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Help on the way for befuddled employees

Updated: May 3, 2013 12:14PM



Originally published: October 5, 2006

Employers will now be able to offer more advice to 40l(k) plan participants, based on new rules proposed by the U.S. Department of Labor. Over the past 25 years, almost every major company has switched from a defined benefit pension plan to a defined contribution 40l(k) plan. That created two huge problems. Employees needed to be taught the importance of contributions. And employees needed to be taught how to invest those contributions.

Employers, fearing a liability, were unwilling to provide advice beyond basic booklets about diversification. Plan participants followed the latest investing fad -- or concentrated their money either in company stock (used for matching purposes) or in seemingly “safe” investment alternatives that would not create the necessary growth for retirement purposes.

All that changes with the new rules. They make it easier for fiduciaries -- those responsible for creating and implementing defined benefit plans -- to adopt automatic enrollment and investment diversification features.

Specifically, the DOL rules acknowledge three appropriate automatic investment plans for 40l(k) accounts. They are: balanced funds, lifecycle funds and professionally managed accounts. If an employer automatically places employee contributions into one of these formats, it will have a “safe harbor” from being sued for bad investment advice.

LIFECYCLE FUNDS have been growing in popularity since they were first introduced about a decade ago, and are already found in many 40l(k) plans. The funds require the individual to choose a retirement year, and then the fund managers diversify investments based on that goal, adopting a more conservative investment strategy as the investor approaches his retirement year. Given the new DOL ruling, the demand for these funds will continue to grow.

BALANCED FUNDS have been around for years.They typically use a combination of conservative stocks, preferred and dividend-paying stocks and high-quality debt instruments to create a portfolio that is designed to produce returns over the long run. Portfolio managers make adjustments to the fund investments, based on their outlook for the various markets.

MANAGED ACCOUNTS are the relative newcomer to 40l(k) plan investing. As the name implies, these are professionally managed accounts within the 40l(k) plan, using the participant’s risk preferences and retirement horizon. Professional managers are chosen by the employer, and are restricted to choosing from the existing investment choices within the plan. The decisions are made by the manager on a discretionary basis.

Financial Engines, the online provider of investment advisory services, is a leader in this growing new space of managed accounts within retirement plans.

For years, employers have used Financial Engines as a “fiduciary” to give individualized investment advice to plan participants. Employees could create secure individual profiles, detailing their contribution levels, income, retirement goals and risk tolerance. Then the “Monte Carlo” modeling engine would give the employee specific recommendations for diversifying her investments.

Recognizing that the process, simple as it is, still intimidated many employees, Financial Engines enhanced its offering to include portfolio management. That is, companies provide their services, and individuals can literally turn over the decision-making process to the Financial Engines professionals. It’s not investment advice: It’s investment management.

According to a recent study by Hewitt & Associates, 7.5 percent of large employers are either currently offering or are planning to introduce a managed account option to their plan participants in the coming year. Some will include it as the default option for new employees. Others may actually enroll existing employees into the managed account service, unless the employee declines.

The total fees of the managed accounts, including the underlying fund costs plus the cost of advice, total about 60 basis points -- or just over 0.5 percent per year. That means an employee with $10,000 in her 40l(k) account would pay about $5 per month in total fees. That’s about the same as most Lifecycle funds charge without any personalized advice.

The new rules open the door to long-term investment advice, the ingredient that has been missing over the years as companies have turned the responsibility for retirement planning over to unsophisticated employees. Now you don’t have to become an investment pro. Your company plan will give you access to the professional advice you deserve. And that’s The Savage Truth.

Terry Savage is a registered investment adviser. Her regular weekly column appears Monday in the Chicago Sun-Times.



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