Data & Research August 14, 2017

Study Finds Preference for Pre-Tax Deferrals Even If a More Adverse Outcome

The study finds most people do not consider tax implications before deciding whether to defer into retirement plans' pre-tax or Roth accounts.
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Researchers for the Center for Retirement Research (CRR) at Boston College examined individual choices between Roth and pre-tax deferrals to retirement plans.

The results of their experiments suggest that individuals may not systematically rely on their beliefs regarding their relative tax rates when making plan choices, but that at least part of that failure is due to a lack of awareness and/or understanding. However, the researchers say, although education increased participants’ use of expected tax-rate changes in their plan choices, participants continued to display an economically “irrational” preference for pre-tax deferrals. 

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The researchers found this to be systematically related to participants’ more general non-economic attitudes and preferences and the relation of these attitudes and preferences to the features of the plans being evaluated. However, they did find that investment risk preference is negatively associated with a preference for pre-tax deferrals and may be influenced by tax-related contextual variables as well.

“Consistent with prior research, our results suggest that individuals, on average, do not respond rationally to the relative economic incentives associated with alternatively structured plans. Further, although errors can be reduced with increased awareness, our evidence illustrates that individuals systematically incorporate non-economic factors into their retirement plan choices, often leading to a preference for [pre-tax deferrals] even when such a choice is economically adverse,” the researchers say in their report.

Even when participants were educated about how their tax rates before and after retirement related to their retirement income, 49% who reported that they expected their tax rates to be lower in retirement nonetheless elected to make their contributions to on a pre-tax basis. Conversely, only 18% of those who reported that they expected their tax rates to be higher in retirement nonetheless selected to make their immediate contributions as a Roth deferral.

The research found that participants, on average, prefer to pre-pay for consumption and positively discount future payments. As the researchers expected, they link the tax costs and savings of Roth deferrals more than they do pre-tax deferrals and see the tax costs and savings of Roth deferrals as more uncertain than those of a pre-tax deferrals.

One other finding of the research is that a sense of urgency regarding saving for retirement is positively associated with savings rates. “While this is not surprising in itself, the current crisis in retirement preparedness suggests that current marketing and education campaigns are not sufficiently stoking investors’ sense of urgency,” the researchers said. “Further research into the factors that increase a sense of urgency for retirement saving could be fruitful for future campaigns aimed at increasing savings rates.”

The research report can be downloaded from here.
Compliance August 14, 2017

Second Sears Stock Drop Suit Includes Puerto Rico Plan

As with the lawsuit filed in July, the new complaint says the defendants breached their ERISA fiduciary by retaining the company stock fund as an investment option under its retirement savings plans when a reasonable fiduciary would have done otherwise.
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Another participant has filed a lawsuit against Sears Holdings Corporation over its continued offering of company stock in its retirement plans after disclosures that the company was not doing well financially.

However, unlike the first lawsuit filed, this one was filed not only on behalf of the Sears Holdings Savings Plan, but also the Sears Holdings Puerto Rico Savings Plan and their participants and beneficiaries.

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As with the lawsuit filed in July, the new complaint says the defendants breached the Employee Retirement Income Security Act (ERISA) fiduciary duties they owed to the savings plans and the participants by failing to employ a prudent process with regard to monitoring the performance of the Sears Holdings Corporation Stock Fund and retaining that fund as an investment option under the savings plans, when a reasonable fiduciary would have done otherwise.

Specifically, the defendants permitted the savings plans to continue to offer the Sears Stock Fund as an investment option to participants even after they knew or should have known that during the relevant period—between May 22, 2014, and the present—that the Sears Stock Fund was a poorly performing investment option, continually failing, to meet its stated performance benchmark; there was no adequate process in place to monitor the continued prudence of including the Sears Stock Fund in the savings plans’ investment lineup; and the fiduciaries were not properly investigating the prudence of continuing to hold and invest the savings plans’ assets in the Sears Stock Fund in the face of well-reported dire circumstances facing the company.

The complaint suggests that rather than waiting until January 1, 2017, when Sears stock already lost tremendous value to close the Sears Stock Fund to new investments, the defendants could have taken numerous steps with regard to the savings plans’ assets invested in Sears stock to fulfill their fiduciary duties to the plans and participants. The complaint says none of these actions would have implicated, let alone been in violation of, the federal securities laws or any other laws.

Steps the complaint suggests fiduciaries could have taken include:

  • Investigating and monitoring the performance of the Sears Stock Fund, and assessed the appropriateness of the savings Pplans’ investment in that fund in light of Sears’ continuously deteriorating business prospects and liquidity constraints;
  • Timely closing the Sears Stock Fund to new investments prior to the start of the relevant period instead of waiting until January 1, 2017, to do so, by which time, the savings plans had already sustained massive losses;
  • Introducing Target Retirement Funds prior to March 1, 2017, and prior to the closure of the stock fund to prevent the losses to the savings plans that resulted from the defendants’ imprudent conduct during the relevant period;
  • Undertaking an orderly divestment of the Sears Stock Fund held by the savings plans, and assisting participants with redirecting the proceeds into other investment options available to them; and
  • Seeking guidance from the Department of Labor (DOL) or Securities and Exchange Commission (SEC) as to what they should have done, resigning as fiduciaries of the savings plans to the extent they could not act loyally and prudently, and/or retaining outside experts to serve either as advisers or as independent fiduciaries specifically for the Sears Stock Fund.

The lawsuit seeks to restore losses to the plan participants incurred because of the defendants’ breaches of fiduciary duties.

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