Retirement plan menu design continues to evolve

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As a former ERISA attorney and senior vice president of advisor services at Manning & Napier, an investment management company, Shelby George believes that automatic plan features, such as auto-enrollment and auto-escalation, have helped get the retirement industry where it is today. But, she says, new fiduciary scrutiny, increased litigation and a potential shift in participant behaviors have made it essential that plan investment menus adapt to address the needs of all participants.

Plan sponsors must continue to offer automatic plan features and do a better job of vetting target-date funds, which are the go-to qualified default investment alternative offered in most 401(k) plans, George said during a conference call with Manning & Napier looking at the new era in retirement plan menu design. QDIAs were instituted to help apathetic plan participants save for retirement with a diversified portfolio.

Auto features became standard best practice in the mid-2000s.

“Through auto features, many of the disengaged plan participants could have improved savings and investment behaviors if auto enrolled, without having to take action on their part,” George said.

Target-date funds, which were developed in 1994, are the most popular qualified default investment alternative. More plans are offering TDFs as part of their retirement plan investment menus. Target-date funds now manage nearly $1 trillion in assets, compared to a mere $28.7 million in 1994.

A recent JP Morgan study showed that 59% of plan participants want someone to make investment decisions for them, so auto features are a fantastic solution for that, George said. “It gives them the resources they need. It really makes inertia work in their favor by encouraging them to save,” she said.

But there are still 41% of people who want to make those decisions themselves.

The industry has a tendency to focus on that 59% “at the risk of overlooking the 41%,” George said. “And while they are a minority in terms of the number of plan participants, it is often the majority in terms of assets.”

Many of these participants are approaching retirement or are already retired. They accumulated their nest egg and are very much engaged with their plans and making critical decisions about their financial futures, including Medicare and Social Security.

Handing over the retirement reins

The number of these minority participants grows every year, George said. That’s because 10,000 baby boomers are turning 65 every day and will do so until 2030 and this group will only grow larger and get closer to making decisions on the single asset class side of the menu.

As they approach decisions about their financial state and how to plan for their future, there is a potential shift in their behavior, she said. Because of the Department of Labor’s fiduciary rules, it is projected that as many as half of plan participants, who would have otherwise rolled over to an IRA, may decide to stay in their workplace plan because many advisers may get out of offering IRA advice in the future.

“Because of the absence of financial advice or the unavailability of that, many people would keep their money in plan even after they retired,” she said. If that happens, retirees would begin their decumulation phase while still in their workplace plan.

This opens up an opportunity for advisers acting as fiduciaries, those acting in an ERISA 3(38) or ERISA 3(21) fiduciary capacity. A 3(38) investment fiduciary adviser is one that takes on full fiduciary responsibility for the selection, monitoring, removing and replacing of investment options on a retirement plan menu. A 3(21) adviser is one that gives investment recommendations but doesn’t have the ability to make the final investment decisions. The majority of advisers today act in a 3(21) fiduciary capacity but 47% of advisers are acting as 3(38) fiduciary advisers to plans compared to 20% in 2011.

“We see a lot more retirement plan professionals taking a lot more fiduciary responsibility or asking advisers to take fiduciary responsibility,” she said. “We do expect those percentages to go up as more and more plan sponsors are looking for co-fiduciaries to help them with the decision-making process.”

The majority of retirement plan providers offer four or more target-date funds because different demographics of employees have different objectives for their retirement savings, said Chris McAvoy, portfolio strategist, multi-asset class solutions, for Manning & Napier.
Some want to keep accumulating money through retirement and others want to reduce their risk.

Leave a paper trail

It is very important that plan sponsors document the process of how they came up with the investment options available on their retirement plan menus.

“We need to be considering the current environment. We need to recognize that we are in somewhat of a tumultuous environment. We are faced with some very unpredictable returns as we move forward,” McAvoy said.

He added that since high returns on investment are no longer guaranteed, plan sponsors need to address that issue in their plan lineups. They need to diversify their offerings and present opportunities for both growth and capital preservation.

“The environment today tells us the returns we talked about will be difficult to come by in the future based on current valuations,” he said.

There has to be a broad diversification across asset classes and strategic allocations to augment asset growth. What’s most important is to look at how to develop these lineups and do it in a manner that doesn’t confuse or overwhelm the end user, McAvoy said.

And even though market conditions have changed, plan participant expectations have not, said Craig Abbott, vice president, retirement plan consultant with Manning & Napier.

“They are not changing their assumptions about future returns or the standard of living based on those returns, volatility or how to generate income in retirement,” Abbott said.

Because people will be in retirement for 25 to 30 years, they need a variety of growth and income options in their portfolios. That means the industry has to expand the types of asset classes it offers within retirement plan investment menus, like real estate, emerging markets and international small cap funds, to name a few. If U.S. securities are not doing well, sometimes other global markets are and they can counterbalance that volatility.

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