‘Staying’ Power

  For years now, I’ve been saying that the only thing wrong with the 401(k) system is that there aren’t enough of them. And to be fair, the past several years have largely validated that view.

Indeed, Vanguard’s latest How America Saves report paints what is, on the surface anyway, a remarkably encouraging picture. Participation rates among eligible workers are near record highs. Contribution rates rose — 45% of participants increased their savings rate in 2025, contributing to an average savings rate of 12.1%, an all-time high. Professionally managed investments dominate participant portfolios. Most investors ignored market volatility entirely — and, doubtless as a result of all that — account balances reached new highs.

Yes, after decades spent worrying about employees failing to enroll, hunkering down in stable value funds, or panic-trading during downturns, the modern defined contribution system increasingly appears to be functioning as designed — or, as Vanguard labels it — a “quiet retirement revolution.”

But another recent study suggests that the industry may be misunderstanding what “success” actually looks like.

Morningstar’s paper, Access, Auto-Enrollment, and Accumulation: A Simulation of Universal Retirement Plan Coverage, modeled the impact of automatically enrolling workers without retirement plan access into a federally administered savings arrangement. The results are impressive. Tens of millions of additional workers could enter the retirement system. Hundreds of billions — perhaps more than a trillion dollars — in additional retirement savings could accumulate over time.

But buried deeper in the analysis is a more revealing point — the real breakthrough in retirement outcomes may not be access.

ad space

It may be continuity.

The Vanguard report and the Morningstar study actually tell a surprisingly consistent story when viewed together. While Vanguard shows a system increasingly optimized around automation and default behaviors, Morningstar shows that the outcomes of even the best-designed system can be undermined if workers cannot remain continuously connected to savings long enough for compounding to matter.

And that matters. Big time. Particularly in view of the workers most vulnerable to those employment “disconnects;” lower-paid, minorities, women, the young…

Let’s face it. The retirement industry has spent much of the last two decades trying to solve the participation problem. In many respects, it has succeeded. Automatic enrollment, automatic escalation, target-date funds, managed accounts, and payroll deduction have fundamentally changed participant behavior — or perhaps more accurately, reduced the need for participant behavior altogether.

More recently, the focus has shifted toward expanding access to workplace programs — reinforcing how strongly availability, combined with automation, improves savings outcomes — even for workers with modest incomes.

But the Morningstar analysis highlights that workers with long periods of uninterrupted participation saw dramatically larger projected gains than workers with shorter or fragmented savings histories. Automatic enrollment helped. Higher default contribution rates helped somewhat. But it was remaining attached to the system through job changes, financial emergencies, and career transitions — that mattered more than almost anything else. “Workers with 10+ years of sustained participation could see 67% to 125% higher retirement wealth under auto‑enrollment scenarios,” according to the report.

ad space

Leakage remains stubbornly high. The number, if not the amount, of hardship withdrawals continues to rise. Cash-outs during job transitions remain common — most particularly in situations where a participant loan is outstanding. Vanguard’s data itself hints at this tension: record balances existing alongside increasing hardship withdrawals. The system has become exceptionally good at getting money into retirement accounts — but still struggles to keep it there when life intervenes.

In other words, the retirement system may be healthier than it has ever been structurally — while on an individual basis many retirement savers remain financially fragile.

That tension becomes even more apparent when looking at which workers benefit most from expanded access proposals. Morningstar found the largest projected gains among lower-income households, younger workers, single women, Hispanic workers, and Black workers — populations historically less likely to have access to employer-sponsored plans.

For years, the policy focus has centered on access: state auto-IRAs, SECURE Act mandates, automatic enrollment requirements, and proposals to expand coverage. Those initiatives matter. They clearly move the needle — and will continue to do so.

But the future success of the defined contribution system may depend less on whether workers can open an account — and more on whether they can stay invested long enough for the system to work as intended.

• Nevin E. Adams, JD

Retirement Income, Defaults and Fiduciary Duty

 I will confess that I am (still) of a mixed mind on imbedding retirement income solutions in 401(k) plans — and a new whitepaper on the implications of the new Investment Selection rule has done little to assuage those concerns.

The Morningstar paper — aptly titled “Guaranteed Income in DC Plans: Evaluating Target-Date Funds with Built-In Annuities” — covers a lot of ground. That said, more than half the paper is background[i] — chronicling both the trend lines to date, as well as offering a readable description of the two primary types of retirement income options that have found their way into the target-date fund framework (and yes, they’re quite different!). Those trendlines have captured the attention (and doubtless recirculation) of the paper, particularly among proponents.

But the “meat” of the paper considers the implicatio
ns of applying the Labor Department’s “new” Investment Selection Rule (though its official label at present remains “Fiduciary Duties in Selecting Designated Investment Alternatives”), and its list of six factors fiduciaries are charged with applying in their consideration(s) of all participant-directed choices[ii] on their retirement plan menu — at least if they expect to benefit from the presumption of prudence the Labor Department proposes to invoke in what it at least calls a “safe” harbor.

Factors Focus

And while those six factors — fees, complexity, performance, benchmarking, liquidity, and valuation — are to be broadly applied under the proposal, much (most? All?) of the coverage and discussion to date has been about the application of the Labor Department’s proposal to private markets, cryptocurrency, and the like. That said, this paper thoughtfully reminds us that retirement income option(s) require careful consideration as well.

Not to blend the first two, but fees on these retirement income offerings are definitely “complicated.” They’re higher than the other components of the target-date fund — the question is, what is the commensurate value? Their addition to the target-date fund definitely also adds mechanical complexity, certainly at the participant level (presumably the default facilitates adoption, but at some point, the participant has to “deal” with the reality).

As for performance — well, as the paper acknowledges, “Evaluating these products’ performance requires accepting upfront that forecasting is hard.” Ditto benchmarking, for much the same consideration. “Participants receiving guaranteed income through a GLWB or income annuity are benefiting from something traditional performance comparisons do not capture,” according to the authors. “This is where the Department of Labor’s emphasis on meaningful benchmarks becomes especially challenging for these products.” 

ad space

And then there’s liquidity and valuation — which are one thing at a plan level, and potentially something quite different at the participant level. Oh, and the authors add a seventh factor; financial strength and the insurer’s credit rating — which while the SECURE Act may well provide helpful guidance there, those factors certainly bear additional, thoughtful consideration — and I would argue particularly so in a default fund scenario.

Complicate ‘Ed’

The paper itself is undeniably positive[iii] in its assessment of the need for, and the opportunities with, these solutions. It not only reviews the growing number of target-date structures incorporating guaranteed income components, it also outlines the potential behavioral and longevity-risk benefits of annuities.

But in my reading, the analysis is far more “nuanced.” Indeed, much of the paper reads like a litany of unresolved complications:

• Different annuity structures behave very differently.
• Fees and guarantees can be difficult to evaluate.
• Liquidity tradeoffs remain significant.
• Portability remains a significant concern — people change jobs, plan sponsors change recordkeepers, recordkeepers get acquired, insurers merge, and rollovers are complicated enough already.
• Participant understanding is limited — to say the least. Much less the understanding of the plan fiduciaries (and advisors) considering these options.

Little wonder that current adoption remains fairly muted despite years of industry attention and encouragement.

Proponents would, and have of course, argued that defaulting participants into these structures merely applies the same behavioral-finance principles that helped positively drive participation and savings rates higher.

If these structures were a straightforward solution, adoption likely would have moved beyond niche implementation by now. Instead, the industry continues searching for a retirement-income framework that participants will understand, fiduciaries will accept, and recordkeeping systems can realistically support — or at least one that can be slipped into a target-date offering that has already passed those tests.

ad space

And while it remains just a proposal at this point, the Morningstar analysis suggests that applying the Labor Department's proposed framework to retirement-income solutions may rightly prove to be more challenging than applying it to traditional investment options.

The challenge is that retirement-income products are not merely investments with different return characteristics; they are insurance structures layered into investment vehicles. That distinction may ultimately require a different fiduciary lens altogether.

And whether the required analysis produces better fiduciary decisions — or simply more complexity — remains to be seen.

• Nevin E. Adams, JD

 

---

[i] In fairness, a full quarter of the 13-page paper is devoted to disclosures/disclaimers.

[ii] Lifetime income options were one of the categories of investment alternatives named in President Trump’s August 2025 Executive Order (even if most wouldn’t be inclined to include them in that category).

[iii] In one executive summary bullet, it’s noted that assets in target-date strategies that include an annuity component for lifetime income grew to $44 billion at the end of March 2026, up from $25 billion a year earlier. However, in a separate bullet it’s acknowledged that “so far, growth has been driven by two series: BlackRock LifePath Paycheck (USD 26 billion in assets at the end of March) and custom target-date AB Lifetime Income (USD 14 billion).” So, $40 billion of the $44 billion in just those two.

Managed Accounts — It’s Not (Just) the Allocation

 Managed accounts have been praised, criticized, and litigated — often on the theory that they’re little more than expensive target-date funds. However, a recent report actually quantifies their impact — and turns out, it’s not an investment story, it’s behavioral.

That report — inauspiciously titled “The 2026 Managed Accounts Research Series: Analyzing the Value of Managed Accounts” — was published in mid-January by Morningstar. Of course, Morningstar has a fair amount of “skin” in the managed account space — a reason, if you will, to find a favorable outcome for the design. 

And, sure enough, the analysis claims that managed accounts outperform target-date funds and the efforts of so-called “do-it-yourself” investors for — well, everyone. More specifically, the report claims that MAs increase the median wealth/salary ratio at age 65 by 5.9% for TDF investors and by 11.4% for DIY investors. Across all plan participants, adopting an MA led to an overall increase of 7.7%. Oh, and it does even better for younger participants, and lower-income individuals.

At this point, my natural cynicism kicked in — though based on my personal and significant experience working with Jack VanDerhei, one of the coauthors, over a period of decades during his long-standing tenure at the Employee Benefit Research Institute (EBRI) — well, let’s just say if Jack says something is “so,” I tend to believe him.

Following the report publication, I had an opportunity to talk with Jack (and Spencer Look, his collaborator in this effort) to better understand their model. For those who haven’t stumbled across the report, they take a significant database of actual 401(k) plan balances and activity and apply sophisticated statistical behavioral modeling techniques to project long-term outcomes based on various assumptions. While it’s not unusual for researchers to deploy statistical modelling, most suffer from a lack of actual data, not only as a baseline, but as a behavioral predictor. Which, I should add, explains (to me, anyway) why the results often don’t match up with how real people respond/react in the real world. 

All that said, this kind of modelling is also dependent on the quality of the underlying assumptions — and here none is perhaps more focused on than cost. Here the assumptions are 40 basis points cost for managed accounts (plus another 31 basis points in fund fees), 30 basis points for target-date funds, and 73 basis points for the DIY group.  Don’t like those assumptions? VanDerhei is willing to plug in different numbers.

ad space

I also questioned whether it makes sense to model “managed accounts” generically, given the wide variation in personalization, design, and cost. Look explained that their review of roughly half a dozen managed account structures — including but not limited to Morningstar’s — showed sufficient similarity to support a generalized model. The same held true for target-date funds.

But here is the part that matters.

As important as factors like cost and asset allocation (not to mention the cost of asset allocation) are to outcomes, the report acknowledges that “…higher contribution rates are the primary driver.” The researchers further note that, “based on our analysis of the empirical data, MA users consistently save more than TDF or DIY investors, even after controlling for age, wage, tenure, and plan design features” — a pattern they say “…suggests that personalized savings-rate recommendations[i] embedded within MAs play a key role in encouraging higher savings rates.” 

While you have to go to page seven of the 19-page report to find that,[ii] to my eyes, it is the most important sentence in it.

Now, I’ve long said that while we talk about “managed accounts” as though they are a monolithic concept, they are not. There are different — in some cases, widely different — levels of personalization deployed — variations in cost and construct. Anyone who ignores these potential underlying differences in application is missing the point. 

I will admit that in considering the value of managed accounts, I had — perhaps as many of you — tended to focus more on the differences in asset allocation that might be possible if we knew more than projected retirement date — not to mention variation in the underlying costs. What I had not factored in was what the Morningstar researchers have — the application of personalization to influence and impact savings rates. 

ad space

If managed accounts meaningfully increase savings rates — not just tweak allocations — that changes the fiduciary conversation entirely.

Because better investing matters. But saving more matters more.

• Nevin E. Adams, JD

 

---

[i] It’s worth noting here that the impact is smaller, but still positive, for AE with escalation plans, with TDF investors seeing an increase of 2.7% and DIY investors seeing an increase of 7.8%. Moreover, approximately 92% of AE plans with auto-escalation show an improvement in the median projected retirement wealth for TDF investors under the MA scenario. In other words, while automated increases in salary deferrals help, those timed and personalized via the managed account platforms provide a superior result.

[ii] It IS, however, right there with the first findings. Apparently, the folks who created the executive summary didn’t view it as being as significant as I did.

What If There Was No ERISA?

 New research puts a new twist on “A Wonderful Life” – answering the question, what if there hadn’t been an ERISA?

ERISA is, of course, the Employee Retirement Income Security Act of 1974 which just turned 50. The analysis[i] – put together by Morningstar Retirement’s Director of Retirement Studies Jack VanDerhei and Associate Director of Retirement Studies Spencer Look – first looks at the current “status quo” retirement readiness impact (more specifically, retirement readiness shortfalls). It then looks at the potential result if there had been no ERISA – or, perhaps more precisely if there had been no individual account retirement plans (defined contribution and IRAs), though allowance was made for the probability of saving to an IRA. 

Now, anyone with a realistic assessment/awareness of the limited availability of traditional pension plans in the private sector (before AND after ERISA’s passage) can hardly be surprised to find that the absence of individual accounts would have a significant negative impact. That said, you might be surprised at the size of that impact. 

The research notes that, when aggregated across all four income categories, the probability of Gen X households running short of money in retirement (granted, this is running short by as little as $1[ii]) would increase from 47% under the status quo to 59%. Millennials would fare worse, with the aggregate probability increasing from 44% to 69%, and Gen Z households would see their exposure soar from a risk of 37% in today’s environment to what the researchers termed a “devastating 72%” without individual account retirement plans. 

The paper also projects the outcomes across various income and education demographics, as well as industry, gender and race. To sum it up, single females, Hispanic Americans, and non-Hispanic Black Americans were found to be at a higher risk of retirement shortfalls. Needless to say perhaps – though the paper does – “[t]he elimination of DC participation and savings would drastically reduce the probability of a successful retirement, particularly for middle-income groups, as they heavily rely on these plans.”

Considering the positive impact of those individual accounts – albeit one limited by the status quo reality of access – it should come as no surprise that a projection that greatly broadens that access – alongside automatic enrollment and auto-escalation (as proscribed in the Automatic IRA Act of 2024) notably improves retirement prospects. Indeed, the researchers find that it could substantially improve retirement outcomes, with an aggregate average wealth ratio increase of 23.8% – and that’s assuming an opt-out rate of 30%![iii]   

All in all, just like good old George Bailey, it’s easy to underestimate the potential impact of the individual account regime that ERISA ultimately fostered – until you are able to imagine what things would be like without it. That said, this research affirms the positive impact – and puts some numbers behind it – while also affirming policy considerations for the future. 

Did I hear a bell ringing…

 - Nevin E. Adams, JD 

---

[i] With a title nearly as long as the paper itself “The Evolution of Retirement-Income Adequacy Under ERISA With a Focus on Defined-Contribution Plans: A Review of the Status Quo, Counterfactual Evidence, and an Analysis of Changes for the Future.”

[ii] Also worth noting, this analysis, unlike most other projection models – takes into account the potential impact of long-term care expenses.

[iii] Which turns out to be close, but less than opt-out rates in a number of the current state-run IRAs.

‘Damned’ (Even) If You Do

 The flurry of lawsuits unleashed on holders of the BlackRock LifePath target-date funds is not without precedent—but it’s surely a head scratcher.

I’m referring, of course, to the recent swarm of lawsuits challenging nearly a dozen of the nation’s largest 401(k) plans and their decision(s) to select, and hold, on their investment menu the BlackRock LifePath target-date fund suite. It’s a decision that the Shah Miller law firm (on behalf of multiple ex-participant plaintiffs) says was the result of fiduciaries who “chased low fees” over performance.[i]

Of course, it’s not unusual for these types of lawsuits cite obscure articles as authority, rely on Form 5500 data that often doesn’t tell the whole story, state as fact things that are really only theories (or opinions), lean on averages, or base comparative conclusions on surveys distorted by sampling size or content. 

But in a characterization straight out of George Orwell’s 1984, this one draws straight from a point of analysis that, to my eyes, anyway, seems to say one thing while the plaintiffs’ attorneys claim to see something completely the opposite. “War is peace,” if you will.

Setting aside for a minute the reality that performance isn’t necessarily indicative of an imprudent process[ii]—and that it’s been far more common over the past two decades for fiduciaries to be challenged on the allegedly “excessive” fees than performance (though the latter is often tagged on to the fee claim), the plaintiffs here have challenged the selection of a fund suite that Morningstar has identified as among the “best” in that category—run by an “innovative team with topnotch resources.”

Nor is the Morningstar evaluation irrelevant here—indeed, the plaintiffs lean heavily on it to draw their conclusions of poor performance, though they do so primarily by challenging the benchmark, insisting that the suite be benchmarked against other target-date suites—despite their striking difference in focus and glidepath. See, the BlackRock series operates with a “to” retirement date focus, rather than the “through” retirement focus that most others in this space have now embraced (and all of the ones the plaintiffs point to). That means, of course, that the asset allocation, certainly in the components nearing retirement age, are more conservative than those that are managing for 20-30 years beyond that. And—in bull markets, anyway—more conservative often means lower performance. On the other hand—and certainly if your goal is to wind down your investment risk as you approach retirement… and here one can’t help but remember 2008… (not to mention 2022…) 

Not that the BlackRock glidepaths are overly conservative—in fact, the Morningstar commentary (and the lawsuits that cite it) acknowledge that for newer target date funds—those for younger investors—BlackRock’s have tended to be more equity-laden, at least compared with those the plaintiffs would have serve as its benchmark. This lawsuits seem to mistake this difference for some kind of “equity discrepancy,” rather than a deliberate, thoughtful glidepath, one oriented to do what all target-date funds once claimed to—to move to more conservative asset allocations as one neared the target date (and, arguably still do, though the “throughs” have a different endpoint in mind). 

There is, of course, a certain tendency among plan fiduciaries to seek the comfort of the pack in making plan design and investment decisions—which is understandable when one considers the personal liability that comes with that assignment. But these suits seem to create a not-so-subtle inference that any glidepath that varies from the through retirement “pack” is going to be viewed as imprudent—not based on a bad or unreasoned theory, but rather based on a specific time window when certain strategies simply don’t match those of different philosophies. 

So, how is this particular approach constructed? The analysts at Morningstar see it this way: “This index-based series benefits from BlackRock’s robust approach to asset allocation and a research-intensive culture. They keep costs low by investing exclusively in passive index funds, though this gives management fewer tools to outperform over shorter periods compared with more active strategies that can tactically tilt the portfolio or select talented active managers. Yet, the team continues to innovate, with current research looking at ways to get targeted fixed-income exposures across the glide path.”

The report goes on to note that, “Continuing to revisit prior assumptions and make proactive changes that are backed by rigorous research gives us confidence that the team will continue to evolve the series over the long term to investors’ benefit.”

Little wonder then that the BlackRock suite winds up with a “gold” Morningstar Analyst rating. 

What’s harder to figure out is why the plaintiffs’ bar decided to take to task the large plans and plan fiduciaries that opted for this suite and approach. 

Well, perhaps except for the obvious.

- Nevin E. Adams, JD

---

[i] There were other allegations that varied with the plan targeted, but the LifePath funds and performance was the dominant claim.

[ii] At this juncture we have no way to know what processes, if any, the charged plan fiduciaries have in place to provide the prudent process and review required of plan fiduciaries—not that the plaintiffs have kept that from inferring its absence. 

Could ESG Options Undermine Participant Outcomes?

Despite surveys to the contrary, a new study finds that overall interest in ESG strategies by participants is “relatively weak” and “driven by naïve diversification.”

The difference may, of course, be attributed to the difference between what individuals say—and what they actually do. Unlike surveys that purport to capture participant (and plan sponsor) sentiments, the research by David Blanchett of PGIM and Zhikun Liu of the Employee Benefit Research Institute (EBRI) looks at the actual allocation decisions of 9,324[i] newly enrolled DC participants who are self-directing their accounts in a DC plan that offers at least one ESG fund. 

‘Weak Preferences’

They do so in a paper titled “ESG Fund Allocations Among New, Do-It-Yourself Defined Contribution Plan Participants,” they claim to find that overall interest in ESG strategies among these participants is “relatively weak,” with only 8.9% of participants having any allocation to an ESG fund and average allocations to ESG strategies of just 18.7% among those holding any ESG funds.[ii] Indeed, while they note “some clear demographic preferences for ESG funds (e.g., among younger participants with higher incomes),” they find that ESG allocations appear to be “primarily a function of weak preferences, driven by naïve diversification.”

Now, that hardly sounds like the heightened interest and engagement with those options that some participant surveys have captured (well, aside from that by younger participants with higher deferral rates and higher incomes). However, the research claims that the two factors which appeared to drive the largest allocations to ESG funds were not related to participant demographics, but rather the number of funds in the participant portfolio and the percentage of participants in the respective DC plan allocating to an ESG fund. 

If that seems a confusing descriptor, they found a “notable increase” in the probability of owning an ESG fund as the number of portfolio holdings increases—basically, the more funds the individual holds, the more likely he or she is to have an ESG offering among them. This tendency they characterized as attributable to “naïve diversification”—again, basically, if you’re simply picking a larger number of funds overall, then they concluded that the decision to allocate to the ESG fund is “likely based on a weak preference, not necessarily conviction in ESG.” Said another way, if you’re picking a lot of different funds, the more you pick, the better the odds that an ESG fund will (randomly) be among them.

On the other hand, those looking for a more optimistic future for ESG might take heart from their conclusion that “the fact ESG allocations increase as more participants in a plan allocate to ESG funds suggests plan interest effects could be an especially strong driver of future growth in ESG funds (despite relatively low usage today).” In fact, they noted a “notable plan interest effect, whereby ESG allocations are significantly higher in plans where general ESG usage is higher.”

Plan Sponsor Cautions

That said, the current decision-making by those participants appears to be “sub-optimal” (worse than you might expect) from a return standpoint—with the researchers here basically finding that participants who self-direct their portfolios have significantly lower expected returns than those using professionally managed investment options, such as target-date funds—something that proponents of professionally managed asset allocation solutions shouldn’t find surprising. To put it another way, those more likely to pick ESG funds are more likely to be the “do it yourself” (DIY) types—and those don’t do as well as those professionally managed solutions. This, as the researchers point out, can be an “important consideration for plan sponsors when adding ESG funds to the core menu to the extent they entice participants to self-direct their accounts.” So, adding an ESG fund might encourage more DIY investing by those interested in ESG—and that interest pulls them away from the professionally managed, higher-returning alternatives.   

In fact, an additional analysis suggests that those DIY participants have expected returns that are approximately 100 basis points lower than investors using professionally managed portfolios, such as target-date funds and managed accounts. And this, the researchers comment, suggests that adding ESG funds to core menus may create additional implicit return “costs” for participants—by adding those options that encourage participants to make choices other than professionally managed multi-asset options (e.g., target-date funds).[iii]

Overall, the researchers comment that their analysis paints a “mixed picture about the actual participant interest, and drivers of demand, for ESG funds in DC plans and suggests that plan sponsors should take a thoughtful approach when considering adding ESG funds to an existing core menu.”

Or—it seems fair to say—when adding (or subtracting) any funds at all.

- Nevin E. Adams, JD

---

[i] Of the 9,324 participants included in the dataset, only 833 had some allocation to an ESG fund, which is 8.9% of the total.

[ii] Among participants with an allocation to an ESG fund, the average allocation was 18.7%, with a standard deviation of 19.0%. The total average balance allocation to ESG funds is 1.7% (including all participants). There are only 56 participants (0.6% of the total) with ESG allocations greater than 50% of their balance and only 19 participants (0.2% of the total) with 100% of their balance in ESG funds. “In other words, even among participants who select the ESG funds, they almost always play a relatively supporting role as part of the overall portfolio.”

[iii] Some of the issues here are no doubt a consequence of current menu constructions. In the sampling studied, no plan offered more than five ESG funds, and the vast majority (approximately 76%) offered only one ESG fund. “This suggests it would be relatively difficult to build a diversified portfolio using only the ESG funds in DC plans currently,” the authors note. Moreover—and adding to the reality that it is “relatively difficult to build a truly diversified portfolio using only ESG funds”—they explain that roughly half of all ESG funds available are large blend funds. Only 13 of the funds (8.7% of the identifiable category total) are fixed income funds, and only 12 (8.1% of the identifiable total) are balanced funds. “The difficulty associated with building a diversified portfolio with only ESG funds has important implications on overall portfolio efficiency. If allocating to ESG funds requires participants to opt out of using a professionally managed portfolio option (e.g., target-date funds or retirement managed accounts), it may negatively impact future expected returns”—a cost the authors say they plan to quantify in a future work.

Is the Retirement System ‘Fragile’?

It’s not all about “the Benjamins,” but a recent analysis of the nation’s private retirement system certainly puts a lot of emphasis on the accumulation of aggregate assets in retirement plans.

The Morningstar report—“Retirement Plan Landscape Report, An In-Depth Look at the Trends and Forces Reshaping U.S. Retirement Plans”—is extraordinarily diverse and comprehensive[i] in its assessment—though while the report’s authors seemed to be striving for a balanced assessment, the overall sense was one of a leaky boat.

No Surprises 

There were some findings that seemed to surprise the authors that didn’t strike me as all that remarkable. Apparently (I hope you’re sitting down for this one) larger plans pay lower fees (expressed as basis points) than smaller plans. They are also more likely to invest in collective investment trusts (which tend to have lower fees, though that isn’t necessarily the case).

What I did find surprising was Morningstar’s assessment that those smaller plans pay, on average, “just” 88 basis points (compared to the 41 basis points estimated for larger plans)—indeed, I found both numbers pretty reassuring. On the other hand, “averages” can often obscure reality, and the authors also found that smaller plans also feature a much wider range of fees between plans—with roughly a third of those plans costing participants more than 100 basis points in total.

And make no mistake: Those higher fees are—literally—a “toll” on retirement. The Morningstar report says that two workers who save the same amount and invested the same way might well result in an individual who worked for a smaller employer (and who participated in a smaller plan) having 10% less in retirement savings. That’s a hefty price to pay—but then this is hardly the only area in life where larger purchasers are able to obtain a volume discount.

ESG ‘Risk’

There was also little surprise in the finding that “Plan sponsors appear to have shied away from considering environmental, social and governance (ESG) information and analysis, in part because of regulatory uncertainty.” Oddly, Morningstar’s analysis—here they leverage their own ratings system to ascertain funds that might be considered to be exposed to ESG “risk”[ii]—produces a number that, while well short of what Morningstar would apparently deem prudent,[iii] still notes that “as many as 48% of retirement plans with at least 100 participants already offer investment strategies that use ESG analysis to evaluate investments”—though that belies the results of most industry surveys (including PSCA’s 64th Annual Survey of 401(k) and Profit Sharing Plans). On the other hand, the report acknowledges that this includes funds with a “broad definition” of ESG—funds that presumably take those type factors into account without touting that as an explicit emphasis (and perhaps without the awareness and focus of plan fiduciaries). Regardless, and undoubtedly for the reasons cited by the report, there’s little question that plan sponsors outside of the public and non-profit sectors have indeed shied away from ESG. At least for the moment.

Assets Oriented

There was, however, some interesting new ground in the apparent “churn” in the system. The report states that more than 380,000 plans closed during the period from 2011 to 2020—a result it attributes largely to employers going out of business. While that is certain a point of vulnerability for those previously covered by those plans (not to mention the presumed loss of employment), the solution for that lies beyond the retirement system per se.

As we have noted consistently, the report expresses concerns about coverage and the access to workplace savings, but ultimately differentiates its focus from traditional retirement system analysis by focusing on the size and flow of the system, as measured by assets. Indeed, and as noted above, the report seems particularly obsessed on the subject of assets—not on an individual level, or on obtaining a measure of retirement income adequacy, but on the premise that more assets mean the ability for plans in the system to negotiate for lower fees (and, on a related note, to opt for investment types, notably CITs, that have lower expenses). But while the emphasis was intriguingly unique, it’s also the basis upon which these authors affix the “fragile” label to the system, as if “the system”—as measured by assets—must constantly grow in order to be considered healthy. 

Now, there were some jaw-dropping numbers behind this premise—the report claims that there have been outflows of more than $400 billion a year since 2015, at least as reported by plans in their annual filings. However, at a time when 10,000 Boomers are said to be heading off into retirement every day, one might well expect a lot of them to be taking their retirement savings with them. 

‘Out’ Flows?

The concerns expressed in Morningstar’s analysis seems to assume that much of the outflow is pre-retirement “leakage”—though they seem equally concerned about rollovers. Why? Well, once again they write that, “More assets in the defined-contribution system would help more sponsors gain the leverage to demand lower fees from asset managers and drive down costs for end investors.” While true enough, it seems an odd anchoring. 

Indeed, in commenting on their assumptions, the authors comment that while they believe their estimates are “conservative,” and that “any errors understate the massive detectable flow of money out of DC plans,” they also admit that it is “…clear from Internal Revenue Service data that most flows out of plans are for rollovers rather than cash-outs…,” though they concede you can’t draw a distinction there between cash-outs and rollovers with the Form 5500 data.

Indeed, while 30,000-foot assessments of the retirement savings landscape are not unique, in looking nearly exclusively at the total pool of assets in that system and its implications, Morningstar’s report makes no attempt to correlate those assets to the needs of the individuals covered by the system. 

‘Pool’ Rules?

That asset-focused prism leaves it to claim that the entire system “relies on a few thousand employers to cover most people saving for retirement,” as though that’s a unique vulnerability. But the defined contribution retirement system is not one gigantic pool that must satisfy all obligations. Sure, it would be great if more employers, specifically more small employers, saw fit to offer a plan—but the fact that they don’t doesn’t put “the system” at risk. 

But those who do have these programs, and take advantage of them, face no jeopardy as a result (although they may well wind up being taxed at higher rates in the future). The U.S. DC system doesn’t “rely” on new employers to offer plans to compensate for those that are no longer doing so—though arguably the coverage gap, and the lack of ready access that results, are an issue of general concern.

All in all, the report offers an interesting assessment of “the system”—more thoughtful and comprehensive than most, though the obsession with total assets seems a bit myopic, and as one might expect a lot of assumptions, perhaps of necessity in a report as broad as this.  

In sum, while its conclusions are perhaps a bit “fragile” upon which to build a firm assessment, there’s plenty there to warrant discussion—and action.  But is the system "Fragile" - only for those who aren't part of it.

- Nevin E. Adams, JD

---

[i] While much of the report focuses on DC plans, the Morningstar researchers also intriguingly acknowledge that more than 33 million people are or will receive benefits from defined benefit plans as of 2019, and that DB plans accounted for more than 30% of distributions paid to participants in 2019 and they do not appear to have peaked. It even notes that approximately 8.8 million people who are no longer working are still entitled to future benefits and 11.7 million people who are still working will eventually receive benefits. Looks like those “dead” pension plans still have a lot of life in them! 

[ii] The percent of assets that are in the various categories of ESG risk assigned by the Morningstar® Sustainability Rating™ for funds, sometimes called the globe rating.

[iii] In fact, the report comments, “…sponsors have left the U.S. defined-contribution system in the aggregate tilted toward investments with more ESG risk—which is the degree to which companies fail to manage ESG risks, potentially imperiling their long-term economic value. Plan sponsors may wish to reexamine their investment choices using an ESG lens.”