The Big Picture: Trends in Defined Contribution Plans

Investors in 401(k) plans may not be saving enough for retirement, on average, but they’re saving more than headline numbers would suggest.

In a wide-ranging panel discussion at the 2013 SVIA Fall Forum, Elizabeth Heffernan, vice president of investment product management at Fidelity Investments, said the average account balance in plans for which Fidelity provides recordkeeping services is about $80,000. But that figure has been depressed, she observed, by the trend among plan sponsors to adopt automatic enrollment policies. Automatic enrollment brings into their plans new participants with very low account balances.

When Fidelity looks only at actively employed participants who have been enrolled and contributing to their plans for at least 10 years, Heffernan said, the average account balance is much higher: $211,000. “If you keep people in (the plans),” she observed, “the numbers do get much better.”

Heffernan was part of a panel discussion that examined trends in each of the three main segments of the defined contribution plan marketplace:

401(k) plans, which are sponsored by private employers; 457 plans, offered primarily by government employers; and 403(b) plans, which are sponsored by public education organizations and some non-profit employers. Among the highlights:

The 401(k) market

In the 401(k) market, Heffernan said, automatic enrollment is increasingly becoming the norm, especially among larger plans. Only about 24 percent of the plans on its books use it, she said, but those plans cover 55 percent of plan participants.

Other key trends Heffernan cited:

  • Target-date funds are the most common default investment option in plans for which Fidelity provides record-keeping services. Also, just over half of the Millennials in those plans, who represent about a third of the overall participant base, contribute 100 percent of their money to target-date funds.
  • Stable value funds are widely used by Fidelity clients, particularly in the larger corporate plan market, although they also enjoy a “fair amount of exposure” in the private employer market. However, Heffernan said, among new plans coming onto Fidelity’s platform, only a small percentage is choosing to offer a stable value investment option. “That’s a bit of a concern,” she said, “although certainly plan sponsors are still committed to it (stable value) in the private employer market.”

The 457 market

Sara Richman, vice president of product management at Great-West Financial, said one of the characteristics of the 457 marketplace is that they tend to be paternalistic. The 457 market includes state and local government plans and also plans sponsored by quasi-governmental employers such as water systems, public schools and public hospitals.

Still, participation rates in 457 plans are lower than they are for 401(k) plans. About 26 percent of eligible employees participate in 457 plans, Richman said, versus about 89 percent in the 401(k) market. Richman attributed the difference in part to the fact that many employees in the 457 market have access to a defined benefit plan at work, and so they view the 457 as a supplemental savings vehicle. Also, automatic enrollment is a fairly rare feature in 457 plans, with only about 8 percent of participants covered.

Although 457 plans are not subject to ERISA—the Employee Retirement Income Security Act—457 plan sponsors often look to ERISA as a guide, Richman noted. Investment options tend to look much like those available in 401(k) plans, with most plans including a stable value fund in their lineup. Target-date funds are also popular, and are often customized for larger plans.

While most 401(k) plans have a designated default investment option, Richman said about 30 percent of 457 plans have none. Among those that do, about 50 percent use target-date funds, and about 10 percent use stable value.

Like their corporate counterparts, sponsors of 457 plans are concerned about the ongoing funding burden associated with their defined benefit plans, Richman said. Despite this, thus far sponsors have made few changes on that front, in part because they often must be negotiated with unions. Sponsors are also increasingly focused on the fees associated with the investment options they offer and are becoming more resistant to “proprietary” products offered by their plan provider, including rollover IRAs, funds and other services. She said multi-manager funds are in demand among large plans. This is also true within the stable value sector.

The 403(b) market

Philip Maffei, senior director in charge of the Stable Value Solutions team at TIAA-CREF, observed that 403(b) plans are offered by over 85 percent of not-for-profit employers in all industry sectors except healthcare, where the figure is 66 percent. Historically, 403(b) plans have used multiple record-keeping and investment vendors, although regulatory changes in 2009 and 2012 have resulted in many plans reducing the number of vendors they use, with some moving to a single record-keeper.

About 67 percent of not-for-profit employees who have access to a defined contribution plan—usually a 403(b)—participate in their plan, and on average contribute 8.1 percent of their salary, Maffei said.

Most 403(b) plans are limited by federal regulation to using mutual funds or annuity contracts; collective funds typically cannot be used. Other than public K-12 school systems, Maffei noted, a stable value option is available in about three-quarters of all plans. In the public K-12 market, that number is only 47 percent.

Since the Department of Labor issued rules spelling out what counts as a qualified default investment option (QDIA), the percentage of TIAA-CREF participants contributing to multi-asset class investments such as target-date funds has increased, to 34 percent in 2011 from 15 percent in 2005, Maffei said. During that same period, the percentage contributing to a principal preservation option decreased to 47 percent from 63 percent.

Like their 457 counterparts, 403(b) plans have been slow to embrace automatic enrollment. Only 14.6 percent use it, Maffei said, even though participation rates are significantly higher—by anywhere from six to 22 percentage points—among those that do. Automatic escalation of deferrals is used by only about a third of those plans that use automatic enrollment.

Even with these innovations only 44 percent of 403(b) plan participants say they are confident of being financially ready for retirement, he said, mirroring findings in other parts of the defined contribution plan marketplace. To improve outcomes, Maffei said more plan sponsors need to improve their plan design to incorporate features such as automatic enrollment and automatic deferral escalation; switch to a single plan-management platform to reduce complexity and minimize expenses; provide participants with access to low-cost fixed and variable annuities, mutual funds, and lifetime income solutions; provide objective, outcomes-based advice and education; and offer supplemental benefits such as retiree healthcare savings plans.

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