Tinkering with ERISA: Congress may amend the decades-old law protecting retirement benefits to allow providers of 401(k) and other retirement plans to advise investors. (Life/Health: Retirement Plans).

When Congress passed the Employee Retirement Income Security Act in 1974, defined-benefit plans dominated and 401(k) plans didn't even exist. Employers took on investment risk, made the fiduciary decisions and handled the paperwork for plan participants.

Nearly three decades later, 401(k) plans dominate the landscape. Participating employees decide how much to invest and what investment options to choose. But under ERISA, plan providers can't give personalized advice, and many plan members are afraid to make their own investment decisions.

"We're asking participants to take on sophisticated responsibilities, but prohibited transaction rules prevent us from giving them individualized advice," said Melissa Kahn, vice president of government and industry relations at MetLife Inc. "Our clients are saying they need help, that they can't do it by themselves."

With the encouragement of the financial-services industry, Congress has tried for three years to loosen the rules and allow plan providers to play a more active advisory role. In May 2003, HR 1000 passed the House of Representatives, 271-157. Supporters of the bill said winning Senate approval would be more difficult, but the primary sponsor, Rep.John A. Boehner, R-Ohio, expressed optimism later in the month.

Authorities understand J how important it is that 401(k)s and other defined-contribution retirement plans succeed. Since 1986, 97,000 mostly small defined benefit plans-serving some 7 million participants-have terminated, according to the Pension Benefit Guaranty Corp., an agency of the federal government. Only 32,000, serving some 44 million participants, remain. The assets of about 95,000 of the terminated plans have been transferred to annuities in the private sector. Meanwhile, 401(k) plans have proliferated. According to a March 2003 report by the Employee Benefit Research Institute, there were at year-end 2001 more than 406,000 plans with some 44 million plan members and $1.76 trillion in assets.

Congress passed ERISA to ensure that employees receive the pension and other benefits promised to them by employers. "The idea of protecting plan members from companies that might act in a self-interested way was a good idea," said Chris Bowman, vice president of retirement and investor services at Principal Financial Group. "The requirements are still sound and important."

ERISA imposes a set of regulations that overlays the retirement-asset area, said Stephen Saxon, a partner in the Washington, D.C.-based Groom Law Group. Because of that, even advisers properly licensed under securities regulations "aren't home free under ERISA," because ERISA raises the issue of fiduciary responsibility, he said.

401(k) plans came on the scene after Congress added Section 401(k) to the Internal Revenue Code in 1978. But as the number of 401(k) plans multiplied and the responsibility for choosing investments shifted to employees, plan providers realized they had to help. In recent years, they have improved their educational programs and have made available increasingly sophisticated tools. "It's a very competitive industry to play in" said Bowman, whose company is the largest 401(k) provider. "We've seen the advent of lots of true advice tools because of market pressure...It's market pressure now driving the change as much as Congress."

HR 1000 is a bill to amend ERISA and the Internal Revenue Code of 1986 to promote provision of retirement investment advice to workers managing their retirement-income assets. It would also protect employees from "excessive investment in employer securities"--the stock of the company that employs them--and the potential for Enron-like meltdowns in the value of retirement plans.

As of the end of last year, Principal operated 26,479 full-service 40 1(k) plans with $30.1 billion in assets. In all, it runs about 45,000 retirement plans with 3 million plan members. The 401(k) plans range in size from only one or two members to about 10,000, but they cater mostly to small- and medium-sized firms with 200 or 300 lives, said Bowman.

The company offers several levels of education and advice, from live presentations for employee groups to written information. Under Principal's Deposit Director service, a plan member can fill Out a questionnaire and receive a suggested model portfolio or a suggested lifestyle fund. The company offers two versions of lifestyle funds, which allocate across asset categories based on age, proximity to retirement and other factors. The company also offers periodic rebalancing of investments.

Personal Help

To offer a more personal recommendation, Principal makes available online a planning tool created by Financial Engines, which incorporates Monte Carlo simulations. These simulations take market risks into account and provide the user with probabilities of reaching investment goals. Coupled with personal data provided by the user, it provides specific investment recommendations using funds in the user's 401(k) plan. Use of software created by an independent third party became permissible under Department of Labor advisory opinion 9A, issued Dec. 14, 2001, which was sought by AIG SunAmerica Inc., a subsidiary of American International Group Inc. SunAmerica wanted to use an asset-allocation model developed by Ibbotson Associates. Several plan providers have made such online advice available.

If HR 1000 were to become law, it would allow that kind of advice to be dispensed by a representative of the plan provider. "Currently, we can only offer such advice outside the qualified plan," said Bowman. "A new law would allow us to do a comprehensive financial strategy session with a plan member, one that considers money both inside and outside a qualified plan."

That would be significant, he added, because for millions of people, the 401(k) represents the primary source of savings besides equity in a home. "It's not a problem. for the high-income individual to find help, but for lower- and middle-income people, this is where they would get their financial-strategy work done."

It might also be significant because plan members overwhelmingly don't bother using the online advice software available from Financial Engines and other such third parties. According to a 2002 Plan Sponsor Survey by the SPARK (Society of Professional Administrators and Recordkeepers) Institute, only 5% of plan members who have such access use the software. Of those 5%, only 35% work with the software long enough to obtain a recommendation. Of those 35%, 75% agree with the outcome, but only 25% implement it. About 53% of the 35% implement some of the recommendation. 'You have to be motivated and computer literate," said Robert Wuelfing, president and chief executive officer of RG Wuelfing & Associates, a consulting firm to the retirement and investment-management industry and CEO of the SPARK Institute.

Providers Enthusiastic

Plan providers have much enthusiasm for providing investment advice, said Wuelfing. "It used to be you gained a competitive advantage through your back-room service and administration," he said. "That's become like processing credit cards. You're expected to do it, and do it on time. Investment education is the new frontier."

Wuelfing said investment-advisory firm Merrill Lynch, with 14,000 or 15,000 advisers, is in a "perfect slot" to benefit from a change in the law. He also mentioned Charles Schwab and mutual-fund provider Vanguard, and he said Principal has an excellent distribution system and brand name.

MetLife has also strongly supported the Boehner bill. "We've seen the evolution of this bill over the past three years, and we think a lot of the concerns have been addressed," said Kahn. "The bill strikes the right balance between employee protections and employees getting the advice they want."

MetLife has $7.8 billion in 401(k) assets in its plans. It is a full-service provider, from plan design through record-keeping. Last year, it sold its large-company plans to outsourcing and consulting firm Hewitt Associates, and it now focuses on small and mid-sized companies.

Kahn said MetLife provides lots of education in the workplace through its agents and financial planners, including general investment concepts, diversification and risk tolerance. "Employees would like to get advice on their entire portfolio, on how the 401(k) fits into the picture, but the law does not permit us to go into that," she said. "Our agents have very personal relationships with clients, and some may have 401(k) plans, but agents have to say, 'I'm sorry, but I just can't tell you what to do with the 401(k).'"

Critics of the Boehner bill argue that advisers operate under a conflict of interest when they are tempted to recommend funds that earn them larger commissions. But Kahn said three forces are at work that prevent such a conflict from developing. One is that strict disclosure of fees would make any perceived conflicts transparent to a participant. Another is that under the bill, financial advisers would be assuming a fiduciary status. "That's huge," she said. "If somebody messes up, then MetLife or another provider becomes a deep pocket. The participant can sue us!' Third, and perhaps most important to MetLife, Kahn said, is that the company's reputation is on the line. "We've built that and don't want to jeopardize it," she said.

Hartford Life Insurance Co. already has a 40 1(k) system in place that wouldn't change if Congress passed a new law. "We applaud Congress for bringing this to national attention, but we're already supporting solutions and addressing the issues," said Jim Davey, vice president and director of corporate markets. "We've been out in front of this bill."

Hartford's business is built on the premise that the financial adviser is key. The company is the manufacturer and administrator, but independent third parties solicit business and advise clients. Thus, Hartford has no ERISA fiduciary responsibility, and its 40 1(k) plan members receive personal advice from ostensibly unbiased third parties.

The company, a major provider of variable annuities and variable life insurance, reinvigorated its 401(k) program in 1999. Last year, it formed about 1,800 new plans with more than $1 billion in assets, Davey said. Hartford's goal is to become a premier provider in the small-company market, which Davey said is the greatest growth area and which best fits the intermediary model.

In addition to personal third-party advice, Hartford offers education programs and advice tools for plan sponsors and participants. Its "Plan for Life" series of workshops, presented by a Hartford education specialist, a financial professional or both, presents the fundamentals of retirement investing based on the four stages of the career cycle: early, mid, preretirement and retirement.

Online advice for participants is through the Morningstar ClearFuture program. Hartford has also arranged for asset manager Neuberger Berman to provide investment advisory services to plan-sponsor clients through the Neuberger Berman Plan IQ. The service will assist plan sponsors in the selection and monitoring of a plan's investment choices and will conduct annual reviews for the business owner/plan sponsor. "Under current law, both of these are third-party engines," Davey said. "Hartford has no fiduciary responsibility on the investment side. We believe the third-party, unbiased solution works in our marketplace."

The third part of Hartford's strategy is open architecture, which complements the first two, said Davey. "It's a necessity to building an unbiased Approach," he said. "Hartford does not mandate that any Hartford funds be offered in the 40 1(k) plan, and the adviser is paid equally for any fund in the menu. It's hard to say you value steps one and two without putting three into place."

Cable TV vs. Retirement Saving

Perhaps the most important message personal advisers can deliver to plan members is that they simply aren't saving enough, according to Wuelfing. Asset allocation and efficient investing won't really matter unless participants have put enough into their plans, he said.

"People equate that they can acquire retirement wealth without a lifetime of hard work, savings and sacrifice," Wuelfing said.

The Department of Labor tracks what is going into pension plans and 40 1(k) plans, and the amounts saved won't last very long into retirement. Before the three-year bear market, the average 40 1(k) participant had more than $50,000 in his or her account, but Wuelfing and company spokesman Jeffrey Close estimated that the value had fallen below $40,000 this spring, and probably down to about $35,000. The median, however, is much lower, because the top 13% of plan participants have about 57% of the assets, they said. "It's very skewed, and the average is very misleading:' said Wuelfing. "That top 13% probably doesn't even need the 40 1(k) assets" for retirement.

Two other tax-qualified plans, the 457s used by municipal workers and the 403(b)s used by teachers, tend to be better funded because they have been around longer. The 403(b)s, also known as tax-sheltered annuities, were designed to supplement traditional defined-benefit plans, and the 401(k) also was designed originally as a supplement, Close said.

The government imposes what it calls "discrimination testing" in 401(k) plans to ensure the plans aren't just a perk for highly compensated employees. But Wuelfing said the reason so much of 401(k) assets are concentrated among a small portion of participants is that discrimination testing doesn't help the lower-paid put more money into their plans. Instead, it reduces the amount the highly compensated can put in.

"People are spending more on cable TV than they are putting into their retirement plan," said Wuelfing. "What is required is some sacrifice today and investing for the long term."

Participation Incentive

Experts were mixed about whether HR 1000 would cause more employers to sponsor 401(k) plans and whether employees would put more money into them. "More employers would offer investment advice as an added benefit, and that would have a dramatic effect on savings levels," said Kahn. "Lately, employees have become gun-shy, particularly the younger employees. They're not joining or they're not putting much money in."

Bowman predicted a loosening of restrictions would have "no profound impact" on the rate of plan formation, but he said there would be an uptick in employee sign-ups. "One of the reasons employees don't participate is that they don't know what to do," he said. "Especially with the bear market, they're afraid to lose money. There's a strong correlation between people getting advice and participating more.

Greater participation would also serve the social good, he said. "Employees would have more confidence because they wouldn't have to try to become financial experts," he said. "There would be a better uptake and a better understanding of how much people need to save. But we're not waiting for the bill to pass. We're working diligently on ways to incorporate third-party advice."

Saxon, however, said the legislation doesn't directly address the problem of employees not saving enough. In addition to his affiliation with the Groom Law Group, he is general counsel of the SPARK Institute. The Pension Preservation and Savings Expansion Act of 2003 (HR 1776), introduced April 11 by Reps. Rob Portman, R-Ohio, and Benjamin Cardin, D-Md., would address more directly the problem of low retirement savings, he said.

"Supporters of the PortmanCardin bill have been trying to whittle away almost 30 years of regulation in the employee-benefits area that has constricted the flow of money into retirement plans," Saxon said. "People have been so concerned with doctors and others taking advantage of tax shelters that they've regulated them out of existence, and they've hurt the defined-benefit plans, too." He estimated, however, that enacting the Portman-Cardin bill would probably take "a couple of more years."

Average Account Balances Among 401(k) Participants

                   Average Account Balance *
Age Cohort **   1999         2000       2001

20s             $8,842      $11,235    $12,993
30s             33,055       34,757     34,884
40s             64,055       64,849     62,900
50s            100,410       98,099     92,468
60s            127,136      119,743    108,958
All             61,116       61,125     58,785

                   Change in Average Account Balance
Age Cohort **  1999-2000        2000-2001     1999-2001

20s                27.1%            15.6%         47.0%
30s                 5.2%             0.4%          5.5%
40s                 1.2%            -3.0%         -1.8%
50s                -2.3%            -5.7%         -7.9%
60s                -5.8%            -9.0%        -14.3%
All                0.01%            -3.8%         -3.8%

* Sample of 6.9 million participants with account balances at year-end
1999, year-end 2000, and year-end 2001

** Age Cohort based on participant's age at year end 1999

Source: Tabulations from the EBRI/ICI Participant-Directed Retirement
Plan Data Collection Project

RELATED ARTICLE: Safe Harbors for Plan Sponsors/Providers

According to the Department of Labor's Interpretive Bulletin 96-1, the following kinds of investment information given to employees do not constitute investment advice:

* Plan information, including the advantages of participating and making the maximum contribution possible.

* General financial and investment information, such as risk and return, diversification, dollar-cost averaging, compounded return and tax deferral.

* Asset allocation models, such as pie charts, graphs or case studies, for hypothetical individuals with different time horizons and risk profiles.

* Interactive investment materials, which allow a plan member to estimate future retirement income needs and assess the impact of investment allocations on retirement income. A subsequent ruling on Dec. 14, 2001, allows the use of interactive online software programs.

Source: U.S. Department of Labor