get them to think about their account balance in terms of how much money they need to save to generate a sufficient income stream to reach financial freedom in retirement.

Although it is possible to have guaranteed income for life with a fixed annuity, there is no assurance that this income will keep up with inflation.  There is a surrender charge imposed generally during the first 5 to 7 years or during the rate guarantee period.

 

Thin(k)ing Smarter Blog #2 – Workplace Wellness and Your Benefits Offering

 

                It's time for our weekly blog! This time we are looking at the 2021 Employee Benefits Research Institute (EBRI)/Greenwald Research Workplace Wellness Survey that was recently released. I encourage anyone who is interested in the survey to take a look here.

                The survey finding that I simply couldn't get out of my head was that roughly seven in ten (70%!) employees say that their employer has a responsibility to make sure their employees are mentally, physically, and financially well. This will be the lens that I use to look at other survey results and tie that into how an employer can offer benefits designed to meet the needs of their employees.

  • Mental wellness programs are gaining importance and popularity among employers. About 30% of employees surveyed are offered mental health related services such as resources to improve mental health, expanded benefits like free counseling sessions or access to a mental health coach. Over 50% of the employees being offered those benefits are using them and even more (over 60%) are interested in those benefits but not currently offered them.
  • About 60% of employees surveyed are currently satisfied with their level of health benefits. However, when employees who indicated increases in healthcare expenses last year were asked “Has increased spending on health care expenses in the past year caused you to do any of the following?” some interesting responses followed:
    • 63% increased contributions to their HSA
    • 49% decreased contributions to their retirement plan
    • 48% delayed going to the doctor
    • 48% indicated an increase in their credit card debt
    • 47% used up all or most of their savings, and
    • 46% took a loan or withdrawal from their retirement account.
  • Financially, there are several ways employers can help employees feel less stressed and more secure. Over half of those survey said their retirement plan savings are the only significant emergency savings that they have. Two in three employees describe their level of debt as a problem, with credit card, medical and student loan debt leading the way. Finally, more than half of employees admitted that worrying about their finances distracted them from work.

One of the most interesting survey questions was when every person surveyed was given a hypothetical $600 benefits budget and was asked to allocate that money across six benefit options (retirement savings account, emergency savings account, HSA, student debt pay-down, college savings account, and “buy” additional paid time off). The findings were that on average, retirement savings and emergency savings accounted for $345 of the $600 they had to spend, with HSA coming in third at $76.

                I believe that this could be a very effective way to survey your employees in the future as you are evaluating your benefits and overall spend. Asking employees to tell you what they value and how they budget those benefits could offer valuable insights into which benefits to offer. It may even highlight a benefit you already offer, and your employees are simply unaware of. Your employees' needs and priorities change over time. Asking for their input can help encourage a greater sense of ownership, help ensure your benefits meet the needs of your workforce, and ultimately help you attract and retain quality employees to help your business grow.

 

Thin(k)ing Smarter Blog #1 – Lessons from Hughes v. Northwestern University

 

Hi all! I am thrilled to bring you the first of our new weekly blog “Thin(k)ing Smarter.” where I will opine on a myriad of topics related to retirement plans and how to “Thin(k) Smarter.” This week we are diving into the case of Hughes v. Northwestern and The Supreme Court ruling that was recently released. Buckle up as I offer a high-level overview of the ruling and highlight what I believe are the most important takeaways.

In this case, the petitioner (Hughes) sued the respondent (Northwestern) claiming Northwestern had violated ERISA's duty of prudence in three ways:

  1. Failing to monitor and control recordkeeping fees, resulting in high costs to plan participants.
  2. Offering higher cost mutual funds and annuities than those charged by otherwise identical share classes of the same investments.
  3. Offering options that were likely to confuse investors

Initially, The District Court granted the respondent's motion to dismiss, which was affirmed by the 7th Circuit Court of Appeals where they concluded that the petitioners' allegations failed as a matter of law. The District Court and 7th Circuit ruled that because the petitioners' preferred type of low-cost investment options were available, it abolished any concerns that other plan options were not prudent.

However, The Supreme Court unanimously ruled that “The Seventh Circuit erred in relying on the participants' ultimate choice over their investments to excuse allegedly imprudent decisions by respondents.” The Supreme Court looked at precedent set by Tibble v. Edison International and opined that the act of determining if the petitioners have stated plausible claims against plan fiduciaries for violations of ERISA's duty of prudence requires “a context-specific inquiry of the fiduciaries' continuing duty to monitor investments and remove imprudent ones.” Justice Sotomayor penned in the Opinion of the Court the reasoning of The District Court and 7th Circuit was flawed, and “Such a categorical rule is inconsistent with the context-specific inquiry that ERISA requires and fails to take into account respondents' duty to monitor all plan investments and remove any imprudent ones

What does this ruling ultimately mean? Simply, it means the case is sent back to the 7th circuit to reevaluate the petitioners' allegations applying the duty of prudence articulated in Tibble. It can also be referred to District Court or we could now see a settlement. We shall see if the court changes its view on this case when giving further consideration of the duty to monitor precedents set forth by Tibble. I tend to believe that because The Supreme Court doesn't set new precedent, offer hard and fast rules for fund selection or the number of funds allowed before participant's become confused, this will have a minimal impact on current and future ERISA litigation. What may happen, is that because courts are required to look at context-specific factors, which will likely take longer to litigate than black-and-white, hard-and-fast rules, we may see more plan sponsors moving to settle and not looking to carry the burden of litigation expenses that can drag on for many years.

Key Takeaways:

  • Having well-documented and prudent fiduciary processes that follow industry best practices is the best way to mitigate risk.
  •  Simply offering low-cost funds as an option in your line-up is not adequate. All investments must be regularly reviewed to ensure they continue to be prudent selections within the fund menu.
  • Regularly benchmarking service provider fees and services against the marketplace can help you ensure your plan expenses remain reasonable. Companies who pay the plan administrative costs remove these expenses from consideration under ERISA. However, the investment costs are still subject to ERISA since employees pay those fees directly.
  • Less is more when it comes to the quantity of funds in your plan's investment menu. There are many reasons from behavioral finance to educational resources and capacity along with fiduciary responsibilities to trim the investment menu down to no more than twenty to twenty-five funds. I would argue something closer to fifteen total investment options is ideal for your retirement plan.