[Senate Hearing 110-780]
[From the U.S. Government Publishing Office]
S. Hrg. 110-780
SAVING SMARTLY FOR RETIREMENT:
ARE AMERICANS BEING ENCOURAGED TO BREAK OPEN THE PIGGY BANK?
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HEARING
before the
SPECIAL COMMITTEE ON AGING
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
__________
WASHINGTON, DC
__________
JULY 16, 2008
__________
Serial No. 110-32
Printed for the use of the Special Committee on Aging
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
index.html
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SPECIAL COMMITTEE ON AGING
HERB KOHL, Wisconsin, Chairman
RON WYDEN, Oregon GORDON H. SMITH, Oregon
BLANCHE L. LINCOLN, Arkansas RICHARD SHELBY, Alabama
EVAN BAYH, Indiana SUSAN COLLINS, Maine
THOMAS R. CARPER, Delaware MEL MARTINEZ, Florida
BILL NELSON, Florida LARRY E. CRAIG, Idaho
HILLARY RODHAM CLINTON, New York ELIZABETH DOLE, North Carolina
KEN SALAZAR, Colorado NORM COLEMAN, Minnesota
ROBERT P. CASEY, Jr., Pennsylvania DAVID VITTER, Louisiana
CLAIRE McCASKILL, Missouri BOB CORKER, Tennessee
SHELDON WHITEHOUSE, Rhode Island ARLEN SPECTER, Pennsylvania
Debra Whitman, Majority Staff Director
Catherine Finley, Ranking Member Staff Director
(ii)
C O N T E N T S
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Page
Opening Statement of Senator Herb Kohl........................... 1
Opening Statement of Senator Gordon H. Smith..................... 2
Panel of Witnesses
Statement of Christian E. Weller, Ph.D., Associate Professor,
Department of Public Policy and Public Affairs, University of
Massachusetts Boston; and Senior Fellow, Center for American
Progress Action Fund, Washington, D.C.......................... 4
Statement of J. Mark Iwry, Principal, The Retirement Security
Project, Nonresident Senior Fellow, The Brookings Institution;
and David C. John, Principal, The Retirement Security Project,
Senior Research Fellow, The Heritage Foundation, Washington,
D.C............................................................ 34
Statement of Gregory T. Long, Executive Director, Federal
Retirement Thrift Investment Board, Washington, D.C............ 66
Statement of John Gannon, Senior Vice President, Office of
Investor Education, Financial Industry Regulatory Authority,
Washington, D.C................................................ 72
Statement of Bruce R. Bent, Founder and Chairman of The Reserve,
New York, New York............................................. 80
APPENDIX
Statement submitted by Pension Rights Center..................... 103
Statement submitted on behalf of Hewitt Associates LLC, Alison
Borland and Frank McArdle...................................... 107
Letter and information submitted by Mercer....................... 120
(iii)
ARE AMERICANS BEING ENCOURAGED TO BREAK OPEN THE PIGGY BANK?
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WEDNESDAY, JULY 16, 2008
U.S. Senate
Special Committee on Aging
Washington, D.C.
The committee met, pursuant to notice, at 10:35 a.m., in
room SD-562, Dirksen Senate Office Building, Hon. Herb Kohl
(Chairman of the committee) presiding.
Present: Senators Kohl, Salazar, McCaskill, and Smith.
Also Present: Senator Schumer.
OPENING STATEMENT OF SENATOR HERB KOHL, CHAIRMAN
The Chairman. Good morning to one and all, and we thank you
all for being here today.
This morning we are going to talk about saving smartly for
retirement. Less than 30 years ago, Congress created a new type
of savings plan, the 401(k), to help ensure Americans have
adequate income in retirement. However, increasingly we are
seeing 401(k) funds being treated as rainy day funds, as
participants take out withdrawals and loans. Today, we will
learn more about the financial repercussions of this practice
and examine policies that can best promote the original purpose
of 401(k)'s, namely the retention and the growth of retirement
savings.
First, let us look at the numbers. According to the
Employee Benefit Research Institute, nearly one in five 401(k)
plan participants do have an outstanding loan. We will learn
from Dr. Weller's testimony that loans and withdrawals are not
only increasing in number, but that loan amounts are growing
substantially as well. We can only expect that these trends
will worsen as more people face economic hardships due to the
housing and credit crises and, over the long term, contribute
to America's already poor record on savings.
We need to be clear that we are not saying that all 401(k)
loans and withdrawals are a bad thing. Research has shown that
making loans and withdrawals available for legitimate purposes
can help encourage people to participate in 401(k) plans.
However, loans and withdrawals can be ill-advised for several
reasons, and we believe that participants should be aware of
the negative consequences they may have on their retirement
savings.
Frankly, I believe that there are some ways of using 401(k)
savings that are patently bad, such as the 401(k) debit card.
By offering a 401(k) debit card, plans send the message that it
is OK to use retirement savings for everyday purchases despite
the fact that the high fees associated with its use will
drastically diminish savings. When a participant can use his or
her 401(k) plan to make casual, everyday purchases, like even
buying a cup of coffee, clearly that is a gross distortion of
the plan's intended use.
We are also concerned about the high fees many plans charge
their participants. These fees can significantly reduce the
amount of savings Americans have when they retire. Last fall, I
held a hearing to consider the impact of these 401(k) fees and
promote their disclosure. Following the hearing, I introduced a
bill with Senator Harkin that would require all 401(k) plan
managers to reveal to both the employers and workers how much
they charge in administrative fees.
Considering the impact fees can have on savings over time,
I am concerned about recent advertising campaigns that
encourage Federal employees and retirees to move their
retirement accounts out of the Federal Thrift Savings Program
and into higher-fee accounts. The TSP has the lowest
administrative costs of any retirement program in the country,
and I believe that these misleading ads are a disservice to
hard-working public servants. Therefore, yesterday I sent
letters to the companies that we know are running these
advertisements asking them to reexamine this practice.
In just a moment, we will hear from several experts and
industry officials about how loans and withdrawals can be used
more responsibly. We will also hear from the manager of the
largest retirement savings plan, the TSP, about their policy on
loans and withdrawals. Following today's hearing, I plan to
introduce a bill with Senator Schumer that will prohibit the
use of 401(k) debit cards and to set a limit on the number of
loans a participant can take.
In closing, the bottom line of today's hearing is that
401(k) and similar defined contribution plans were created to
ensure that people would have adequate savings for retirement,
not as a source of credit to use casually. The Federal
Government provides $325 billion in tax benefits over the next
5 years to encourage retirement savings each year. I believe we
have a duty to make sure that they are used properly so that
all Americans can have a secure retirement.
Let me turn now to Ranking Member Senator Gordon H. Smith
for his comments.
[The prepared statement of Senator Kohl follows:]
OPENING STATEMENT OF SENATOR GORDON H. SMITH, RANKING MEMBER
Senator Smith. Thank you, Mr. Chairman. Ladies and
gentlemen, all of you, thank you for being here today and to
our witnesses, we appreciate the contribution you are making by
your testimony here before this committee.
These are tough times for American families. Gas and food
prices are at record highs, and this makes it difficult for
many families to fill up their cars and pay for essential
groceries.
The current economic environment also makes it difficult
for many families to pay their bills on time, or at all. Many
people are faced with missing one or two payments that they
have every intention of making up the next month, but the next
thing you know, they are in a hole trying to dig their way out
of debt and just do not have the cash to do it.
Given how common this scenario has become, I am not
surprised that many Americans are looking to their retirement
savings to help them make ends meet. Fidelity has seen an
increase of 16 percent in 401(k) hardship withdrawals in
comparing the first quarter of 2007 to 2008.
And according to a survey released in February by the
Transamerica Center for Retirement Studies, at the end of last
year, 18 percent of workers had loans outstanding from their
plans, up from 11 percent in 2006.
Although I understand the reasons, this trend concerns me
and us as tapping into 401(k) savings today can have a
significant impact on one's level of income at retirement age.
According to Vanguard, an employee who takes out two loans
totaling $30,000 from their 401(k) and pays them back in 5
years will have almost $40,000 less in their 401(k) after 30
years than an employee who takes no loans. Considering the
median 401(k) account balance in 2006 was about $66,000,
$40,000 is a lot of money.
This leads me to my final point, one I have made many times
before: Americans need to save more for retirement. For most of
us, our 401(k)'s will be our primary source of retirement
savings, and $66,000 is certainly not enough money to retire
on, especially if you take out another $40,000.
I have been working over the past few years on ways to help
Americans increase their retirement savings. I am pleased that
Mark Iwry and David John from the Retirement Security Project
are with us today to share their perspective and ideas on this
topic. Mark and David came up with the concept of the automatic
IRA, which Senator Bingaman and I then developed into
legislation. Our auto IRA bill would allow those employees not
covered by a qualified retirement plan to save for retirement
through automatic payroll deposit IRA's. The auto IRA bill is
currently under consideration by the Senate, and I hope my
colleagues will join me in pushing for its much needed passage.
Again, I thank you all for being here and look forward to
this hearing.
Thank you, Mr. Chairman.
[The prepared statement of Senator Smith follows:]
The Chairman. Thank you, Senator Smith.
At this time, we are pleased to welcome our panel.
Our first witness will be Dr. Christian Weller. Dr. Weller
is a Senior Fellow at the Center for American Progress and an
Associate Professor of public policy at the University of
Massachusetts in Boston. He is an expert on retirement income
security and his work has been featured in numerous academic
and popular publications.
Next we will be hearing from two witnesses who will share
the joint time: Mark Iwry and David John. They are both
principals with the Retirement Security Project.
Mr. Iwry is also a Senior Fellow at The Brookings
Institution. Previously Mr. Iwry served as the Benefit Tax
Counsel at the U.S. Treasury Department between 1995 and 2001
where he was responsible for tax and regulations relating to
tax-qualified pension and 401(k) plans.
Mr. John is a Senior Research Fellow at The Heritage
Foundation where he has written and lectured extensively on the
importance of reforming our Nation's retirement system.
Next, we will be hearing from Gregory Long. Mr. Long is
Executive Director of the Federal Retirement Thrift Investment
Board, and he serves as the managing fiduciary of the Thrift
Savings Plan, or TSP. The TSP is the largest defined
contribution plan in the world, serving over 3.7 million
current and former Federal employees and uniformed service
members with over $200 billion in assets. Previously Mr. Long
worked for CitiStreet and Putnam Investments.
Our next witness will be John Gannon. Mr. Gannon is the
Senior Vice President for Investor Education at the Financial
Industry Regulatory Authority, or FINRA. Previously he served
as the Deputy Director of the Office of Investor Education and
Assistance at the U.S. Security and Exchange Commission.
And finally, we will be hearing from Bruce Bent. Mr. Bent
is the founder and Chairman of The Reserve and its sister
company, Reserve Solutions. The Reserve manages over $120
billion in assets, making it the third largest family owned
asset manager in the United States.
We welcome you all. We look forward to hearing from you and
we would appreciate it if you would hold your testimony to 5
minutes. Mr. Weller?
STATEMENT OF CHRISTIAN E. WELLER, PH.D., ASSOCIATE PROFESSOR,
DEPARTMENT OF PUBLIC POLICY AND PUBLIC AFFAIRS, UNIVERSITY OF
MASSACHUSETTS BOSTON; AND SENIOR FELLOW, CENTER FOR AMERICAN
PROGRESS ACTION FUND, WASHINGTON, DC
Dr. Weller. Thank you very much, Chairman Kohl, Ranking
Member Smith, for inviting me here to talk about 401(k) loans
and trends in those loans and the causes of those loans.
I will make the point that demand for 401(k) loans is
largely driven by economic necessities. The economic
necessities are unemployment, bad health, and home ownership,
especially during the housing boom. Now, as the housing crisis
grips the country, more and more individuals are tapping their
401(k)'s to help smooth over the troubled economic times. But
this means that families leveraged their retirement security to
ease their present financial insecurity.
To counter this trend, policymakers must reduce the need
for people to borrow. This will require substantial
improvements to income growth for American families and a
commitment to providing health and unemployment insurance to
citizens who experience unexpected health expenditures and job
loss.
Let me give you a little bit of background on 401(k) loans.
When families encounter rising demands on their budgets such as
medical emergency, a spell of unemployment, or higher cost for
necessary items, including housing, they often turn to consumer
loans to help them smooth over a rough patch. Workers who are
covered by a 401(k) can borrow from their own savings. An
account holder may borrow up to half of his or her retirement
savings with no penalty as long as the loan is repaid within 5
years. The interest rate is low, typically 1 to 2 percent above
the prime interest rate, but there are clear drawbacks. Once
the money is out of the retirement account, it does not earn a
rate of return. The low interest rate also means that you get
low additions to retirement savings, and if you do not pay the
loan, there are substantial penalties.
The impact of the 401(k) loans can be severe. We calculate
in our paper that we are releasing today with the Center for
American Progress some hypothetical examples. We find that if
you take out $5,000 in loans as a typical worker, in the first
5 years of having such a loan, you can reduce your retirement
savings by the end of your career by up to 22 percent depending
on the various assumptions. That is a substantial reduction in
retirement savings.
This reduction in retirement savings comes typically at a
time when other retirement income is also going down. This is
the case right now. Housing values have fallen at the fastest
rate in more than 3 decades and financial markets have been in
turmoil for a year now decimating existing retirement savings.
At the same time, families are increasing their borrowing from
401(k) loans due the growing economic hardships.
We also find that 401(k) loans generally add to the total
debt burden the families have. They do not substitute for other
loans. 401(k) loans grew in total amount to $31 billion in
2004, the last year for which we have data, up from $6 billion
in 1989, an increase of almost 400 percent. This reflects just
simply the fact that more people have loans and have the access
to those loans.
But it also means that borrowers are tapping out on other
loans. What we find in particular is the 401(k) loan holders
have typically median debt payments relative to income of 22.5
percent of their income, substantially higher for those who do
not have those loans, 18 percent. This would not be the case if
401(k) loans substituted for other forms of debt.
There have been a number of important shifts in terms of
demographic characteristics of who is taking out the loans. The
differences between minorities and whites have been shrinking,
meaning whites have been taking out loans faster than
minorities over time. 401(k) loan holders also have gotten
younger and they have also become more educated over time. So
this is becoming increasingly a middle class phenomenon, if you
will.
The reason why people borrow is because they have to. The
primary reason we find is bad health. A spell of bad health
increases having a loan by more than 50 percent. Also, home
ownership, especially during the housing boom, has forced
people to borrow more from their 401(k) loans. However, that
comes at a cost. We find that home owners who have a 401(k)
loan typically have higher mortgage payments, less equity, and
are more likely to have an adjustable rate mortgage. That means
basically home owners who are financially tapped out otherwise
are now borrowing from their 401(k)'s to basically just afford
the down payment in the housing boom period.
So the solution here for us at least is that we need to
find ways to keep people from borrowing, from tapping into
retirement income security. That means we need to strengthen
income growth, but we also need to create a stronger social
safety net so that people do not have to use their 401(k) plans
as supplemental unemployment insurance or health insurance.
Thank you very much.
[The prepared statement of Dr. Weller follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Chairman. Thank you for your testimony, Mr. Weller.
Mr. Iwry, Mr. John?
STATEMENT OF J. MARK IWRY, PRINCIPAL, THE RETIREMENT SECURITY
PROJECT, NONRESIDENT SENIOR FELLOW, THE BROOKINGS INSTITUTION;
AND DAVID C. JOHN, PRINCIPAL, THE RETIREMENT SECURITY PROJECT,
SENIOR RESEARCH FELLOW, THE HERITAGE FOUNDATION, WASHINGTON, DC
Mr. Iwry. Mr. Chairman, Senator Smith, I am Mark Iwry with
The Brookings Institution. This is my colleague, David John
with The Heritage Foundation. We are both principals of the
nonpartisan Retirement Security Project, and we are pleased to
appear together essentially as a single witness before you
today to emphasize the importance in this area in particular of
an approach that transcends traditional partisan and
ideological divisions.
We would like to present our views jointly on savings,
including the automatic IRA proposal that you, Senator Smith,
and Senator Bingaman have introduced as the lead cosponsors,
and on the leakage issue that is the main topic of this
hearing.
Senator Smith, you have already described the problem of
inadequate saving, as have you, Mr. Chairman. We recognize that
adequate retirement security and adequate saving require not
only increasing saving, which David John will discuss in
connection with the automatic IRA, but preserving savings that
have already been done so that they do not leak out of the
pension system by being consumed prematurely.
Often the discussion of pension leakage focuses on loans
and hardship withdrawals. But in a system that is increasingly
dominated by 401(k) plans that are funded by voluntary employee
contributions, many people may be reluctant to contribute
unless they know they can have at least limited access to their
savings if they have a critical need. And the employer that is
sponsoring the 401(k) traditionally has had an interest in
encouraging those voluntary contributions and therefore an
interest in allowing loans and hardships as a kind of liquidity
carrot for people to participate in the plan because broad
participation enables the employer to pass the
nondiscrimination standards and enables the top people to
contribute more to the plan.
Things are changing. 401(k)'s are coming of age. Sponsors
are no longer uniformly interested in getting rid of accounts
for terminated employees. And automatic enrollment--that is,
putting people in the plan automatically unless they opt out--
is transforming the 401(k) landscape in a way that is very
potentially relevant to this leakage issue. This may mean that
plan sponsors, because they have higher participation through
automatic enrollment, will be less concerned about using access
to savings as an inducement to broader participation and can
sponsor K plans that limit leakage, that use automatic or
behavioral strategies to reduce the occasions when people take
lump sums from the plan in particular after they leave
employment.
Accordingly, at least as a first step, it may be worth
exploring whether sponsors are willing to engage in a best
practice of allowing lump sums on termination of employment
only if they are directly rolled over to another employer plan
or IRA or the departing employee has reached a specified age,
such as 55 or 65 unless the employee can demonstrate a hardship
and a need for the immediate access to the funds, such as
extended unemployment. This would fall between the defined
benefit approach to post-employment leakage and the current
401(k) practice. We would be happy to discuss our specific
proposals, including the need for a leakage policy after
retirement, that is, more annuities and lifetime income in
401(k) plans during your question and answers.
David?
Mr. John. The other source of leakage that should concern
both this committee and the Nation as a whole is the money that
never got put in the plan in the first place. And this comes
basically from two sources. One is the fact that roughly 78
million workers are employed in the U.S. by a company that does
not offer any form of retirement savings plan at all, and other
workers will have employment with these companies maybe as an
interlude between jobs with companies that do offer this sort
of retirement savings plan.
In response, as Senator Smith has mentioned, Mark and I
developed the automatic IRA. The automatic IRA would probably
affect roughly 40 million out of the 78 million workers. It is
designed as a simple, low-cost, low-burden option for the
employer and a simple low-cost savings option for the worker.
It is crafted to discourage employers from moving from a 401(k)
plan down to an auto IRA. As a matter of fact, it is actually
crafted exactly the opposite: to encourage people to start with
an auto IRA and move up to a simple or a 401(k).
I will close by citing a study by Prudential Insurance
Company. They found that 8 in 10 employees were very interested
in the auto IRA, and they said, ``In fact, the more employees
learned about the auto IRA, the more they were interested in
it.''
Now, this same study also surveyed about 200 smaller
employers, the ones who had offered this, and they found that 8
in 10 businesses believed that the design overcomes their
concern and support the adoption of the auto IRA. Again, the
more they heard about it, the more they liked it.
Further, they discovered that roughly 54 percent of
eligible employees would be creating new savings rather than
moving savings around.
We think that leakage is a very serious problem, and we
appreciate the fact that you are addressing that in this
hearing. But at the same time, we need to look at both sources
of leakage, both out of existing plans and, as I say, the money
that never got there in the first place.
Thank you.
[The prepared statement of Mr. Iwry and Mr. John follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Chairman. Thank you, gentlemen.
We would like to hear from Mr. Long at this point.
STATEMENT OF GREGORY T. LONG, EXECUTIVE DIRECTOR, FEDERAL
RETIREMENT THRIFT INVESTMENT BOARD, WASHINGTON, DC
Mr. Long. Chairman Kohl, Ranking Member Smith and members
of the committee, my name is Greg Long. I am the Executive
Director of the Federal Retirement Thrift Investment Board and,
as such, the managing fiduciary of the Thrift Savings Plan for
Federal employees. I welcome the opportunity to appear before
your committee to discuss the TSP loan and in-service
withdrawal programs.
I commend the committee's efforts to focus public attention
on protecting and strengthening retirement savings programs,
especially with regard to those participants who might engage
in unnecessary borrowing or indiscriminate early withdrawals.
The board's own experience over the past 20 years shows that a
close attention and a willingness to adjust in these areas is
critical to ensure a good balance between the goals of
achieving participants' long-term retirement goals and meeting
their short-term needs.
In 1988, TSP participants who contributed their own funds
were first permitted to borrow for four specific purposes:
medical expenses, education, financial hardship, or to purchase
a primary residence. Documentation to demonstrate the loan's
purpose was required. Participants could have a maximum of two
loans outstanding. Like 401(k) plans, TSP loans were subject to
restrictions found in the Internal Revenue Code and in
regulations issued by the IRS. As with similar loan programs in
401(k) plans, our loan is intended to encourage employees to
voluntarily contribute their own funds by allowing limited
access to those funds when necessary.
After 8 years of administrative experience, the board
identified three areas that required improvement. First, the
four purposes were viewed by some as overly restrictive.
Second, the documentation process, which for a worldwide plan
like the TSP, was of necessity conducted over long distances by
mail, was administratively difficult. Finally, some
participants with financial difficulties were already
overwhelmed by debt. They required debt relief in order to get
their heads above water.
The board worked with the Congress and Senator Ted Stevens
in particular, who is widely regarded as the father of the TSP,
to resolve these issues in legislation. As a result of the
Thrift Savings Plan Act of 1996, the board was permitted to
offer general purpose loans requiring no documentation.
Additionally, in-service withdrawals for financial hardship and
for those who attained age 59 and a half were allowed for the
first time.
As expected, loan activity increased. Between 1997 and
2003, the number of participants with loans increased from
219,000 to 554,000. Although we cannot demonstrate any direct
connection, the FERS participation rate increased from 82.9 to
86.9 percent during the same period.
The TSP loan program was again modified in 2004. The need
for this change was identified a year earlier when the board
implemented a new daily valued record keeping system. A
relatively small number of participants were found to be
borrowing slightly larger amounts over and over again in an
apparent attempt to supplement their basic pay. A review of
this practice found that one participant had used the program
to borrow 31 times.
As the board was implementing a new record keeping system
in 2003, this serial borrowing caused significant
administrative problems. In July 1904, after careful study and
a review of private sector practices, the board implemented
three changes: a $50 loan fee, a 60-day waiting period between
loans, and a limit of just one general purpose and one primary
residential loan at any time.
We view these changes, which we continue to employ today,
as highly effective. A total of 353,000 new TSP loans were
disbursed during 2003. In 2005, that number dropped to 192,000.
The overall number of loans, which was rapidly approaching 1
million, has steadily declined.
Meanwhile, the total average monthly contribution per
participant has continued to steadily increase, from $432 per
month in 2005 to $497 per month in 2008.
Unlike the changes that characterize the 20-year history of
the TSP loan program, the in-service withdrawal program, which
first became available in 1997, has had only one major change.
Originally, like loans, hardship required documentation. As
with loans, the board found this requirement to be
administratively burdensome. Therefore, with the introduction
of the new record keeping system, participants were permitted
to self-certify their hardship conditions. However, I would
like to point out that in addition to the tax consequences,
participants are also restricted from making employee
contributions and therefore from receiving matching
contributions for 6 months after taking a financial hardship
withdrawal. Therefore, there are deterrents built into the
program.
Finally, I have also provided the committee with copies of
our 2008 edition of Highlights, which is our newsletter. The
feature article of this newsletter, which is published on our
website, is being sent to participants. The key article is
called ``Look Before You Leap.'' I would like to explain why I
found it necessary to issue such a caution to participants.
Earlier this year, I stepped out of the board's office in
downtown Washington and I saw a bus stop billboard that urged
Federal employees to transfer their ``old'' TSP accounts--I put
that in quotes--to the advertising sponsor's IRA. Shortly
thereafter, a second advertising campaign, which is similarly
targeted, told readers that their TSP accounts would retire.
I am here today to advise that after 21 years, the TSP is
still young and vigorous. It is not getting old and it does not
intend to retire. Thanks to the wisdom of Senator Stevens and
other congressional authors, it will continue to follow the
timeless principle of tracking broad market performance while
adding value for participants via very low administrative
expenses.
And our participants recognize the value of the TSP. Last
year, over 20,00 checks came in for a total of $478 million
rolled into the TSP from private sector 401(k) and IRA
accounts.
Thank you for the opportunity to testify. I would be
pleased to respond to any questions.
[The prepared statement of Mr. Long follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Chairman. Thank you very much, Mr. Long.
Now we will hear from Mr. Gannon.
STATEMENT OF JOHN GANNON, SENIOR VICE PRESIDENT, OFFICE OF
INVESTOR EDUCATION, FINANCIAL INDUSTRY REGULATORY AUTHORITY,
WASHINGTON, DC
Mr. Gannon. Mr. Chairman and members of the committee, I am
John Gannon, Senior Vice President for Investor Education at
the Financial Industry Regulatory Authority. As the largest non
governmental regulator for the country's securities firms,
FINRA's top priority is to ensure fair markets for American
investors.
On behalf of FINRA, I would like to thank you for the
opportunity to testify on such an important topic. You have my
written testimony, so this morning I would like to highlight
what we at FINRA view as emerging threats to a secure
retirement.
For today's investors, especially those close to
retirement, the number of hurdles on the road to financial
security is growing every day. The cost of living is up. Home
prices are down, and credit has dried up. Financial
institutions that once seemed invincible have failed or are in
trouble.
The Washington Post reports that nearly three out of five
middle class retirees will likely run out of money if they do
not change their spending habits. Supporting that is a recent
AARP study citing the personal bankruptcy filings for middle-
aged Americans has risen by more than 50 percent since the
1990's.
When people feel pinched for cash, they often choose risky
ways to make ends meet. In fact Fidelity, T. Rowe Price, and
Vanguard have reported significant increases in 401(k) hardship
withdrawals since last year. A recent Wall Street Journal
Harris Interactive Survey found that about one-quarter of
adults actively planning for retirement have prematurely
withdrawn money from their retirement investments.
Also feeding into this anxiety or unscrupulous financial
professionals, many of them unregistered. They push investments
that promise security, but too often they end in financial
ruin.
At FINRA, we believe that the first line of defense for
every investor is education. That is why we are focused on
teaching investors about the importance of retirement savings
and the consequences of early withdrawals from 401(k)'s. FINRA
is focused in two ways to help protect investors and teach them
in these uncertain times. First, we use surveillance and
enforcement tools to detect and deter abusive sales practices.
Second, we do everything we can to educate investors to help
them make the best financial decisions.
I would like to highlight two areas of concern today: early
retirement scams and 401(k) debit cards.
As you know, section 72(t) of the IRS Code permits penalty-
free early withdrawals from company-sponsored plans before the
age of 59 and a half. Some financial advisors tout 72(t) as a
loophole that allows investors to retire early by withdrawing
assets and reinvesting them. Investors are often promised
unrealistically high returns, but are rarely told about the
down side of those investments.
One case in particular comes to mind. A few years ago, a
57-year-old retiree from Belton, MO was promised that his 72(t)
investment would earn 9 percent. He was persuaded to invest $1
million in retirement savings into two variable annuities, and
7 months later, $225,000 of his principal was gone. But that
was just the beginning. Eventually he lost over $450,000 due to
the negligence and fraud on the part of his broker.
More recently, FINRA sanctioned two securities firms,
Citigroup and Securities America, for misleading investors in
this way. They were fined $5.5 million and ordered to pay $26
million in restitution to hundreds of former Bell South and
Exxon Mobil employees. In both cases, the firms were onsite
targeting employees at their work places. Given the aging U.S.
demographic, we are likely to see even more investors
victimized in this way. FINRA will continue to take action
where investors are treated improperly.
Another potential threat to a secure retirement is the
relatively new 401(k) debit card. In May, FINRA published an
investor alert outlining the dangers of 401(k) debit cards, and
we hope investors heed our warnings.
Investors can use a debit card to borrow directly from
their 401(k) account for any purpose, but as they spend it,
they may wipe out a good portion of their retirement savings.
Taking money out of your retirement savings, even for a short
period of time, can be disastrous.
FINRA has developed a number of tools that focus on
building and protecting retirement savings.
First, we have our 401(k) Learning Center on our website,
finra.org. Here we explain everything from 401(k) enrollment to
the risks of cashing out before retirement.
FINRA has also teamed up with the Retirement Securities
Project and AARP to establish Retirement Made Simpler, an
effort to use automatic features such as automatic enrollment,
to increase participation in 401(k) plans.
We issue investor alerts, warning about early retirement
pitches and products that could be harmful and we offer online
tools to help employers check out early retirement sales people
and avoid potential scams.
Mr. Chairman, FINRA appreciates the opportunity to testify.
We look forward to working with the committee, the SEC, and
other regulators to expand Americans' financial knowledge and
to help them build a secure retirement. I would be happy to
answer any questions.
Thank you.
[The prepared statement of Mr. Gannon follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Chairman. Thank you very much, Mr. Gannon.
Finally, we will hear from Mr. Bent.
STATEMENT OF BRUCE R. BENT, FOUNDER AND CHAIRMAN OF THE
RESERVE, NEW YORK, NY
Mr. Bent. Chairman Kohl, Ranking Member Smith, and
distinguished members of the committee, my name is Bruce Bent.
I am the Chairman of The Reserve, the leading cash management
specialist for institutional and individual investors. I am
also Chairman of Reserve Solutions, a sister company. Reserve
companies currently manage over $125 billion.
The Reserve is best known as the creator of the money
market mutual fund. We wanted a product that would provide a
return that reflects actual money market interest rates while
providing safety of principal, liquidity, and a high degree of
safety. As we all know now, the money market fund has been
extremely successful with nearly $4 trillion invested in it. I
say that for purposes of identification.
I am here today to discuss ReservePlus, the qualified
pension plan administrative services that we provide.
ReservePlus was created to help address the challenges of
increasing participation by lower income and younger workers
who traditionally do not participate because they feel they
cannot afford to lose access to their earnings.
To begin, ReservePlus does not approve loan requests,
establish or interpret loan policies, and is not a plan
fiduciary. We are simply a software processor. Our service is
made available only to participants who have been directed to
us by plan administrators in accordance with their employer's
policy. Once a participant's request has been approved, they
direct the plan administrator to transfer their money into a
loan account within their plan. The amount in that account is
then invested in a Reserve money market mutual fund.
Participants may then access the amount of their account using
checks or a debit card.
Each ReservePlus participant is provided with materials
containing a description of the service, its operation, and
associated charges. The committee has been provided with copies
of these disclosures.
The account opening fee averages $75 and the subsequent
annual maintenance fee ranges from $25 to $50, charges that
typically apply to both conventional loan programs and
ReservePlus and are paid to the plan administrators, not
Reserve. As is usual with plastic-based transactions, there is
a $2 fee for cash advances but no fee for purchases by check or
card. In addition, the plan participants pay themselves an
interest rate of the prime rate and a service fee to
ReservePlus which ranges from 2.9 to 3.25 percent on loan
balances actually utilized.
The average loan balance for participants in plans
utilizing ReservePlus is approximately 35 percent less than the
average loan balance for all plan participants, specifically
$4,800 versus $7,200. Our default rate is 2.2 percent, and we
have been unable to determine what the industry average default
rate is.
ReservePlus is different from traditional loan programs
because participants may establish an account without actually
withdrawing funds. A traditional loan actually forces money out
of a plan by requiring a participant to withdraw the entire
amount approved immediately in a lump sum. With ReservePlus,
the participant's funds remain within the plan, continuing to
earn sheltered investment returns until the participant
withdraws them. The participant may withdraw as little or as
much as needed at any time, up to the amount approved by their
employer. There is no lump sum withdrawal requirement. When
participants know they have access to their money, they
contribute more into the plan and take less out of the plan. At
the end of the day, participants accumulate greater overall
retirement savings using ReservePlus services over conventional
loan processing.
Participants with ReservePlus services are also less likely
to default on their plan loans when they leave the job.
Industry practice for traditional loans requires them to be
repaid through payroll deductions. As a result, employees that
are terminated, resign, or retire are no longer able to
continue repaying their loans via payroll deductions. In these
circumstances, plans utilizing traditional loan processing
typically give a participant only 90 days or less to repay all
outstanding loans.
A participant who is unable to repay the outstanding
balance will incur a taxable distribution, subject to regular
city, State, and Federal income taxes, and an additional 10
percent penalty if they are under the age of 59 and a half.
Obviously, the participant's retirement savings will also be
reduced by the amount of the default. This instant repayment
requirement in traditional plans is a significant deterrent to
employees joining a plan because it comes at a time that the
participants are least able to afford it. This is not so with
ReservePlus.
Unlike traditional loan programs, ReservePlus is not
dependent on payroll deduction and allows participants to
continue making their regular payments even after they leave
their employer. Given the increasingly mobile workforce, this
feature of ReservePlus helps safeguard participants' retirement
savings. ReservePlus also allows participants to prepay in
advance, in whole or in part, at any time and to reduce the
amount available in their loan account at any time, unlike
traditional loan processing through payroll.
We designed ReservePlus with several concrete advantages to
plan participants over traditional loans. I share your concerns
for America's seniors and for hard-working Americans like my
parents, a postal employee and a school cafeteria worker. I am
very proud of the innovations ReservePlus offers to
participants in overcoming many shortcomings of the prevailing
practices that encourage workers, regardless of income level,
to participate in retirement plans to the maximum level as soon
as they are eligible.
Thank you for your time. Again, I am happy to answer your
questions.
[The prepared statement of Mr. Bent follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Chairman. Thank you very much, Mr. Bent.
We will turn now to my colleague, the ranking member,
Senator Smith, for his questions, and then we will turn to
Senator Salazar and Senator McCaskill. Senator Smith?
Senator Smith. Thank you, Mr. Chairman. Gentlemen, all of
you, your testimony has been excellent.
I wonder, Mark and David, as you have gone out with your
very bipartisan proposal on automatic IRA's, I think you both
commented that the more people know, the more they warm up to
it. I assume I heard you correctly.
Mr. John. You did, yes.
Senator Smith. You know, obviously we are here because we
have a real dilemma. We have a national savings problem. We
have a demographic bubble with the baby boom generation getting
ready to retire and insufficient preparation for retirement. We
are looking for what we can best do to facilitate the
retirement of elder Americans.
I am wondering in your opinion, any of you, which is worse?
Plan loans or hardship withdrawals? What is the most
destructive thing that could be done to one's 401(k) plan?
Mr. Iwry. Senator Smith, the loan at least is repaid. The
withdrawal is not generally repaid.
And worse than either of those, if I may, is actually the
lump sum that is distributed or offered to a participant each
time they change jobs, leaving a 401(k) plan. We probably have
more leakage coming from lump sums paid out between jobs than
we do from the more restrictive loan and hardship withdrawal
regimes that apply while the person is employed. So that is the
area that I think we need to question as the highest priority.
Do we really want to be offering the money to a participant
every time he or she changes from one 401(k) sponsor to another
rather than having an affordable, seamless savings system?
Senator Smith. Clearly, plan loans and hardship withdrawals
are designed to provide liquidity as an inducement for people
to enroll in the first place. I think you have all made that
clear. But if you go to an automatic enrollment system, do we
need those kinds of inducements? Where do we draw this line?
That is really what I am getting at.
Mr. Iwry. I think it is a great question. It is a
balancing. The employer is trying to induce participation by
offering enough liquidity so people feel they can get that
money if they really desperately need it. But we should leave
that door open only a crack, and an automatic enrollment plan
gets that kind of participation probably with less need for
liquidity as an inducement. Therefore, the employer should feel
freer and we would hope policymakers would feel freer to narrow
that opening to reduce the access because we do not need it as
much in the modern auto enrolled 401(k) universe. So I think
your policies of restricting leakage, as I understand them,
looking carefully at whether we can restrict leakage some more,
are timely.
Senator Smith. Several of you have commented that the more
people know, the more comfortable they are. Are we at the
Federal Government level, the Department of Labor, Department
of the Treasury doing enough to educate people so that they
understand and feel they can get involved?
Mr. Gannon. Senator, there is always more that can be done
with educating investors about 401(k)'s and other retirement
savings vehicles. We are constantly trying to strive to get the
information that is out there into as many hands as we can. I
mean, that is why we work through the FINRA Financial Investor
Education Foundation to give grants to organizations such as
libraries so that the information can get into every community.
There needs to be much more done with that.
Also, information has to be available at the time that
people need it. So that means when they are going to get a loan
from their 401(k), is the education available at that point? Is
it available when they are taking a hardship withdrawal? Is it
available when they are making financial decisions with respect
to their financial savings?
Senator Smith. The last question, Mr. Chairman. It seems
that in Congress we like to speak and act as though the cycles
of supply and demand do not exist, and we can repeal them, that
market corrections and cycles in our economy, we can somehow
control. We have never been able to do that. But that certainly
has been the history in Congress. As much as we would like
times always to be good, we have had bad times in the past
since the introduction of the 401(k). Is this down cycle
different in terms of the leakage you are seeing?
Dr. Weller. So far the data is not out. We will not firmly
know until next year when we get the new data from the Federal
Reserve.
It does not look at all that different from what we have
seen from the recent surveys. It does not look all that
different. We expect the numbers to increase, the loan amounts,
the number of people who have those loans, but those are
clearly tied to both the availability of health insurance and
the availability of unemployment insurance and other savings.
And in that regard, the current downturn is different because
people now have much more debt than they used to.
Right now for the first quarter of 2008, with a record
amount of 132 percent of disposable income, that is the highest
number we have ever seen. Personal debt to income has risen
four times faster than it did during the 1990's. So now there
is less fall-back position for families. So that makes it
different, but generally I think the factors that drive people
into a loan are not that different from previous loans. Again,
it is the lack of savings to smooth you over a rough patch,
either health insurance or unemployment insurance.
Mr. Iwry. Senator, obviously, we trust this too will pass,
but in the meanwhile, we should be doing everything we can to
help people keep their savings for the long term when better
times are here.
Senator Smith. Thank you, Mr. Chairman. I would be pleased
to be added as a cosponsor of your bill.
The Chairman. Thank you very much, Senator Smith.
Before I turn it over to Senator Salazar, I just want to
make one statement and ask a single question for all of you.
Companies like Karsten Manufacturing, which is the maker of the
Ping golf products, which we all familiar with, do not allow
any loans on their plan and still they boast a 92 percent
participation rate, significantly because they have a very
generous matching fund provision in terms of company
contributions.
So if we have generous matching funds and if we have
automatic enrollment and we do not allow people to opt out, in
many ways is that the most desirable kind of a plan that we
would like to see? What do you think, Mr. Weller?
Dr. Weller. There is a number of ways of, obviously,
increasing both participation and contributions. Matches are a
big part in terms of at least increasing contributions. They do
not do that much in terms of participation. But automatic
enrollment is certainly one way of going.
I also want to add something to the liquidity option that
was discussed here. Yes, the evidence from the past shows that
if you have the loan option, hardship withdrawal option, it
does increase contributions, but over time, the evidence seems
to suggest that that effect has diminished, at least according
to our research.
So I think that other factors such as automatic enrollment
and employer matches are a much better way of increasing
participation and to wealth and ultimately that goes in line
with what Mark said in terms of restricting the access to
loans.
Mr. John. For us, the short answer is yes, and when it
comes right down to it, education is a key, but plan design we
have found actually is much more of a determinant of success.
And I think this is one case where that shows that.
The Chairman. Mr. Long and then Mr. Bent.
Mr. Long. I have viewed loans as a necessary evil,
necessary to encourage participation. As automatic enrollment
becomes more popular and at some point used within the TSP and
as matching becomes more lucrative, the necessity of loans
starts to decrease.
The Chairman. Mr. Bent?
Mr. Bent. Several weeks ago I learned of a person that
resigned from their job because they had no access to their
401(k). An example of unintended consequences of restricted
access. So maybe a little bit more flexibility would be
helpful.
The Chairman. Mr. Gannon?
Mr. Gannon. Well, to give you an example, obviously we
believe strongly in auto enrollment, auto escalation because we
work with the Retirement Securities Project to promote those
efforts with medium-sized employees. To give you an example, at
FINRA we established auto enrollment in 1997. Our participation
rate went from 75 percent to over 97 percent, and you see that
time and time again when employers move to auto enrollment and
auto escalation features. There is little down side to using
those features.
I am concerned about loans. I am even more concerned about
debit cards because I believe they will lead to current
consumption. You should not be using your 401(k) to buy pizzas
and lattes, and that is the only reason I think you would use a
plastic card.
The Chairman. Thank you, Mr. Gannon.
Senator Salazar?
Senator Salazar. Thank you very much, Chairman Kohl, and
Ranking Member Smith, for holding this important hearing,
Saving Smartly for Retirement. That is a very important subject
and something that I am glad Senator Kohl has decided to put a
focus on.
What I would like you to comment on for me is the current
economic circumstance and what you might paint out to be what
could be a parade of horribles happening with people's
retirement accounts and 401(k)'s. We all know the statistics
related to what is happening with fuel and $4 a gallon gas. We
know the hardship that people are facing with respect to home
ownership, given the housing crisis that we are seeing across
America. We know what is happening with the huge escalating
costs in higher education, and we know what is happening with
health care costs for Americans. People may disagree whether we
are in a recession or not, but I do not think there is any
disagreement that there are a lot of Americans who are facing
tremendous hardship.
So when you have that kind of hardship and you are feeling
that kind of economic pain, you start looking to those
potential assets that you have to help you through these hard
times. And so whether it is taking loans from your 401(k) or
maybe taking an early withdrawal from your 401(k), what is the
parade of horribles here? If the economic times continue to be
as painful as they are, I think, in the last several months, if
they continue to exacerbate, what is going to happen to the
saving smartly for retirement?
Dr. Weller. Well, I think when it comes to the current
economic situation, it is important to understand that the down
turn in the housing market and the stock market has made a bad
situation worse. It was not like we had this wonderful economy
before 2007 and everything was going well. On the contrary. The
labor market was weak. People had to borrow a lot of money.
That made them very vulnerable to the current economic
downturn, and that is exactly what we are seeing at this point.
People already had very few savings. They were highly
leveraged. So they are losing their homes. Their home equity is
dropping. At this point, people own the smallest share of the
homes that we have on record; 46 percent of their home is
actually their own.
So I think the parade of horribles at this point means we
are going to see more foreclosures. We are going to see more
bankruptcies. We have seen an 80 percent increase in the
bankruptcy rate, 90 percent in bankruptcy filings since 2006.
So that is the first line of defense. We are going to see
massive foreclosures and defaults and that is going to
continue.
The second part is we are going to see people struggling
with higher costs of living and that ultimately means less
retirement savings. And on top of that, because we are in a
weak economy, employers are cutting back on the benefits that
people have traditionally relied on to make ends meet just as
in retirement savings and health insurance.
So ultimately what that adds up to is that we see a big
drop down in financial security and ultimately in retirement
income security. Again, it is a little too early at this point
to come up with complete numbers, but we already saw a big drop
in retirement income security from 2001 to 2004, and we expect
that to continue as we get the new data for 2007.
Senator Salazar. Let me ask you this question and the other
panelists may follow up on that. Given that reality which you
described I think very well, what then should we in the U.S.
Senate be thinking about doing to deal with some of the
consequences of the economic hard times that we are in?
Dr. Weller. Well, I think you need to think about three
things. The first one is to increase incomes where we can
through improved earned income tax credits and other measures
along those lines, promote savings through a saver credit,
refundable saver credit preferably, along those lines, to have
a real wealth-building strategy, and ultimately what I call an
efficiency policy to shelter families from the effects of
rapidly rising prices, for instance, for health care, for our
energy, and other things. That means broader energy efficiency,
more efficiency in the health care system. I think those are
the general three directions to go in in terms of policy.
Senator Salazar. Mark or David?
Mr. Iwry. Senator, we can very much focus on the fact that
this downturn will not last forever, and it will not be the
last downturn that we will see. So I think one of the things
that the Senate should do is keep the Nation's eye on the long
term and focus on the solutions to the potential parade of
horribles, ways to prevent it.
I think Mr. Weller put it well. We need to make it easier
for people to save and to not make it too easy for them to
withdraw their money. Expanding the savers credit, making it
refundable, is key. The automatic IRA proposal that Senator
Smith and Senator Bingaman have been lead cosponsors on is key.
There is a reason why that has been endorsed by both a former
chairman of the Council of Economic Advisers for President
Reagan and for President Clinton, Marty Feldstein, Laura Tyson,
respectively, why it has been endorsed by the New York Times on
its editorial page and by the Washington Times chief political
correspondent, and other bipartisan endorsements.
And we need to make sure that the parade of horribles does
not include easy access to carefully built-up retirement
savings through a flood of things like debit cards or other
devices that make it overly easy for people to undo all the
hard work they have done in building up their savings.
Senator Salazar. I have about 50 seconds here. So does
anybody else want to comment?
Mr. Gannon. Yes, Senator. More than 10,000 Americans are
turning 60 every day and I think that is the difference with
the economic down-climb we are seeing now, is that people are
needing their money from their retirement savings. If you are
25 and there is an economic downturn, time is on your side to
recover from that, but if you need to take withdrawals today
for the near future, it is a much more difficult situation for
you. Either you are going to have to continue working or you
are going to have to live on less income.
And we need to address better ways to make sure that people
understand how to withdraw money from their retirement savings.
There is much investor education that has been done about
saving for retirement. There has been little done to teach
people about what are the best ways to withdraw, how to use
annuitization to enhance your ability to keep that money for
your entire retirement period.
Senator Salazar. Thank you very much.
Thank you, Mr. Chairman.
The Chairman. Thank you very much, Senator Salazar.
Senator McCaskill?
Senator McCaskill. Thank you, Mr. Chairman.
I come from a State where one of our most treasured values
is common sense, and it defies common sense that giving
Americans plastic is a way to increase savings. It just does
not make sense to me, Mr. Bent.
I would like to ask you about your relationships with the
employers in these plans. Your debit cards are around because
they are profitable, I assume, for your company.
Mr. Bent. Not yet, but one would hope so, yes.
Senator McCaskill. And how long have you been doing this?
Mr. Bent. I guess we have been working on this for about 7
years now.
Senator McCaskill. 7 years? And your company has not been
profitable yet?
Mr. Bent. No, it has not.
Senator McCaskill. I assume that the reason the employers--
your testimony was that you really are like a passive
processor.
Mr. Bent. That is correct.
Senator McCaskill. That these people are being directed to
you.
Mr. Bent. Correct.
Senator McCaskill. Well, what is the motivation of these
fiduciary employers to direct people to you? Why would they
want to do that?
Mr. Bent. Because it encourages people to come into the
plan. It encourages people to stay in the plan if they loose
their job.
Senator McCaskill. And they are making money.
Mr. Bent. I am sorry?
Senator McCaskill. And they are going to make money.
Mr. Bent. Who is going to make money?
Senator McCaskill. The employer gets part of the money.
Right?
Mr. Bent. No, no, no.
Senator McCaskill. They do not get anything?
Mr. Bent. Of course, not.
Senator McCaskill. I thought I heard in your testimony that
they get part of the fees.
Mr. Bent. No, no, not at all. Not at all. That is the plan
administrator.
Senator McCaskill. OK. Well, so what you are saying is the
fiduciary duty that these plans have--they see giving their
participants a debit card to access the money as within their
fiduciary responsibility, and that is why they are turning to
your--
Mr. Bent. What we are finding statistically is more people
are willing to participate because they feel they will have
access to their money in time of need. In fact, what we are
seeing is that there is less money being borrowed through our
program than there is through a conventional program. In a
conventional program, what you have to do is anticipate an
entire need and you take all that money out of the plan at one
time. That is not the case with us.
Senator McCaskill. OK. Well, I know you have testified that
when they have a debit card, they contribute more into the plan
and take less out of the plan.
Mr. Bent. Correct.
Senator McCaskill. I would sure like the backup for that.
Mr. Bent. Fine.
Senator McCaskill. That is hard for me to believe.
And you are saying that they are accumulating greater
overall retirement savings by having a debit card that they can
go and buy a latte with it?
Mr. Bent. I think that is a gross exaggeration. If you look
at the data that is provided by the other people on the panel,
irresponsible loans amount to very little of the whole thing,
of all the loans that are taken from the plan. So I would not
extrapolate some gratuitous comment from some other commentator
up here on that.
It is psychological. When we started the money funds, we
went to the brokerage houses and we said to them, we want you
to take your clients' balances and give them to us, put them in
a money market fund. And the reaction of the brokerage houses
was, you are out of your mind. That is the essence of profit
that comes to the brokerage house.
As a result, we had to fight to get into the brokerage
houses. Today there is over $3 trillion that is invested in
money market funds from brokerage houses because, in fact, the
clients of the brokerage houses leave more money there because
they know they have access even though they don't use it.
The second step we took in the money market funds is by
opening checking accounts against the accounts. So then the
brokerage houses said to us, you are truly out of your mind
because this way they are going to take the money out of here
and it will not be within the brokerage house. What happened is
more money came into the plan.
Finally, a debit card was attached to the access of money
market funds within brokerage houses, and indeed, more money
came in.
So it is a psychological thing. It is not a question that
people use it. It is a question that they know that they can
get to it.
Senator McCaskill. Well, I have just got to tell you I am
not aware that the advantages of credit cards and debit cards
have led to savings. Every experience I have had in my life is
counter-intuitive to that. And I would like the backup for
these claims--
Mr. Bent. I would be more than pleased to do that.
Senator McCaskill [continuing]. That people are saving more
because they can charge.
Now, let me ask you a specific question, and if it is your
testimony that the plans have no profit motive whatsoever to
turn people to your program and that you are just a passive
processor, I am assuming you are out selling this concept to
people.
Mr. Bent. We try.
Senator McCaskill. Let us assume hypothetically that
somebody takes out $7,000 worth, which is the average amount of
a loan that is being taken out right now. Let us assume someone
owes you $7,000 on one of these debit cards and they lose their
job. What is the interest rate they are going to pay on that
right now?
Mr. Bent. They pay 7.9 percent, 5 percent of which goes
back to their plan, 2.9 percent is paid to The Reserve.
Senator McCaskill. Total.
Mr. Bent. Total.
Senator McCaskill. So you are only collecting 2.9 percent
on this debt.
Mr. Bent. That is correct.
Senator McCaskill. Well, you are never going to make money.
Mr. Bent. Bless you.
Senator McCaskill. So it is not prime plus 2.9.
Mr. Bent. It is prime plus 2.9.
Senator McCaskill. What is the total amount of interest
they are paying right now?
Mr. Bent. 7.9 percent. I think what you are missing is the
fact that it is their own money. So what I am doing is I am
administering the loan. I am not lending money to them.
Senator McCaskill. But I am talking about if they owe the
money, if they have spent the money, what are they paying?
Mr. Bent. They owe it to themselves. They are paying 7.9
percent.
Senator McCaskill. And how long will it go before they get
a penalty from the IRS for using that money or have to pay
extra taxes?
Mr. Bent. Well, if they do not use ReservePlus and they go
to the conventional--
Senator McCaskill. I understand. If they use ReservePlus I
am asking.
Mr. Bent. If they use ReservePlus, they can stay there for
5 years and pay back their loan.
Senator McCaskill. What happens in 5 years if they have not
paid it back?
Mr. Bent. The same as what happens under a conventional
loan.
Senator McCaskill. I understand. But instead of having a
deadline of 90 days, they always have the 5-year deadline which
they have with your money with the debit card or they have with
a conventional loan. It is a 5-year limit.
Mr. Bent. Correct.
Senator McCaskill. And do you think they all understand
that clearly?
Mr. Bent. It is the same as it is with a conventional loan.
There is nothing different.
Senator McCaskill. Well, I understand, but with most credit
cards you do not have to pay them back in 5 years.
Do you think that most people understand that on that
amount, the total is going to go significantly up in 5 years?
Mr. Bent. Senator, I think you are confusing credit cards
and this access to your savings.
Senator McCaskill. I think the consuming public is going to
confuse credit cards and access to these savings because it
feels and walks like a duck.
Mr. Bent. My apologies for not being able to convey this to
you, but it is their money. It is not my money. I am not
lending them money. Whether they go through The Reserve plan or
a traditional plan, if they default on the loan, what happens
is that then they will pay taxes on it. I am not changing the
law. That is not within my power.
Senator McCaskill. I understand.
Mr. Bent. I am strictly an administrator.
Senator McCaskill. Thank you, Mr. Bent.
The Chairman. Thank you, Senator McCaskill.
Before we turn to Senator Schumer, one question for you,
Mr. Long. You testified that you were concerned about recent
ads urging TSP participants to roll their accounts over into
higher fee IRA's. I agree with your concern, and I am calling
on these companies to stop running ads that portray TSP as
``irrelevant or outdated.''
Can you share with us why you think these ads are
misleading and why most participants would want to stay in the
TSP?
Mr. Long. The ads that I saw, one of which suggested that
you should leave when you are retired or when your TSP account
retires, or the other one was referring to your old TSP
accounts. TSP accounts are not old and TSP accounts do not
retire. People who leave the Federal service are welcome to
leave their retirement funds with us and we actually encourage
them to do so because the TSP has one very big advantage over
virtually all private sector plans, that is, a tremendously
attractive fee structure. And so, yes, I was not pleased when I
saw ads that suggested that TSP was old or retired.
The Chairman. Thank you very much.
Senator Schumer?
Senator Schumer. Thank you, Mr. Chairman. I appreciate your
letting me attend this hearing because this is an issue I have
been involved with for a long time.
In the 104th Congress, whenever that was--what are we now?
The 110th? So about 12 or 13 years ago. Anyway, I was in the
House, so it was before 1998. I read about a bank doing this. I
think it was BankOne. And I was really upset because I think
that savings is so important and there is so much pressure on
people in today's society to spend, spend, spend and not to
save. And here we had set up in Congress this great device, the
401(k), which encourages people to save, and to allow you to
just go with your debit card and take money out of your 401(k)
was a big mistake, given everything that has happened here.
And you can make the arguments, as Mr. Bent ably does,
about the free market and all of that, but you know, we are not
in the 1890's anymore. I think doing things to encourage people
to save for their future makes a great deal of sense.
Anyway, I introduced the legislation then, and much to my
surprise, BankOne withdrew the product. So I figured this issue
was over. And when you called this hearing, I was not even
aware that Mr. Bent's bank was doing this. I said, I am coming
and I am going to introduce legislation with you, Mr. Chairman,
to deal with this issue. And I appreciate your invitation and I
appreciate we are doing this because to me it makes a great
deal of sense.
And, Mr. Bent, I know you say it is their money. It is
their money. There are penalties. But people scrounge to get
that money into the 401(k), whether it is theirs or their
employers. It is hard and we should not make it easy to take it
out. I mean, there are unusual circumstances. God forbid a
terrible illness. No one would say wait for your retirement if
you need money for a terrible illness. On the other hand, if
there is an impulse to buy a flat screen TV and take many out
of your 401(k), I think there should be barriers, and there
certainly are not barriers with an ATM card.
So I am supporting this legislation.
I missed your testimony, Mr. Bent, but do you have another
argument other than, ``It is their money?'' What about savings?
What about the idea that it is easy in this society to have
short-term gratification patterns and hard to have long-term
gratification patterns? We provide other incentives for people
to save either for their retirement or other things. It is not
a flat tax code that says consumption and savings get the same.
I for one would like to see greater incentives for people to
save.
Just give me your general view. And I understand your right
as a capitalist to go ahead and do this--
Mr. Bent. Thank you.
Senator Schumer [continuing]. In free market America. You
understand our right to say this is bad policy and--no offense
to you--
Mr. Bent. Absolutely.
Senator Schumer [continuing]. We ought to change it.
But just give me your view a little bit about what I said,
about the difficulty for people saving in today's society, that
one of the great problems with America is we do not save
enough, that we should have incentives for savings and not to
simply consume. Some would argue that we are in the present
recession because we like to stuff our face. We export less
than we import. We save less than we borrow. We consume more
than we produce.
And it is one of the great problems in America. And in a
small way, what you are doing here would exacerbate that. Tell
me what you think.
Mr. Bent. I think you are wrong. We are in a situation--you
asked.
Senator Schumer. I do not mind.
Mr. Bent. We are in a situation where lots of people who
are younger and lower income do not participate in the 401(k).
The idea of having to opt out of an automatic enrollment is
great. We put that in in our plan as soon as it was possible.
But that being said, you still have a situation where
people want to have access to their money. My argument, that it
is their money and they should have access to it. But I am not
talking about that. I am talking about encouraging people to
come into the plan and save more and borrow less because of the
access. It is psychological. They do not use it, as evidenced
by the fact that our average loan is lower. It is 35 percent
lower than a traditional loan.
And the clincher with our program.
Senator Schumer. You are saying your plan encourages
savings.
Mr. Bent. That is correct. It encourages participation and
it encourages--how can you argue against that? If they are
taking less money out--
Senator Schumer. Because you are making the argument that
if your plan was not available, people would go into their
401(k)'s in another way, and that is just not going to be the
case. Practical logic tells you when you can just use it as a
credit card or debit card, it is a lot different than if you
have to go through a whole lengthy process to do it.
Lots of people buy on impulse and regret buying what they
bought on impulse the next week.
Mr. Bent. If you would like to go to Fidelity right now and
you want to take out a conventional loan, you go click, click,
click, click. The check is in the mail.
Senator Schumer. Maybe we should not allow that either.
That is not a good argument. I mean, to say other people do
something that is not good--
Mr. Bent. No. What I am saying is that you are trying to
paint my product as something evil. It is not. It encourages
people to participate in 401k's and we do not alter borrowing
restrictions.
Senator Schumer. I am not saying it is evil. I am saying it
discourages savings, encourages consumption.
Mr. Bent. We can debate it forever but the facts are it
does not.
The final thing is when someone loses their job, under a
conventional plan they have to pay their money back in 90 days.
That is not the case with ReservePlus. You can continue to make
payments for 5 years. It is a major advantage.
Senator Schumer. But every withdrawal is a new loan, each
one with its own fees and everything else. Right? So in other
words, if you got one big loan of $5,000 or you used your
credit card and did 10 different withdrawals of $500 each,
would you not pay many more fees in your situation?
Mr. Bent. No, not at all. If you go back to BankOne, in the
BankOne situation where they had the 401(k) access, the money
came out in a lump sum. It was immediately outside the plan,
and therefore, any interest that the people earned on that
money before they actually consumed it was outside of the plan.
So one, conventional plans incent people to take out monies in
a lump sum. Mine does not. Because conventional plans force
people to anticipate needs and withdraws lump sums so that any
interest that they earn on the money they take out, would be
taxed immediately. Under ReservePlus it is not the earnings
remain tax deferred within their plan.
Senator Schumer. But there are new fees under yours each
time.
Mr. Bent. No, no, no. I am working up to it.
What we do is we move from the conventional corpus of the
fund, your retirement fund, which is stocks, bonds, although
that has not been a great place over the last 8 years, and you
go into a money market account. The money market account is
within the plan. So I have $50,000 in the plan and I think I am
going to need $5,000 it moves from the stock and bonds, into
the loan part of the plan, which is invested in a money market
fund. But it is still within the plan. You pay no fees. You pay
a fee if you want to sign up for the loan, but that goes to the
TPA administrator. That is true whether it is a conventional
loan or ReservePlus processing.
So you are now into the money market account. Let us say,
you access $50 at a time or $500 at a time. There are no
additional fees. Nothing. Effectively you pay--
Senator Schumer. What if you increase the money in that
money market fund by $500 at a time? You say you take $5,000.
You have set aside $5,000 out of your $50,000. What if you only
set aside $500 and then you set aside another $500 and you set
aside another $500?
Mr. Bent. No fees.
Senator Schumer. No?
Mr. Bent. Not from me, no. Not at all.
Senator Schumer. I am not sure that is--OK. That is not my
understanding.
Mr. Bent. Well, your understanding is wrong.
Senator Schumer. OK.
How about Mr. Iwry? Do you have something to say here?
Mr. Iwry. Yes. I think you are right, Senator. An
individual can take out more than one loan.
Senator Schumer. Right.
Mr. Iwry. And the limits on the total amount of loans do
look to how much you have outstanding on a look-back basis, but
that does not mean that you cannot take out what you need--
Senator Schumer. Another loan with additional fees.
Mr. Iwry [continuing]. Then take another loan out. Right.
Senator Schumer. Is he wrong?
Mr. Iwry. So you can do that--
Mr. Bent. Oh, he is right. He is agreeing with me, not you.
Senator Schumer. No, he is not.
Mr. Bent. Yes, he is.
Senator Schumer. Who are you agreeing with, Mr. Iwry?
[Laughter.]
Mr. Iwry. I am agreeing with you, Senator.
Senator McCaskill. Smart guy.
Mr. Bent. What did I say that was wrong? I am sorry. I
misunderstood what you said then.
Mr. Iwry. The Senator I think is making the point that a
person who does not have a credit card or a debit card access
to loans can also take out only as much as she might need, and
if she needs more, can then take out another loan for an
additional amount.
Mr. Bent. But there are fees charged for each time you do
it under the TPA fee structure right now. That is what his
question was. I do not have those fees. So you are wrong.
Senator Schumer. OK. Let me go on here.
Let us a do a comparison here. Maybe this will bring some
of this to light, although this is a slightly different issue.
You contain a comparison because you talk about the average
loan amount of a Reserve loan compared to a regular loan, and
you say the average amount is different. Right?
Mr. Bent. Correct. Lower.
Senator Schumer. But to compare the products, we need to
make a different comparison. So let us take two people with the
same income and a plan balance who each take out $8,000. OK?
Now, the first person takes out $8,000, puts the money in a
bank, and spends $2,000 each quarter for a year, and then
repays the loan within 5 years. The second person puts $8,000
in a ReservePlus account and withdraws $2,000 each quarter for
a year and then repays the loan within 5 years. So that is the
apple-to-apple comparison. Fundamentally, these people are the
same.
Now, but because each withdrawal under your plan is
considered a separate loan with a separate fee, plus the setup
fees, is the second person not worse off, or are they the same?
Mr. Bent. No. They are better off with mine.
Senator Schumer. Why?
Mr. Bent. Because, No. 1, there are additional fees for
each advance because there is only one loan.
No. 2, with a conventional loan you take the money out and
you put it in a bank and any interest you earn you pay taxes
immediately.
Senator Schumer. So you are saying a person in your Reserve
account just pays one fee.
Mr. Bent. Correct.
Senator Schumer. Mr. Iwry?
Mr. Iwry. Senator, if I may, the fees that would be charged
on a normal plan loan depend on the particulars of that plan.
Senator Schumer. Of course.
Mr. Iwry. And in many cases, there would be very little fee
charged by the plan. There are lots of large 401(k) plans in
which there is only a nominal fee that is charged.
Senator Schumer. Is your fee nominal?
Mr. Bent. My fee is nonexistent. It depends what the TPA
charges.
Senator Schumer. No. But you did say you charge a fee.
Mr. Bent. No. The fee is for the amount that is utilized.
So there is no fee for opening up a loan account.
Senator Schumer. Opening up that money market account.
Mr. Bent. Correct.
Senator Schumer. That is what you said. But there is a fee
each time you borrow against the money market account.
Mr. Bent. No, no.
Senator Schumer. No fee at all.
Mr. Bent. No.
Senator Schumer. So this is fee-free?
Mr. Bent. It is fee-free relative to what you are saying,
and in addition--
Senator Schumer. But is it fee-free, period? What fees do
people pay?
Mr. Bent. They pay the TPA, the plan administrator. They
pay him--I think we said--average $75. That does not go to me.
It goes to the plan administrator. If the plan administrator
sets up--
Senator Schumer. And you get no fee at all. Your company
gets no fee for any of this, aside from your annual? I am
talking about fees each time they take out a loan.
Mr. Bent. No, there is not. Plus, what he ignored was the
fact--
Senator Schumer. I think we have a--
Mr. Iwry. Senator?
Senator Schumer. Let Mr. Iwry. Go ahead.
Mr. Iwry. Senator--
Mr. Bent [continuing]. The interest that is earned--am I
speaking or is he?
Senator Schumer. Mr. Bent and then Mr. Iwry.
Mr. Bent. OK. The interest that is earned when the money
comes out in a conventional loan is taxed immediately. With
ReservePlus it is not. Under the scenario that you outlined,
the person is better off under my plan than they are in a
conventional plan.
Senator Schumer. Go ahead, Mr. Iwry.
Mr. Iwry. Mr. Bent's written statement says that the plan
participants pay a service fee to ReservePlus, which ranges
from 2.9 percent to 3.25 percent.
Senator Schumer. Yes. What is that?
Mr. Iwry. On loan balances actually utilized.
Mr. Bent. Exactly.
Senator Schumer. But that is what we are saying.
Mr. Bent. It is not a transaction fee.
Senator Schumer. OK, but they pay a fee.
Mr. Bent. Of course. [Laughter.]
Of course. There is a difference. There is a substantial
difference.
The Chairman. Senator Schumer, you have done great.
Senator Schumer. Thank you, Mr. Chairman. Thank you.
The Chairman. Do you want to make a comment?
Senator McCaskill. Well, I wanted to ask a question.
I am confused. If anyone is not confused at this point,
they have not been listening. [Laughter.]
What I do not understand is how you have the ability to
call this fund still as part of the fund. What you are saying
is legally they are setting aside part of their money and
putting it on one of your money markets.
Mr. Bent. Which they can do in a conventional plan today.
Senator McCaskill. I get that. I get that. But you are
saying the difference is it is still part of the fund.
Mr. Bent. Correct.
Senator McCaskill. And that there are no penalties that
inure to them, none of that.
Mr. Bent. Absolutely.
Senator McCaskill. Then why is it that you get 5 years if
they quit and the loans only get 90 days? You are saying that
if they leave their job, they do not have to repay it in 90
days. You are saying that if they leave their job, they do not
have any penalty. They have up to 5 years to pay themselves
back without having to endure the penalties.
Well, if it is still part of the fund, if you are still
considering this part of their fund, what is the legal--maybe
it is not an artifice. It feels like an artifice. What is the
legal artifice that allows you to remain part of that of fund
for purposes of a 5-year payback and not have the 90 days?
Mr. Bent. Take the 401(k) fund. Divide it into two parts.
In the fund you have a conventional investment fund and you
have the part the beneficiary has decided that they want to
have that as an access loan fund for them. It is within the
plan. If they leave their employer tomorrow and they have not
used anything in that loan fund, no harm, no foul. Zero. They
do not owe anything to themselves. They do not owe anything to
me. There is no fee. There is nothing. It is all within the
plan.
Senator McCaskill. But what if they do owe? You have
testified that the benefit of your plan over a conventional
loan is the reason everyone is dying to get these debit cards
because they are going to be--they are saving money money--is
because they do not have to worry about the 90- day payback.
What legal basis are you using to say you do not have to pay it
back in 90 days?
Mr. Bent. You have fund A and fund B within the retirement
plan. One is conventional, stocks, bonds. The other one you
have designated as a loan fund. It is all within the plan. You
have not used any of it.
Now you use some of it. Arbitrarily you use $5,000. OK?
Senator McCaskill. Right.
Mr. Bent. You now have the $5,000 out. It is a loan. You
have used it for whatever you use it for--
Senator McCaskill. Right.
Mr. Bent [continuing]. Medical expenses, so on and so
forth.
You then lose your job.
Senator McCaskill. Right.
Mr. Bent. Under a conventional loan policy, tradition if
you will, you have 90 days to pay it back to your fund. The
employer could choose to have it paid back over 5 years, but
they do not. Traditionally they do not because they want to get
it off their books.
Under my program, what I will do is I will accept payments
from those people to pay back their loan to themselves, and
they do not have this cataclysmic event of losing their job and
having to pay the loan back in 90 days.
Senator McCaskill. I understand. So this is the choice, a
business choice, of your company. There is no legal requirement
they pay it back to their fund. Their employer just wants it
back that quickly. And you do not care if they take longer.
Mr. Bent. Paraphrasing, yes, correct.
Senator McCaskill. Thank you, Mr. Chairman.
The Chairman. Well, we thank you. Senator McCaskill,
Senator Schumer, and all the members of the committee. I
believe we have again brought to the surface the importance of
retirement programs, and the importance of the 401(k). We need
to shore it up, and to be certain that it is used for the right
purposes, this is important to our country. And we will be
following up with you and with legislation toward that end.
You have been very good today. Your testimony has really
advanced, I believe, the cause, and we appreciate your being
here. We appreciate all of you for being here today.
And this hearing is adjourned.
[Whereupon, at 11:55 a.m., the hearing was adjourned.]
A P P E N D I X
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