Unions Need to Upgrade 401(k) Default Investments

Brotherhood in unions leads to a paternalistic approach to union 401(k) savings plans ??because brotherhood means that union members are all part of a family, and that the union is responsible for taking care of its members. This is especially true in defined contribution savings plans where participants make the investment decisions, and bear all the risk.

Defined contribution (savings) plans are replacing?defined benefit (pension) plans?because they enable an employer to better control the amount it contributes, and they permit beneficiaries to participate more actively in the process of building a personal retirement fund.?

Union trustees sincerely want to protect 401(k) participants against investment losses, especially those who can’t make an investment decision. Trustees want to make the best decisions they can on behalf of these defaulted participants.

But the unfortunate reality is that trustees do not protect defaulted participants when they place them in a target date fund (TDF). Most target date funds are way too risky at their target date with more than 85% in risky assets comprised of 55% equities with most of the balance in risky long-term bonds.

The $800 billion Federal Thrift Savings Plan (TSP) and the Office Professional Employee International Union (OPEIU) are?notable exceptions to this practice. Both are 70% safe at their target date. Fortunately, trustees can emulate this protection by taking back control. Off-the-shelf TDFs simply don’t work because they take too much Sequence of Return Risk that can spoil retirement with dignity.

Union trustees need to take back control of their Qualified Default Investment Alternative (QDIA)

Union trustees should not settle for one-size-fits-all TDFs that are very risky at their target date. Participants deserve better. Personalized target date accounts (PTDAs) provide the flexibility that trustees need in order to protect defaulted participants and ?PTDAs should also extend this flexibility to non-defaulted participants.

PTDAs are not new, but they have been improving. The latest innovation is called Soteria, named after the goddess of deliverance from harm because it protects in the Risk Zone spanning the 5 years before and after retirement. Soteria puts the plan’s investment advisor in the driver’s seat. The advisor specifies the investment line-up and supervises the recordkeeper’s utilization of Soteria software.

How Soteria works

Personalization cannot be provided for defaulted participants because they do not want to engage, so the Qualified Default Investment Alternative – QDIA – is best left to the plan trustees. PTDAs give trustees great flexibility, Trustees choose the target date for defaulted participants. This specification is by age (like the day the participant turns 65) rather than a 5-year or 10-year grouping. Trustees also choose the risk of the glidepath. Low, middle and high risk glidepaths are provided, and these can be blended.

Self-directed participants do want to engage so they value the ability to personalize. About a third of the $3.5 trillion in TDFs is from non-defaulted participants. These participants choose their risk and their target date, and they can change these at will.

The glidepaths provided by the PTDA are the most important consideration. Soteria’s Conservative and Moderate glidepaths defend against Sequence of Return Risk, something that most TDFs don’t do. Soteria also re-risks in retirement to extend the life of assets.

A dozen benefits of Soteria

Soteria is designed to meet the individual needs of each participant. It offers a number of advantages over traditional target date funds and other PTDAs, including:

1. Personalization: ?Considers each participant's individual risk tolerance, time horizon, and financial goals. This helps to ensure that each participant is invested in an asset allocation that is appropriate for them. Personalization is the ultimate customization. It’s important because investing is personal.
2. Both defaulted and self-directed participants benefit: Something for everybody.
3. Tracks the patented Safe Landing Glide Path with a proven 16-year track record: Win by not losing.
4. Puts the investment advisor in the driver’s seat: Soteria is a partnership with advisors and recordkeepers.
5. Target date is the precise month of retirement: No more grouping in 10-year or 5-year ranges.
6. Flexibility: Offers a variety of investment options, so participants can choose the ones that best meet their needs. This flexibility can help participants to achieve their retirement goals more effectively.
7. Cost-effectiveness: More cost-effective than traditional target date funds and managed accounts. This is because it does not require the same level of administrative overhead.
8. Improved retirement readiness: Helps participants improve their retirement readiness by providing them with a personalized investment strategy that is tailored to their individual needs.
9. Increased participation: Helps increase participation by making it easier for participants to choose an investment strategy that is right for them.
10. Substantive prudence: is doing what is right and best for participants. By contrast, “procedural prudence” is doing what others do, even if it’s not the best for participants. Excessive fees were procedurally prudent until lawsuits changed that.
11. Manages Sequence of Return Risk: Defends at the target date because losses in the Risk Zone can ruin a retirement with dignity. Less than 40% risky.
12. Paternalistic: Aims to protect beneficiaries from harm.

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Conclusion

The TDF oligarchs – Vanguard, Fidelity and T Rowe Price – do not provide PTDAs. Oligopolies are never good for consumers because?they block new entrants and stifle innovation. Oligarchs like the status quo, so they protect it.

Why unions rather than other types of savings plans? Union 401(k) trustees are paternalistic – they sincerely want to protect beneficiaries. To provide this protection, trustees need to take control of their QDIA. The fiduciary Duty of Care is like our responsibility to protect our children from possible harm. Plus, from a legal perspective, the best fiduciary protection is beneficiary protection.