Monday, April 08, 2013

403(b)izarre: Make It Automatic Part I of IV

Is your car an automatic or stick shift?

You probably don't have to think about it, unless you're driving a sports car, it's an automatic.  Even many sports cars these days come as automatics.  Less than 7% of cars sold today are "manual."

The reason is simple, driving an automatic is easier.
When it comes to the 403(b) retirement program offered to most of the nation's k-12 school employees, they are getting a stick shift (actually they are getting the shaft) when they really need an automatic.

While many school employees think they are buying a sleek, sexy and sporty vehicle, in fact they are being sold a lemon.  The 403(b) program is mired with problems, but it can all be mostly fixed by moving to an "automatic" transmission.

What do I mean?

If I were asked (I often am) how a school employer or union could make an immediate impact on the financial lives of their employees and improve their odds of retiring with significance, I would tell them "Make It Automatic."

What does "Make It Automatic" mean and why is my recommendation often met with scorn, derision and even mockery?

I'll explore both in this first of a new segment on my blog I call 403(b)izarre.

The "Make It Automatic" program I recommend is increasingly in use today in the private sector, backed by very specific laws and regulations.  Not only is it baked into law, it's backed by very prominent behavioral economists with decades of research. Famed, behavioral economist Richard Thaler just penned an editorial for the New York Times list weekend (April 5th, 2013) emphasizing this series main point (the ideas of which came from Thaler, Bernartzi and Tversky/Kahneman). 


The Pension Protection Act of 2006 opened the doors to the private sector (ERISA plans) to allow them to automatically enroll participants into 401(k) plans as long as they follow certain "safe harbor" guidelines.  If followed, the employer would be exempted from liability.  The PPA related to automatically:
  • enrolling participants into a 401(k) plan
  • defaulting participants into an appropriate Qualified Default Investment Alternative
  • allowing for increases to the savings rate each year
These three simple automatic ideas (auto-enroll, auto-default and auto-escalate) represent behavioral finance's first big incursion into the retirement planning world and have the potential to change the retirement outcomes of millions of Americans (but remember, millions more are still without a plan - so it doesn't solve everything).  If followed, participation rates can easily hit 90% or more, even without a match.

The PPA does not technically apply to state and local government entities.  Worse, the very entities that could make this happen fight vehemently against its implementation.

If a school employee wants to contribute to a 403(b) currently, it's entirely a "manual" process. In most cases they are forced to go through a salesperson.  If the employee searches hard and finds a low-cost, quality 403(b) option they must fill out an agreement with their employer, fill out an application with the provider and then monitor their paycheck to make sure the right amount comes out and is sent to and deposited by the provider.

While this process doesn't sound difficult, when you consider that the employee may have to choose from dozens or even hundreds of investment options and has little information on any of them - it can be daunting.

Currently this process is alleviated by the use of a 403(b) agent, a sort of used car salesman who will help them navigate the "lot" of products to find the one most suitable.  Instead, they are sold a lemon and the agent makes lemonade...usually turning the sale into a qualification for a trip to somewhere exotic (Monte Carlo here we come!).

It doesn't have to be this way, there is now a path to 403(b) freedom and it starts with "Make It Automatic!" The opposition is fierce though.

Who is opposed to this newly available freedom? 

I'll post one part a week for the month of April.

Scott Dauenhauer CFP, MSFP, AIF
The Teacher's Advocate