It’s no secret that the U.S. has a saving problem. Most Americans are generally in the dark when it comes to how much to save and what investments to make. Ask them about the Department of Labor’s (DOL) proposed fiduciary rule and you’ll get an even blanker stare. But interestingly, the proposed rule could have a big impact on many who are saving for retirement.
When it comes to saving for retirement, U.S. households need a lot of handholding. Whether it is due to behavioral reasons such as lack of self-control or discipline, or simply a lack of financial knowledge, many of us save less than optimal amounts. Widely embraced policies, such as automatic enrollment and automatic contributions within 401(k) plans, have been successful in helping overcome some of these issues. But with changing times, there comes additional problems.
These days, it is very rare to hear someone say, “after 30 plus years with the same company, I am retiring.” In fact, according to the Bureau of Labor Statistics, for wage and salary workers 16 years and over, the median number of years with their current employer was 4.6 years in January 2014. For those aged 25 to 34, the median number of years was three. This could mean as many as 15 different jobs for this generation over their working life. Many millennials see frequent job changes as a tool for career improvement. However, continuous circulation between jobs also has implications for their retirement savings.
When they change jobs, employees have the option of leaving their funds with their old employer, transferring it to a plan with their new employer, rolling it into an IRA, or taking cash out. According to a Government Accountability Office (GAO) report, some plan sponsors do not want to retain separated employees’ accounts due to administrative burdens, costs and legal liabilities. The paperwork that is required to roll into a new account can be a burden for some employees. Many young workers take the path of least resistance and take the cash out, especially if their account balances are low. For example, according to a 2011 AON Hewitt survey, 42 percent of terminating employees took a cash distribution.
Financial advice becomes crucial at the point of rollover, and helps keep savings intact. Employees are less likely to take cash distributions if they are guided by financial advice. In fact, one company found that when terminating employees were contacted by phone by a licensed representative of a financial company, they were 3.2 times less likely to take a cash distribution compared to a similar worker who received only written communications. However, the DOL rule could inhibit communication between licensed representatives like broker-dealers and employees by requiring the broker-dealer to become a fiduciary. Inhibiting these communications will increase the likelihood that terminating employees will cash out their crucial retirement savings. A new report by the American Council for Capital Formation takes a close look at the impact of the DOL’s rule. By some calculations, a lack of educational communications to transitioning employees could result in an additional $20 to $32 billion of cash outs annually, decreasing the retirement savings of affected individuals by 20 to 40 percent.
This is just one of the issues flagged by the critics of the rule. There is also the impact on small businesses that rely on financial advice to set up their retirement plans. In fact, when a financial adviser is involved, a small business with 10 to 49 workers is 50 percent more likely to set up its own retirement plan. Smaller businesses are twice as likely to set up their own retirement plan with the help of financial advisers. However, the DOL rule could hinder this ability since the seller’s exception under the proposed rule (when sellers clearly communicate that they are selling a product and not advising) does not apply to individuals and small businesses. Many experts think that the lack of a clear seller’s exception will limit or discourage many small businesses from starting their own plans, negatively impacting the public policy goal of increasing access to retirement plans.
U.S. retirement markets are continuously evolving, with changing demographics as well changing economic realities. A comprehensive retirement policy designed to maintain growth in savings, expand coverage and prevent leakage during job changes is imperative for retirement security. The recently re-proposed DOL fiduciary rule, meant to protect the retirement savings of individuals, might not be in consumers’ best interests. The DOL rule should be more fully analyzed and adjustments made to ensure that low- and moderate income individuals are not priced out of personalized guidance and advice.
Wilber, Ph.D. is a senior economist at the American Council for Capital Formation, a nonprofit, nonpartisan organization advocating tax, energy and regulatory policies that facilitate saving and investment, economic growth and job creation.