'Inside' Straits

 A recent Wall Street Journal (WSJ) article asked what I view as a rhetorical question; “Do you really know what’s inside your 401(k)?” Rhetorical in that I suspect the answer from most people — certainly if they’re honest — is “no.”

Now there are many aspects to a 401(k) that bear scrutiny, but the article was focused on target-date funds (TDFs) — a mechanism that I think has been a boon for most of the novice investors (and savers) that I suspect most 401(k) participants (still) are.

You check one box (heck, these days that box is checked for you) and tap into the expertise — and ongoing expertise at that — of professional money managers to provide your retirement savings with a diversified portfolio mix. No longer do you have to concern yourself with weightings of stocks and bonds, value versus growth, domestic versus international — just leave it to the experts. 

But the WSJ article’s focus was a cautionary note — mostly concerned at the unexpected things that a collective investment trust (CIT) vehicle (now 52% of all TDF assets, according to the article) might open the door to — specifically alternative investments, notably so-called “private investments.” Which, the article points out, might undermine the cost advantages of the CIT with those alternative holdings that are more expensive, less transparent/readily valued, and illiquid.

Indeed, the author goes so far as to comment, “As far as the managers of private assets are concerned, the ‘target’ in target-date funds is you.” Of course, his concern is that the less rigorous reporting requirements of a CIT (compared to a mutual fund) would allow investors to be taken advantage of — as though they’re actually even skimming that mutual fund prospectus.

Let’s face it — target-date funds with all their simplicity (at least in the choosing) and promise have been pitched as a “do it for you” solution, and tens of millions of (too) busy, preoccupied participants have trusted their retirement savings to these vehicles assuming that the professional investment class — not to mention the plan sponsor fiduciaries that screened them — know what they’re doing.

Unfortunately, in some cases, that trust may have been misplaced.

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Something not mentioned in the WSJ article is that most of the manufacturers of those vehicles several years back embraced a “through” retirement date glide path, rather than the “to” retirement date that was the original “pitch.” The latter meaning that you’d gradually move to a much more conservative asset mix at your projected retirement date. And while there is still certainly a modest shift in that direction, the shift in emphasis means that I suspect there are a lot of folks nearing retirement that have a portfolio mix that is significantly more exposed to stocks than they might expect and/or want.[i]

Some of this shift is, doubtless, a sense that individuals want to stay invested in those funds, irrespective of retirement date.[ii] Some doubtless a desire to report better returns, since I suspect most fiduciaries are (still) paying more attention to the current returns than the conceptual integrity of the glidepath.

Regardless, it is, to my eyes, anyway, a shift from the original premise — and one that I suspect many participants haven’t noticed, and one on which plan fiduciaries may not have focused. The inclusion of alternative investments (particularly when folks are talking about 20% allocations) is one thing — but the structural glide path of these options, particularly when positioned as a default investment, strikes me as even more fundamental.

That said, and as the WSJ article closes, “None of this means you should turn your back on these funds, which can give you a powerful boost toward a sustainable retirement. It does mean you’ll need to know what you own and speak up if you don’t like it. The ultimate hands-off investment is going to require you to be a lot more hands-on.”

I would say that goes double for those responsible for the selection and monitoring of these plan options.

• Nevin E. Adams, JD

 

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[i] Note — not saying that the shift in glidepath focus isn’t legit, or even beneficial — it just seems that most folks probably missed that “memo.”

[ii] Cynics might even suggest that the shift is a function of TDF managers simply wanting to keep hold of that money all the way through the individual’s retirement, rather than handing it over to a different manager. 

What’s Wrong with Automatic Enrollment?

Automatic enrollment has long been touted – and proven – to be an effective way to overcome retirement savings inertia in 401(k) plans. But these days automatic enrollment plan design seems to be suffering from its own inertia.

For all the good press and positive results that automatic enrollment gets, one might well expect that every plan would embrace it. And yet today, nearly a decade after the passage of the Pension Protection Act, many still don’t. What’s wrong with automatic enrollment?

Everybody doesn’t do it.

Only the most naïve industry professional ever assumed that the Pension Protection Act of 2006, even with all its incentives and encouragement (and not a few barrier removals) would transform a voluntary savings system into something that all employers everywhere would feel comfortable – or would be able to afford – automatically enrolling every eligible worker.

And yet, more than a decade later, only about two-thirds of the largest employers have embraced automatic enrollment – and only about a quarter of the smallest programs, according to PLANSPONSOR’s 2017 DC survey. Oh, you see numbers that suggest the adoption rate is higher, but those surveys tend to skewer toward larger programs, where – as the numbers above indicate – automatic enrollment is much more common.

There are legitimate concerns, mind you. Anecdotally many plan sponsors – particularly small plan sponsors – are simply unwilling to impose another financial “draw” on their workers’ paychecks, and most will tell you that they have had those “you need to participate” conversations with their workers, only to have them decline. Moreover, the costs of an employer match when you’re talking about taking participation from a 70% (or thereabouts) level to 95% or higher can be significant.

For those who worry that a higher default would trigger a higher rate of opt-outs, surveys indicate that the “stick” rate with a 6% default is largely identical to 3%.

On the workforce management front, it’s worth noting that there are surveys that show that American workers are increasingly delaying retirement (or think they will be able to) due to concerns about retirement finances. Delayed retirements may also reduce the employer’s ability to hire new employees, reducing the flow of new ideas and talent into the organization.

But even when the plan includes automatic enrollment…

There’s a fault with the default.

While you see surveys suggesting that a greater variety of default contribution rates is emerging, the most common rate today – as it was prior to the PPA – is 3%. There is some interesting history on how that 3% rate originally came to be, but the reality today is that it has been chosen because it is seen as a rate that is small enough that participants won’t be willing to go in and opt-out – and, after the PPA, we have some law to sanction that as a target.

That said, nobody thinks 3% will be “enough” – neither to maximize the employer match in most plans, nor certainly to allow workers to accumulate sufficient funds for retirement. That wouldn’t be so bad – it’s a starting point, after all – except that…

The contribution rate is set – and never “reset.”

The authors of PPA’s automatic enrollment safe harbor knew that the 3% default wouldn’t be “enough,” and they had the wisdom to include a provision that called for an automatic “escalation” of that contribution rate – 1% a year (though, weirdly, they included a cap of 10% in the law). Plan sponsors – for many of the reasons that have slowed the adoption of automatic enrollment – have been even slower to embrace automatic escalation. The PLANSPONSOR DC Survey found that only about a third (35.7%) of the largest plan sponsors automatically escalate contributions unless the participant opts out (about the same amount allow the participants to choose to automatically escalate). However, once again smaller plan sponsors are significantly less likely to embrace this plan design.

But even then…

Only the newly hired are automatically enrolled.

For years now, the standard – even among employers who embrace automatic enrollment – is to extend it only to new hires – we’re talking only about a third of plans extend this to other than new hires. The rationale is that existing workers have had their opportunity – and in all likelihood many opportunities – to participate in the plan. Moreover, while the PPA doesn’t mandate going back to older workers, plan sponsors desirous of those safe harbor protections either have to, or have to be able to establish that they have.

Regardless of safe harbor concerns, it’s hard to imagine that plan sponsors who have cared enough to embrace automatic enrollment aren’t just as concerned about the retirement well-being of their more tenured workforce as they are about those recent hires.

However, even among the newly hired, some may have previously participated in another plan – and at a higher contribution rate. Automatically enrolling them certainly removes one of those “first day” new employee hassles – but may not be doing them any favors in terms of their retirement savings.
As with the default contribution rate, surveys have found positive movement on this front in recent years, particularly at the point of provider conversions (amongst a series of other plan changes).
Indeed, a small, but growing number of plans are…

Giving workers a second chance.

There’s a new-ish concept called reenrollment. Initially, it was a means by which plans could, at the point of conversion to a new platform, “reenroll” participants into a newly selected default investment fund, generally a balanced or target-date fund that had been chosen as the plan’s qualified default investment alternative, or QDIA (they were generally given time to opt-out of that decision before conversion). More recently, it has been expanded to basically treat all eligible non-participants as new hires – auto-enrolling them in the plan, and in some cases, reenrolling at the default rate if they happened to be contributing below that rate.

That said, this approach is not only new-ish, but not very common. Even among the largest plans (more than $1 billion in assets) responding to the PLANSPONSOR DC Survey, more than 86% don’t do any part of this.

There are, of course, good things with automatic enrollment, mostly that there are today many participants saving at 3% (and a match) who weren’t saving anything previously.

So, what’s wrong with automatic enrollment? Well, there are some participants who were auto-enrolled at 3% who would probably have enrolled at a higher rate, and some who change employers and are being auto-enrolled at a “start over” rate. In most cases the default contribution rate isn’t changed (by the employer, and certainly not by the participant), and auto-enrollment is still (mostly) limited to new hires.

What’s wrong with automatic enrollment? Nothing, once we remember that it’s (only) an effective starting point – and one that, like most good decisions, requires some follow-up.

- Nevin E. Adams, JD

See also, 3 Things You Should Know About Automatic Enrollment. And for some caveats on automatic enrollment, see Why the ‘Ideal’ Plan Isn’t.

3 Things You Should Know About Automatic Enrollment

One of the most celebrated plan design features of the 401(k) era is automatic enrollment. Nearly as old as the 401(k) itself, once upon a time it was called a “negative election.” But regardless of the name, the concept has been extraordinarily effective at not only getting, but keeping, workers saving via their workplace retirement plans.

However, adoption of the design, after a surge in the wake of the passage of the Pension Protection Act of 2006, now seems to have plateaued. Moreover, current data suggests that, while automatic enrollment adoption has certainly had a positive impact on retirement outcomes, we’re not getting as much mileage from it as we might.

So, here are three things that plan sponsors — and others — should know about automatic enrollment.

1. You don’t have to default contributions at 3%.

Three percent was the standard default contribution rate for automatic enrollment plans long before the Pension Protection Act of 2006 incorporated it as part of its auto-enroll safe harbor. Originally cited in a now-obscure IRS regulation years before the advent of the PPA, in the years to follow, it was largely embraced because it was seen as little enough that it wouldn’t spur massive opt-outs by automatically enrolled participants.

With more than a couple of decades of experience under our belts (a third of that under the auspices of the PPA), we know a couple of things. First, that 3% is indeed too small an amount to spur most auto-enrollees to opt out. In fact, there have been any number of studies — and some real-world experience — suggesting that a defaulted contribution rate twice as high would produce very nearly the same result.

What many plan sponsors may not know is that while that the auto-enrollment safe harbor of the PPA calls for a minimum starting deferral of 3%, it is a floor, not a ceiling.

But another, and more important, thing that we’ve all known from the very beginning is that a 3% rate of deferral is not enough.

2. If you are going to default at 3%, make sure you accelerate the contribution rate.

Automatic enrollment and contribution acceleration have always been separate things: the former a decision made by the plan sponsor, with the participant having the ability to opt-out; the latter a voluntary decision by the participant, facilitated by the plan sponsor.

These two traditionally separate concepts were wedded in the PPA’s automatic enrollment safe harbor, and for a very sound reason: As noted above, a 3% deferral is not enough.

Current survey data suggests that plan sponsors continue to separate these two design choices, and that tells me two things: 

• most plan sponsors who adopt automatic enrollment designs aren’t doing so with an eye toward taking advantage of the PPA safe harbor; and
• while many plan sponsors are willing to make one monetary decision on behalf of their workers, they apparently aren’t nearly as willing to make two, however integral it might be to retirement security. 

3. Automatic enrollment isn’t just for new hires.

Despite our extended history with automatic enrollment, and the PPA’s safe harbor that contemplates its extension to all eligible workers, to date most plans — roughly two-thirds — that have adopted automatic enrollment have done so only for new hires. Over the years, I have heard a variety of explanations for this trend — anything from a hesitation to “suddenly” take contributions from long-time workers (who have ostensibly declined to take advantage of previous opportunities to join) to a general resistance to running the risk of stirring up trouble with existing workers.

However, to me, the most logical explanation is economic: Just take the likely increase in participation rate (generally from 70% to 95% or so) resulting from automatic enrollment, and then figure out the increase in matching dollars that would result, particularly for an employee population that is likely more tenured and highly compensated.

Little wonder that so many decide to “let sleeping dogs lie.” Though in all my years of experience working with 401(k) plans, I have never heard of even a single participant who objected to being automatically enrolled. On the other hand, I’ve heard dozens of stories of long-tenured workers who had, for a variety of reasons, put off signing up for their 401(k) — but who, when they finally were enrolled, were oh-so-very-grateful for that “start,” however delayed.

And that, perhaps as much as anything else, is something plan sponsors should know.

- Nevin E. Adams, JD

"Left" Overs

On more than a few occasions in my youth, I would misplace some object of importance. Generally it was just something I set aside for just a moment in pursuit of some more interesting endeavor—and sometimes it was something I set down and forgot about until much later.

Regardless, being unsuccessful in locating the object, I was frequently inclined to suspect that the culprit responsible for the disappearance was my mother, who—as mothers do, spent more than a little of her existence picking up objects that had been left unattended in unsuitable places. There were, however, times when she had played no role in the “disappearance,” and she’d admonish me to look more diligently—that “it didn’t just get up and walk away on its own…”

Now, while there were times when I was certain that the object in question had done just that, once I was able to retrace my steps, to recall where I had been and when—and, inevitably, there it was.
That said, I wasn’t always happy to find things where I left them; comic books don’t hold up well in the rain, for instance, and fragile objects left in the reach of younger siblings (or pets) can have a frustratingly short shelf life.

Retirement plan sponsors, and those who support their efforts, have worked long and hard to engage participants with the management and oversight of their retirement plan balances, with mixed results. However, even the most engaged participants seem to struggle to find the time, inclination, or discipline to revisit those initial investment choices, much less to do so at the appropriate times. In fact, left to their own devices, it’s likely that many—perhaps most—retirement plan participants looking to see how their balances are invested would find them right where they “left” them at that initial enrollment meeting (though with proportions shifted by the markets in the interim).

Enter the target-date fund (TDF), a type of investment fund apportioned according to what investment professionals deem to be an appropriate age-based blend of stocks, bonds, and other asset classes for an individual within a particular target date of his or her retirement.

Though their mark was being made prior to the sanction of the design as a qualified default investment alternative (QDIA) in the Pension Protection Act of 2006, target-date fund availability and usage have soared along with the ensuing expanded adoption of automatic enrollment. Indeed, nearly three-quarters (72 percent) of 401(k) plans in the EBRI/ICI 401(k) database included target-date funds in their investment lineup at year-end 2012, and 41 percent of the roughly 24 million 401(k) participants in that database held target-date funds. Among participants who were offered target-date funds as a plan option, 60 percent held them at year-end 2012, and target-date fund assets represented 22 percent of the assets of plans offering such funds in their investment lineups.

Reflecting the growing popularity of automatic enrollment, at year-end 2012, nearly 54 percent of the account balances of recently hired participants in their 20s were in balanced funds (a significant subset of which is in target-date funds), compared with 7 percent in 1998. Moreover, at year-end 2012, 43 percent of the account balances of recently hired participants in their 20s were invested in target-date funds, compared with 40 percent at year-end 2011.

The impact of these shifts, chronicled in the extensive EBRI/ICI 401(k) database, is already manifested in the increasingly diversified portfolios of newer hires and younger participants. Beyond that initial allocation decision, the TDF design incorporates an ongoing rebalancing over time, one that shifts the underlying portfolios such that they are less focused on growth and more focused on income over time—a rebalancing that occurs automatically, and without requiring the input or involvement of the participant-investor.

That is likely to have a significant impact over time, because with retirement investments, as with life, we often plan to come back and revisit our choices more often than time (or life) allows.

Nevin E. Adams, JD

“401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2012” is available online here.
In 2011, an EBRI Issue Brief provided an informative examination of the use of target-date funds (TDFs) by a consistent group of 401(k) participants in plans that offered them in 2007 through 2009. See “Target-Date Fund Use in 401(k) Plans and the Persistence of Their Use, 2007–2009,” online here.

"Freedom" From Choice?

You may remember little else about the 1989 film “Field of Dreams,” but odds are you have invoked a version of what is likely its most famous quote, “If you build it, they will come.”

Unfortunately, for many, building retirement savings is more complicated than constructing a baseball diamond in the middle of an Iowa cornfield. Most experts will tell you that the most important decision in retirement saving is deciding how much to save, not how those savings will be invested―and yet, for years, much of the education and discussion about retirement saving has been focused on investing.

Enter the target-date fund (TDF), a type of investment fund apportioned according to what investment professionals deem to be an appropriate age-based blend of stocks, bonds, and other asset classes for an individual within a particular target-date of his or her retirement. Perhaps more importantly, that apportioning is automatically rebalanced over time, as the target date approaches, becoming less focused on growth and more focused on income over time. It’s an approach to which individuals and plan sponsors alike have come to embrace with little of the reluctance that often accompanies new retirement plan designs; one that runs counter to decades of expanding retirement plan menus and education designed to help participants make better use of those choices.

Consider that 72 percent of the more than 64,000 401(k) plans in the EBRI/401(k) database, included target-date funds in their investment lineup at year-end 2011,¹ and that nearly 4 in 10 of the nearly 24 million participants in that database held target-date funds.² That’s sharply higher than 2006, the year that the Pension Protection Act of 2006 included target-date funds in its definition of qualified default investment alternatives (QDIA), when about 57 percent of plans included those offerings on their menus, and fewer than 1 in 5 participants held them in their account(s). Perhaps more significantly, at year-end 2011, 51 percent of participants in their 20s held target-date funds, compared with 32 percent of participants in their 60s.

Recently hired participants―those more likely to be automatically enrolled in their employment-based 401(k), and to have their savings automatically invested in a QDIA (frequently a target-date fund), were, not surprisingly, more likely to hold target-date funds than those with more years on the job: At year-end 2011, 51 percent of participants with two or fewer years of tenure held target-date funds, compared with 37 percent of participants with more than five to 10 years.

In fact, an August 2011 EBRI Issue Brief noted that, among consistent participants in the EBRI/ICI database who were identified as auto-enrollees in 2007, 97.2 percent were still using TDFs in 2008, and 95.7 percent used them in 2008 and 2009. Even among those not identified as auto-enrollees, just over 90 percent continued to use them from 2007‒2009 (see “Target-Date Fund Use in 401(k) Plans and the Persistence of Their Use, 2007‒2009,” online here).

Now, one can find fault with the target-date design: There are different views on what is an “appropriate” asset allocation at a particular point in time; discrete perspectives as to what asset classes belong in the mix; notions that individuals aren’t well-served by a mix that disregards individual risk tolerances; arguments over the definition of a TDF “glide path” as the investments automatically rebalance over time; and even disagreement as to whether the fund’s target-date is an end-point, or simply a milepost along the investment cycle. That said, and as the EBRI/ICI data show, target-date funds, as well as their older counterparts, the lifecycle (risk-based) and balanced fund(s), have become fixtures on the defined contribution investment menu. For a large and growing number of individuals, these “all-in-one” target-date funds, monitored by plan fiduciaries and those that guide them, are likely to be an important aspect of building their retirement future.

Of course, the future they’ll build will likely be better if those investments are properly used, carefully monitored, better understood―and funded by the appropriate amount of savings.


Nevin E. Adams, JD

¹ See “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011,” online here.

² In addition, 20 percent of the participants in the EBRI/ICI 401(k) database held non–target-date balanced funds, and 3 percent held both target-date and non-target-date balanced funds at year-end 2011.

Starting (Over) Points

Earlier this week, an EBRI research report quantified the financial impact of setting a higher starting point for 401(k) default contributions—and it can be significant.

Most private-sector employers that automatically enroll their 401(k) participants do so at a default rate of 3 percent of pay,(1) a level consistent with the starting rate set out in the Pension Protection Act of 2006 as part of its automatic enrollment safe harbor provisions—but it’s a rate that many financial experts acknowledge is far too low to generate sufficient assets for a comfortable retirement.

EBRI has previously modeled the impact of automatic enrollment(2) (see “The Impact of Automatic Enrollment in 401(k) Plans on Future Retirement Accumulations: A Simulation Study Based on Plan Design Modifications of Large Plan Sponsors,” online here). In the most recent research, using EBRI’s proprietary Retirement Security Projection Model® (RSPM), the impact of raising the default contribution rate to 6 percent for younger workers (who might have 31–40 years of simulated 401(k) eligibility) in plans with automatic enrollment and automatic escalation was evaluated to see how many would be likely to achieve a total income real replacement rate of 80 percent at retirement.

As noted earlier, the higher starting default made a significant impact; more than a quarter of those in the lowest-income quartile who had previously NOT been simulated to have reached the initial replacement rate target (under the actual default contribution rates) would reach the target as a result of the increase in raising the starting deferral rate to 6 percent of compensation. Even those in the highest-income quartile would benefit, although not as much.(3)

But what about when those workers change jobs: Would they “start over” at the new employer’s starting default rate, or would they “remember” and carry their higher rate of savings at their prior employer into the new plan? The modeling actually looked at both those scenarios,(4) and found that 15–26 percent of the lowest-income quartile that would otherwise not have reached the target threshold under their existing plan-specific deferral rates would now do so at the 6 percent level, as would 13–22 percent of those in the highest-income quartile.

In life, “starting over” can be a painful, awkward process, as anyone who’s restarted a career or home can attest. But, depending on where you are starting from—and what kind of start you make—it can also be an opportunity.

- Nevin E. Adams, JD

(1) Which, it should be noted, also contemplates an annual 1 percent automatic escalation of that starting rate, up to a designated level. Neither the automatic enrollment nor automatic escalation provisions are mandated by the legislation, unless the plan sponsor wants to take advantage of the PPA safe harbor protections.

(2) One point that had been made clear in previous research was that some workers who were defaulted into a 401(k) auto-enrollment (AE) plan (without auto-escalation provisions) would continue to contribute at the defaulted contribution rate chosen, typically in the range of 3 percent of compensation. Traditionally, and in the absence of these AE provisions, many workers eligible for workplace retirement savings plans have voluntarily elected to start contributing at a 6 percent rate (a point commonly associated with the level of matching contribution incentive provided by employers). However, some participants in AE plans—who otherwise might have voluntarily chosen to participate at a higher contribution level—instead might simply allow their savings to start (and remain) at the default rate. As a result, they were likely contributing at a lower rate than if they had been working for a plan sponsor offering a voluntary enrollment (VE) 401(k) plan AND had made a positive election to participate.

(3) The modeling assumed actual plan-specific default contribution rates with (1) an automatic annual deferral escalation of 1 percent of compensation; (2) that employees opted out of that auto-escalation at the self-reported rates from the 2007 Retirement Confidence Survey findings; (3) that they “started over” at the plan’s default rate when they changed jobs and began participation in a new plan; and (4) that the plan imposed a 15 percent cap on employee contributions.

(4) Among other criteria, the modeling also considered auto escalation rates of 1 percent and 2 percent.

Underlying Assumptions

Last week the Government Accountability Office (GAO) issued two reports focused on 401(k) plans: one on target-date funds, the other on potential conflicts of interest. As seems to be its custom in such reports, the GAO communicates its conclusion in the titles: “Key Information on Target Date Funds as Default Investments Should Be Provided to Plan Sponsors and Participants” and “Improved Regulation Could Better Protect Participants from Conflicts of Interest”—and, IMHO, there’s little controversy in those statements.

The reports themselves offer a great informational primer on target-date fund designs and issues (you’d be surprised how many plan sponsors still don’t quite grasp the concept of “glide path”) as well as the fee structures and revenue-sharing components that underlie the 401(k) retirement savings system. Both reports acknowledge that efforts are already under way to remedy the shortfalls the reports identified in both, while at the same time promoting solutions to those shortfalls that may not be cost/impact-justified.

As you peruse the target-date fund report (see “GAO Urges More Help with TDFs for Plan Sponsors”), you’re struck once again by the wide variety of answers to the question, “What is an appropriate asset allocation for participants at retirement age?” much less the assumptions that underpin it. One might well expect to find different assumptions regarding the markets, investment classes, and how the latter will respond to the former over the course of decades—and, in fact, these assumptions lie at the core of the target-date fund glide path and design. One might well expect (though many apparently didn’t) that those differences of opinion would translate into very real differences in asset allocation, even at retirement age.


There are, however, assumptions imbedded in these TDF approaches that, IMHO, are not nearly as well-communicated and/or understood by plan sponsors; assumptions that are predicated on certain participant behaviors that, in the words of the GAO report, “may not match what many participants actually do.” There is the assumption about what participants will do at the target date—either transfer those assets to another vehicle or retain their investment in the TDF.

This, of course, is the essence of the “to versus through” debate that has, since the 2008 financial crisis, drawn increasing scrutiny, if only because, IMHO, most plan sponsors (and plan participants) assumed that their target-date fund investment was designed to take them TO that date, not beyond it. Of course, that assumption bears within it another assumption: that the participant has managed to achieve a certain level of savings accumulation. Many haven’t, of course, and this knowledge underlies the assumption of those who employ the “through” approach to TDF designs, assuming that a longer equity exposure will serve to shore up that shortfall. Which, by the way, is another assumption imbedded in the “through” designs—that the participant will leave the money invested in that TDF (if not the plan itself) past their projected date of retirement.

Moreover, even the “to” TDF camp tends to assume that participants will buy an annuity at retirement, though they frequently don’t.

The GAO report noted that each of the eight TDF managers it contacted “considered contribution rates in establishing its asset allocation strategy,” noting that “some explicitly noted that these assumptions did not match the general pattern of contribution rates.” It will surprise few to learn that their assumptions were generally higher, but that they “hoped that rates will increase as workers adjust to DC plans serving as the sole employer-based retirement account,” according to the GAO report.

And, of course, since a growing number of participants were defaulted into TDFs to begin with, nobody has any real idea if they will behave the way participants have historically or not.

That said, the GAO has recommended that the Employee Benefits Security Administration (EBSA) (1) amend the QDIA regulations such that fiduciaries are required to document whether factors beyond age or retirement date are relevant, (2) provide guidance to plan fiduciaries on the limitations of benchmarks on those funds, and (3) expand participant TDF disclosures to provide information regarding the assumptions concerning participant contribution and withdrawal intentions. EBSA was at least open to the first two (though not commenting directly, since they are currently in the process of recrafting those regulations), though it resisted the last as being a “very complicated and subjective undertaking which could affect a plan sponsor’s decision to offer any target date fund option(s),” according to EBSA’s response to the GAO report.

But, IMHO, if that gives a plan sponsor pause in offering a particular option—well, perhaps it should.


—Nevin E, Adams, JD

See also “IMHO: When You Assume…”

The GAO target-date fund report is at http://www.gao.gov/new.items/d11118.pdf

Decision Decisions

As a parent, you spend a lot of time telling your kids what to do, and perhaps more time than you think you should convincing them that it was their idea. If you’re lucky, you get to watch them make the “right” choices on their own—and to see them turn out well in the end. What you really try to avoid doing, certainly as they enter adulthood, is to make those decisions for them.

With defined contribution plans, over the last three decades or so, mostly we told workers what to do (or at least what people very much like them should do). And, despite a lot of hand-wringing to the contrary, most did. There were, of course, “holdouts”—a stubborn and/or inattentive group that resisted those entreaties, at least up until the point at which we did the right thing “for” them by automatically enrolling them in these programs. One might have thought that their resistance was thoughtful, perhaps principled, and maybe economic—and yet, survey after survey shows that those who were defaulted in stayed there. Were they lazy, afraid to make the wrong decision, unable to make any decision, or merely inattentive? Perhaps all of the above. Regardless, the debate about whether we should “impose” on them our sense of the right thing to do—to make that decision for the “recalcitrant” minority—would seem to be over.

The New Frontier

The new frontier in participant decision-making appears to be retirement income or, more precisely, helping individuals make arrangements for a suitable stream of income post-retirement. There is a general—and perhaps increasingly pervasive—sense that the solution to this challenge is already at hand (or could be with a tweak here and there): the annuity.

That assumption was in evidence last week at a presentation by a panel of behavioral finance academics at an event sponsored by Allianz (1). As part of its response to the Labor Department’s RFI on retirement income, Allianz had worked with the inimitable Schlomo Benartzi to assimilate a wide range of behavioral finance techniques to better understand participants’ reluctance to embrace annuities (at least in large numbers), and to help remedy “the annuity puzzle” (yes, it even has a name, apparently). Certainly from an academic perspective, there is no valid reason why an individual seeking a dependable stream of income in retirement wouldn’t take advantage of a product that purports to do just that. And yet, in the “real” world, individuals continue to defy those expectations.

All of which, to my ears, began to beg the question, Should we be helping participants to do the “right” thing about retirement income, as we did about retirement plan enrollment? Should we be making that decision for them as well?

It is an idea that is already “out there,” and one that seems of interest to the Obama Administration. Certainly there is a concern that many take their multiple defined contribution distributions between “now” and whenever retirement finally occurs in cash and deploy them for purposes other than retirement. This “leakage” from the system almost certainly depletes the accumulative effect of retirement savings for many younger and lower-income workers, leaving them to literally start over at their next place of employment (there is some evidence that larger balances accumulated by older workers are more routinely rolled over into tax-advantaged vehicles such as an IRA).

Which again leads one to ask, what WOULD be the harm in letting a default mechanism make the “right” decision for them, certainly so long as they could opt out? Hasn’t our experience with automatic enrollment shown not only that people are willing to let good decisions be made for them, but that they appreciate it as well?

We once resisted automatic enrollment as a design choice for reasons that seemed just as daunting: We didn’t know the “right” deferral percentage, weren’t sure how it should be invested, worried that it would lose value between the time it was withheld and (potentially) returned, and were bothered by the potential conflicts between state wage law and federal directives. The Pension Protection Act effectively resolved those issues, provided a structure for a valuable safe harbor protection, and yet managed to avoid mandating its approach. As a result, it’s more likely than ever that more savers will have more savings to manage at retirement, perhaps for longer in retirement, than would otherwise be the case.

Now, for most situations at present, the retirement income amounts involved may well be too small, the products available too expensive and/or complicated, the protections for employers and participants alike too vague, the portability and/or access to the funds frustratingly problematic. And, let’s face it: Current annuity designs (2) don’t really come in a convenient “trial size.”

Still, IMHO, we need to focus on creating workable, sound default decisions—because the alternative for many until we do will be making decisions by default.


—Nevin E. Adams, JD

(1)All in all, it was a fascinating presentation, and the report summary that accompanied it is well worth a read (see “Annuities Get a Behavioral Finance Makeover” ). Those reports included notions that workers, and especially older workers, pay too much attention to recent stock market movements, suffer from a “hyper” aversion to risk, and, after their mid-50s supposedly have a particularly tough time making complex financial decisions. All of which purported to explain not only why workers don’t make good investing decisions at retirement, but perhaps even to suggest that they wouldn’t want to (ironically, one study indicated that, given the opportunity to make an active decision to purchase an annuity, a surprisingly robust 49% did).

(2)For the record, I’ve no particular affinity for the annuity concept per se vis-à-vis an alternative that provides the reliable stream of income at retirement for a reasonable price, and no reason to think that an adviser-led participant solution couldn’t compete very effectively with an annuity, much as an adviser-led investment program can do as well (and perhaps better) as a qualified default investment alternative. Of course, every participant doesn’t have access to an adviser, and many don’t have accounts large enough to warrant those attentions—and we need solutions for those participants as well.