Exclusive Interview: Industry Veteran Greg Carpenter Draws a Line Against Too Much 401k Paternalism
Greg Carpenter founded Employee Fiduciary in 2004. With 29 years of experience in accounting and finance, He has brought his expertise to a variety of advisory, senior and executive management roles. Greg has worked for a national accounting firm, a Fortune 500 plan sponsor, a major brokerage firm, and he served as the CEO of a major 401k TPA firm. He is a CPA and his MBA from The University of Chicago Booth School of Business and earned his BA from Yale where he majored in American Studies with a concentration on history and literature. He puts his broad training to good use as author of the popular blog The Frugal Fiduciary.
FN: Tell us a little bit about yourself and how you ended up doing what you’re doing now.
Carpenter: I’ve always thought the 401k market for small businesses has been underserved and overpriced. The industry norm is to exclusively charge asset-based fees resulting in small businesses getting tagged with outrageous fees and lukewarm service. I long felt I could build a business model that matches fees with the cost of service delivery. Having done so, I think it’s important to continually strive to keep a tight product box and control costs fanatically. The industry probably thinks I’m wearing a hair shirt and eating locusts. That’s fine with me.
FN: Share with us a bit of how the recordkeeping industry has evolved since the 401k plan was first introduced – from the initial era of unitized accounting and custom portfolios to the dominance of mutual funds today.
Carpenter: Mutual funds and 401k plans are like peanut butter and jelly – the accessibility and trading cycles are perfect fits, leading to dominance in the 1980s. But since the mid-1990s fund companies have been under increasing price pressure – new technology enabled price competitors. Fund companies fought back. The key change: Fifteen years ago the fund companies dropped all purchase loads and put in place the NSCC standard for overnight trading at pennies a trade. Daily valuation became the standard almost overnight. But margins were slashed. I see a similar trend today with the explosion of passive investments and indexed ETFs. The market will continue to evolve toward lower costs.
FN: Given how recordkeeping has evolved away from unitized accounting, how does the current interest in adding ETFs bring back the issue of unitized accounting and how has recordkeeping technology changed from the 1980’s to make unitized account easier?
Carpenter: Besides big hair and parachute pants? The core technology to do unitization has not changed since the 1980s. What has changed is trading costs. Back then it was prohibitively expensive to trade into or out of positions in individual securities. There was no such thing as daily valuation and trading would likely be limited to quarterly or annual transactions. Daily valuation quickly became the standard when mutual fund transactions costs were competed away beginning in the late 1990s. Plans are trading securities for two cents per share, making daily transactions economically viable. Look for even more economies in the future.
FN: There’s also a growing voice to add an annuity option to 401k plans. What’s your feeling on this? Is it easier for employees simply to roll their assets out of the plan and buy the annuity that way? Or can the typical recordkeeping system adequately handle individualized annuities?
Carpenter: The issue is plan sponsor overload, not recordkeeping capabilities. Recordkeeping systems are adequate, but would add administrative complexity. We ask an awful lot of plan sponsors as it is. To burden them with payout options would only add to the current fiduciary deficits. I believe that participants who would utilize annuity payouts have sufficient alternatives available outside their plan.
FN: Fidelity recently released data showing a third of the participants in the plans they cover have opted for the default fund. You’ve got a pretty sizable database yourself. Does this number seem small, large or comparable to what you’ve seen? Why do you think participants seem to be selecting the default option?
Carpenter: Our data is comparable. QDIA is the reason why. We are seeing many sponsors and advisors opt for target date funds as the default option. Younger participants in particular are embracing the “set it and forget it” approach to investing and they are happy to be guided to the appropriate default option. We are still seeing participants who never get around to setting their investment options, but now they are defaulting into an appropriate asset allocation for a long-term investor. We tend to see the more enlightened retail investors in our plans. They very clearly see the need for diversification and appropriate asset allocation – they just need some help making it happen.
FN: In terms of plan design, there’s a trend to go towards auto-enrollment and auto-escalation. What can you tell us about these two trends? Do you see them in the plans you serve? Why or why not?
Carpenter: I’m a big proponent of behavioral economics. The scholarship is pretty authoritative. Auto-enrollment and auto-escalation work. They are here to stay, and will gain in popularity. That said, smaller employers are beginning to use it, but the employer match is still the key to employee participation. We work with a lot of professional firms utilizing safe harbor plans, so the match is still the big draw for employees.
FN: Some voices in the retirement plan industry are suggesting retirement savings should be mandatory. We know that saving “early and often” is a key ingredient to retirement success, but at what point do we cross the line into the realm of paternalism with any mandatory savings rules? Is there a better way to handle this (e.g., auto-enrollment with an opt-out option)?
Carpenter: My first reaction is “Hell yes!” until I stop to consider who will be making the rules for the mandatory contribution. The DOL? We also have to address the vast differences allowed in plan designs, investment choice and plan costs passed to employees. Forcing some employees to participate in a truly poor plan is just not in their economic interests, however well-intentioned the policy. Even assuming such a law would get through Congress (it won’t), we have a lot of work to do in leveling the playing field for participants before we could even consider such a plan. I think the best the paternalists can do for now is auto-enrollment and auto-escalation.
FN: Some members of the political class in Washington are looking to remove some of the tax advantages from retirement plans in order to raise current revenues (and at the expense of future revenues). How do you think plan sponsors will react if retirement savings loses it tax advantage?
Carpenter: There will be much wailing and gnashing of teeth. Three reasons it will never happen. First, retirement plans are big business. Corporate lobbyists will never let it happen. Second, what else do we have for retirement savings? This is a bipartisan issue. Third, Congress and the Administration would need to co-operate to get it done. Enough said.
FN: For the last several years, the mass media meme seems to be that the 401k has failed and we should return to the “good old days” of defined benefit plans. What are your feelings about this?
Carpenter: The 401k has failed the have-nots, not the “average” participant. I think your average orthopedic surgeon is well-served by our current retirement system. If you’re comfortably middle class, you can make the 401k work as a retirement vehicle. Any less income requires a herculean effort at saving and real sacrifice to your current standard of living. I think most of us would agree that we need to do something. That’s why the meme resonates. Outside of academia and some industry media, however, there is little appetite for addressing income inequality.
FN: Is there anything else you’d like to share with our readers?
Carpenter: Our firm works with hundreds of advisors, TPAs and plan sponsors who are follow best practices and make a positive difference for plan participants – exclusively with small business 401k plans. We are seeing best of class plans for small employers all over the country that rival and outperform the large plans. Take a step back and look at the long-term trends for our industry. Costs, access, education and investment quality continue to trend positively. It may seem like slow progress, but it is happening.
FN: Greg, it’s been great of you to share your experiences with our readers. You’ve got a lot of good ideas and we’re sure our readers would love to read more on your blog The Frugal Fiduciary.