Our nation needs to replace its existing retirement system — now.
Social Security can provide only a floor of retirement income. Most defined benefit plans in the private sector have closed, and those in the public sector are dramatically underfunded. Workers today have to rely increasingly on a patchwork of 14 different kinds of defined contribution plans. These plans are complex, costly and challenging for employers to oversee and for participants to manage. Moreover, large numbers of our workers have access to no retirement plan.
We recommend legislation that will create a single private DC system that can cover all working Americans with a single set of rules.
A key part is that all employers who currently deduct payroll taxes — unless they sponsor a defined benefit plan — would be required to arrange for payroll deduction of a percentage of each employee's pay to be contributed to a trusteed retirement fund.
Employees may opt out, but experience has shown that if contributions are automatic, relatively few employees do so.
Sponsors of these TRFs would be trustees, with fiduciary responsibilities. Each TRF would have a trust deed, a published investment strategy and annual audits. The strategy would specify the fund's objectives, the broad diversification of its investments, its level of risk and its fee structure.
Mutual fund managers and consulting firms would want to get into the huge business of managing TRFs. They would have to establish separate funds for which they would be trustees for their TRF clients. For mutual funds and consulting firms, TRFs would represent a separate business. In Australia, for example, a fund manager may establish a superannuation fund and invest the assets in its mutual funds. A TRF trustee would not have to manage its TRF funds; it could hire managers for the TRF portfolio. But the trustee would be responsible for the investments just as a pension plan sponsor is responsible for all the investments in its pension fund portfolio.
The TRFs would have to register with a central agency overseeing TRFs and confirm annually that each continues to meet fiduciary requirements. The agency, which would be established by legislation, could logically become part of the Department of Labor.
A TRF sponsor may charge a nominal administrative fee and an investment management fee, but no marketing costs. These fees must be the sponsor's sole source of income from a TRF.
If an employee does not select a TRF, his employer would have to designate a default TRF. To be registered as a default TRF, the fund must be appropriate as possibly the sole investment vehicle for a person's entire retirement assets.
If an employer has been contributing directly to a DC plan, the employer would continue to make those contributions, but to a TRF instead.
TRFs will relieve employers from all fiduciary responsibility. Employers' only responsibilities would be to arrange for payroll deductions as requested, and to select a default fund for workers who don't choose a particular TRF.
Employees may select a new TRF for their contributions each year and may transfer their TRF assets to a different TRF at any time. If they change jobs, they may continue with their prior TRF. Participants may retain their existing DC accounts. They may no longer contribute to them, but they may transfer assets from them into any TRF.
The government would contract with a private corporation, such as Morningstar Inc., to publish annually for each TRF its benchmark asset allocation, performance data, measures of risk and expense ratios. That corporation would provide comparative information — a great benefit to employers and employees.
Anyone giving advice for a fee to participants about their TRFs would be considered a fiduciary and would have to meet fiduciary requirements of working in the sole interest of each client.
Every TRF and other DC fund would be required to send to a central accounting overseer — which could be the new agency created by the TRF legislation or a private firm contracted by the agency — the market value of each participant's account as of year-end. The agency would then send each participant a statement showing the market value of all of his DC accounts, and the maximum tax-deductible contribution the participant could make to his TRF in the current year.
The TRF concept has advantages over current DC vehicles because:
- All workers would have access to a workplace retirement plan, whereas today less than 40% of all workers participate in an employment-based retirement plan.
- A single DC plan would replace the current complexity of 14 kinds of plans.
- All contributions would be vested immediately.
- Through default TRFs, employees, unless they opt out, would have reasonably suitable investment of his pension assets.
After workers retire, unless they buy an annuity, which few do, they must manage their investments for the rest of their lives. This leaves them subject to serious risks: investment, inflation and longevity.
This proposal offers a basis for near-term action by Congress and the administration to help resolve the serious problem of funding workers' retirement.