The Need to Educate 401(k) Employees

Mark A. Nadler, Terry E. Rumkler

February 1, 2002

While Americans concern themselves with the poor quality of public K-12 education, an even larger educational crisis looms before us. Surveys of average Americans indicate widespread financial illiteracy. Most Americans don’t understand how financial markets operate and the role of portfolio diversification in managing risk.

What keeps thrusting personal investment education to the forefront of public concerns is the replacement of traditional or fixed pensions with 401(k) types of plans. Under a fixed pension, employers are responsible for the retirement of their employees, while employees are responsible for their own retirement under a 401(k).

A mismatch exists between the average employee’s ability to develop a retirement investment plan and their responsibility under a 401(k). This problem is compounded by the Employee Retirement Income Security Act (ERISA)—enacted in 1974—which inhibits, because of liability laws, employers from providing their employees with individualized investment advice.

Two bills now pending in Congress are designed to help employees deal with their retirement planning. In the House, Rep. John A. Boehner (R-OH), has introduced The Retirement Security Advice Act (H.R. 2269). This bill, which recently passed in the House, makes it clear that employers are not responsible for the individual advice given by professional advisers to their employees. This will encourage employers to supply financial advice to their employees.

One difficulty with H.R. 2269 is that it allows 401(k) providers—the financial companies that sell financial assets to employees—to also act as financial advisers. This represents a conflict of interest which unions and the AARP argue hurt employees.

An alternative remedy, which is now in legislative form, would impose a higher fiduciary standard—read as greater liability—on employers who select advisers who also manage the investments of their offered defined contribution plan. Senators Jeff Bingaman (D-NM) and Susan Collins (R-Maine) have introduced, as an alternative to H.R. 2269, the Independent Investment Advice Act of 2001 (S.1677). This legislation frees from liability 401(k) sponsors who designate and monitor an investment adviser who is not affiliated with the offered 401(k) plan and who cannot profit from employees’ investment decisions.

Both pieces of legislation are inadequate in not recognizing the three steps necessary for Americans to become proficient in retirement planning: first, education and motivation; second, information; third, advice. What the average American needs first and foremost, even those not participating in defined contribution plans, is personal financial education and motivation. Neither bill provides for this.

The benefits from personal financial education both to the individual and the wider society are significant and include a more self-reliant workforce, increasing worker productivity, greater participation in company retirement plans, and a type of financial awareness that increases employee understanding of financial issues that they face. Personal financial education is a public good that warrants support from both political parties.

Many questions concerning this educational and motivational step need to be answered before a sensible program of implementation can be designed. The real question here is whether 401(k) providers can and should perform this educational function. Few, if any of them, have the expertise in developing programs to educate the average financially unsophisticated employee. Also, given the conflict of interest that potentially exists between educational and advisory functions, especially given the climate created by the Enron and Arthur Andersen debacle, it’s hard to make a case allowing defined contribution providers to do both.

Once this educational and motivational step is complete, 401(k) covered employees are ready for information and advice. Information refers to the investment opportunities available to the 401(k) participant. This function must be performed by the 401(k) provider. What about financial advice? Given that each employee is educated in the rudiments of personal investing, allowing an organization’s 401(k) provider to supply financial advice will become less problematic.

What Americans need is legislation that creates incentives for employers to provide and employees to utilize financial education. Once this step is taken, a bill that reduces employer liability, like Rep. John Boehner’s, will then be useful in helping Americans become self-sufficient in their retirement planning.

Mark A. Nadler, Ph.D. and Terry E. Rumker, CFP™ are professors of economics and business at Ashland University and are members of The Financial Education Company, LLC. They can be reached at