401(k) Plan Center

Progress: 401(k)'s Have Simply Gotten A Whole Lot Better

Progress: 401(k)'s Have Simply Gotten A Whole Lot Better

It is pretty easy to focus on what is wrong with our defined-contribution retirement system. Lots of employees still do not have access to workplace retirement plans. Fees can be too high, especially for workers at smaller firms. Sometimes employees face making complex decisions with relatively little guidance. Many of us do not save as much as we should for retirement. All of these things are true.


Progress in the 401(k) battle

401(k)’s have simply gotten a whole lot better

By Bruce Thompson

May 30, 2015

It is pretty easy to focus on what is wrong with our defined-contribution retirement system. Lots of employees still do not have access to workplace retirement plans. Fees can be too high, especially for workers at smaller firms. Sometimes employees face making complex decisions with relatively little guidance. Many of us do not save as much as we should for retirement. All of these things are true.

And these are all reasons TWM saw the need for change and got involved with 401(k) plans several years ago.  But the good news is that, through the efforts of fiduciary advisers (as opposed to advisors, read salespeople) across the country, we have succeeded in changing the conversation for plan sponsors and their employees.  Over the past few years, 401(k)’s have simply gotten a whole lot better.

·         Insights from behavioral economics have led to the development of retirement plan features that have encouraged greater employee participation and higher deferral rates.

·         Fees are starting to come down and revenue sharing (the opaque system of kickbacks among record keepers, investment managers and investment advisors is under attack.

·         After passing fee disclosure legislation a couple years ago, the DOL is now creating a new fiduciary rule which will require professionals giving advice to operate as fiduciary advisers or at least disclose if they are operating as advisors (e.g. brokers, insurance companies, banks) which operate on a sales or “suitability” rather than a fiduciary standard. So advisors will have to give plan sponsors and employees disclosures saying, in effect, I’m not bound to recommend the best or lowest cost investment options for your plan, and I receive kickbacks from some of the mutual funds that I do recommend.”

·         The industry and advisers have developed investment options that simplify decision-making.

·         401(k) plan assets are much better diversified than they were in the past.

In my mind, the debate has shifted from a discussion of whether 401(k)’s can work for employees--they definitely can--to a debate about the best way to maximize the benefits of defined-contribution plans and to bring them to a greater number of workers. Here are a few of the signature developments that have significantly improved the retirement system.

Improvements in 401(k)’s
Autoenrollment and autoescalation. The Pension Protection Act of 2006 (PPA) made it much easier for employers to autoenroll their employees in 401(k)’s, by providing relief from some costly regulations. In 2006, 12% of 401(k) plans provided by Vanguard offered autoenrollment; by 2014, that had risen to 36%. According to Jeanne Thompson, a VP at Fidelity Investments, 70% of very large plans currently offer autoenrollment.  
Bank of America has found that plans with autoenrollment have achieved participation rates that are 32% higher than for plans that do not have such a provision.

A solid majority of employers that offer autoenrollment also autoescalate their employees' contribution levels. Among plans administered by Fidelity, Thompson said that 38% of increases in employee deferrals last year resulted from autoescalation.

Target-date funds and target allocation options. Plans that autoenroll employees now typically default them into target-date funds or managed account programs. Prior to passage of the PPA, some plans defaulted employees into money market or stable-value funds, which are poor options for long-term investors. In 2014, Vanguard reported that about 41% of employee contributions went to target-date funds, a near doubling of the proportion in 2010. The data show that by using these relatively simple-to-understand investment options—we think target risk funds make more sense than target-date funds, but that is a separate article – workers can achieve solid investor returns without needing to become investment experts.

Immediate eligibility. Not all that long ago, a majority of 401(k) sponsors enforced a waiting period before employees could participate in their workplace retirement plans. Jim Smith, a VP of Client Solutions in Morningstar's retirement business, said that approach tended to depress 401(k) participation rates, as it gave workers an opportunity to procrastinate about signing up for the 401(k)--and also forced HR departments to "reengage" with employees months after they had started work. Now, more than three fourths of plan sponsors provide immediate retirement plan eligibility for their employees, according to Aon, so the 401(k) signup has become part of new employees' orientation procedures. Especially for employees who change jobs many times over the course of their careers, immediate eligibility for 401(k)’s should materially improve their retirement security.

Reduced amounts of company stock in plans. Financial advisors generally recommend that workers limit their holdings of company stock, as employees are already exposed to the vicissitudes of their employers' business fortunes. At times, overexposure to company stock has led to disastrous results, as was the case for Enron employees who saw their life savings wiped out when their employer declared bankruptcy. Nevertheless, a couple of decades ago, it was still quite common for employers to provide 401(k) matches in the form of company stock. Companies also had a habit of encouraging workers to buy company stock in their retirement plans. As a result, Aon says that more than 30% of employee assets were invested in company stock in 1997. By 2014, just 11% of assets were invested in company stock--still too high, but the trend is moving in the right direction.

Simplification of options (Tyranny of choice). Behavioral research from Richard Thaler and others has shown that when people face making complex decisions, they often procrastinate. My colleague Andy Richardt recently posted this article on the subject: What Buying Jam Can Teach Us about Saving for Retirement

 

Many 401(k) providers have responded by simplifying the enrollment process. Bank of America found that by "minimizing upfront choices," it could achieve a nearly 40% increase in the percentage of employees who enroll in a 401(k). One small change was to ask employees to pick from among three deferral rates, rather than asking them to make up their own. Indeed, B of A found that employees most often chose the first deferral rate listed, which suggests that employers have a lot of opportunities to "nudge" people to make optimal retirement-savings decisions. Thompson reports that Fidelity has also achieved meaningful increases in participation rates with a streamlined enrollment process, including cutting down on the number of deferral choices.

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