With the technological advancements in money management platforms and payroll systems, one has to wonder whether the costs associated with ERISA compliance could be removed from the retirement plan system. If we could safely remove those costs, it's likely we could help employees accumulate between 20% and 30% more money for retirement. So it's worth considering.
Since most employees work for small employers, and the costs of complying with the Employee Retirement Income Security Act of 1974 are high for small plans, most plans are carrying a big compliance drag. While it's difficult to estimate the exact drag on retirement assets, it's probably somewhere in the range of 0.5% to 1% of assets, depending on the size of the plan.
And investment distribution costs create an additional drag. Because of the cumbersome nature of ERISA plans, it is expensive for investment firms to sponsor and serve them. This creates additional distribution costs in the form of higher investment management fees, service fees and broker costs. Depending on the plan structure and size, those costs can easily run between 0.25% and 0.75% of assets. If we lump it all together, it's fair to say that in many cases the total ERISA drag is close to about 1% of plan assets.
If you could save 1% on your plan expenses, that could have a sizable effect on individuals' retirement plan balances. Let's assume we have an employee who saves $10,000 a year from age 25 through age 65. If the employee could earn an annualized rate of 7.5% without ERISA, the account would be worth about $2.44 million. But if ERISA reduces the return to 6.5%, then the employee would only have about $1.87 million. In other words, without the ERISA drag, the employee would have about 30% more in retirement assets.
If we put it to a vote, most employees would prefer to have us figure out how to remove those costs and let them retire with more. So do we still need ERISA?
As long as employers have access to — and control — over an employee's retirement money, then ERISA is an important safeguard for employees. Thus, ERISA is certainly necessary for defined-benefit plans and profit sharing plans where the employer is responsible for investing the funds on behalf of the employee. But for the plain-vanilla 401(k) plan, we could remove the ERISA drag without creating any additional risk for the employees.
Today, through payroll systems and more sophisticated investment platforms, we can quickly move money from an employee's paycheck directly into his or her own investment account. If the employer has no control over the employee's retirement money, there really is no need for ERISA in those cases.
With a few legislative changes, we could easily allow more employees to opt-out of ERISA plans and use direct-deposit features to save on their own. This would free up employees to accumulate more assets for retirement, which should be the ultimate goal of the system.
401(k)s:: First, we could allow employees to open their own 401(k) accounts, just like they can open an IRA. We already have a solo 401(k) for the self-employed. Conversely, we could allow employed investors to create individual 401(k) accounts separate from their employers. This way, the employee could individually have access to the much higher contribution limits.
Since the individual 401(k) would not be tied to the employer, the account could be opened directly at a brokerage firm of the employee's choice (just as the employee would do with an IRA). With no employer access to the funds, there is no need for ERISA compliance once the money has moved to the employee's individual account. The account custodian will keep track of all contributions and investment activity, just as it does for an IRA.
Moreover, the employee would have access to the full array of investment options, many of which would likely be lest costly and more competitive than what is currently available in many employer-sponsored 401(k) plans today.
IRAs: : We could equalize the contribution limits for IRAs and 401(k)s. There is no reason why these limits are not the same. If you can contribute $16,500 ($22,000 if age 50 or older) on a tax-deferred basis to a 401(k), why can't you do the same thing with an IRA? The tax law essentially discriminates against individual savers. We need to either allow for individual 401(k)s or equalize the IRA limits.
Matches: : Since many employers do match retirement plan contributions, we could allow discretionary matches to individual 401(k) accounts or IRAs. Just simplify the rules and require the employer to make the same fully vested match for all employees. If they want to match 2%, then it's 2% for everyone. Many employers would select this simplified approach in exchange for not having to operate the plans under ERISA. The match could be contributed monthly or on an annual basis.
Simplify: : For the last 30 years, we have consistently made the employee retirement plan system more complicated. Every year new regulations are added to govern how employers interact with employees on their retirement money. If we remove the employer from having access to the employee's money, it becomes a lot easier, and information technology allows us to do that.
Summary: In general, ERISA compliance raises the costs of building assets for retirement and limits investment choices for most employees. While ERISA was an important addition to the regulatory landscape in the early 1970s, today there is little reason to subject all employees to the ERISA drag. We have the tools to create alternative channels for employees to safely and efficiently build their retirement assets, and we should let them do that.
Charles J. Farrell, J.D., LL.M., is an investment adviser with Northstar Investment Advisors LLC in Denver.
