Fee disclosure rules, coupled with a number of high-profile lawsuits against 401(k) plan sponsors, have renewed employers’ interest in retirement plan fees. Martha G. King, managing director of Vanguard’s institutional group, spoke to EBN about the evolution of retirement plan education, employers’ focus on fees and the challenges of guaranteed annuity products within 401(k) plans.
What changes have you observed over the years in what plan sponsors are looking for from a retirement plan service provider?
My early years at Vanguard were in the defined contribution side of the business, and then I was away for about 10 or so years running [a different division] so I’ve had this gap in time. So for me, the changes are noticeable. I think there’s more interest in understanding cost, and the unbundling of the defined contribution business. Many sponsors are looking at the position of recordkeeper and the investment manager separately. This has forced service providers to get their game into top-notch form.
Has that contributed to the proliferation in exchange-traded funds?
Not necessarily. Mid-sized and larger sponsors can get a lower cost index solution in the traditional mutual fund form. But below that, depending on what the recordkeeper will make available, maybe ETFs are a solution worth considering.
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Overall, sponsors seem focused on investment costs, whether that’s lower cost target-date funds, or any other kind. That’s actually a really good development because ultimately it’s in the best interests of participants because, all else being equal, if the cost of those investments is lower, participants have a higher likelihood of reaching their goals.
What else has changed?
When I left the institutional business, participant education was seen as a key driver that would ultimately affect participant behavior. Fast forward 10+ years, and one of the big “ah-ha’s” is that while participant education does matter, we now know plan design is the single biggest thing that will impact likelihood of good participant outcomes.
Does that have to mean defaulting participants into target-date funds?
[For] everything from auto-enrollment to having well-diversified investments, including a QDIA lineup, target-date funds are the most ideal choice because that really increases the likelihood the participants are investing properly. And then things like auto-escalation of deferrals are the ones that have the biggest impact on participant outcomes.
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Has plan participant education gone as far as it can go?
No. Once a plan sponsor has adopted the most effective plan design features, the work isn’t finished there. We will use behavioral-based campaigns to remind or encourage the participant “in the moment” when it’s time to take action. For example, I might receive a message like, “Martha, good job getting into that plan, but you could be doing more. If you simply upped your deferral rate by one percentage point, you could … ” and so on. Using technology and personalization most of all will give you maximum effect.
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What is Vanguard’s philosophy with regard to target-date fund design?
We believe that the investment time horizon doesn’t end at the date of retirement. So equity allocations for those under the age of 40 are at 90%, they decline to 50% at age 65 and they’ll fall to 30% by age 72.
Do sponsors ask you to customize target-date funds if they disagree with your asset allocations and glide paths?
We have the flexibility to consider requests for customized solutions, although many of the custom solutions I’ve seen already created out there are higher cost. So customization may be important to some plan sponsors, but at this point our clients are largely using Vanguard target-date funds, and we’re the largest target-date fund provider in the U.S.
How big would a sponsor need to be for customization is viable?
We haven’t drawn a bright line on that. But plans of a certain size really should not be entertaining the thought of customization; it’s just too costly, and any value they think they might be creating by doing so would be sort of eaten away by higher costs.
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What are the common misperceptions employees have about retirement that need to be overcome?
I think a lot of participants underestimate what will be required to prepare properly for retirement. They haven’t thought about things like longevity risk, inflation risk and health care risk. People have always thought about market risk when they think about how to prepare themselves for retirement. But I think the vast majority of participants aren’t sure how to invest their portfolio in retirement, how to have a draw-down plan, if they should just rely on Social Security or pension plans to the degree they have them, if they should be thinking about additional guaranteed income.
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So my observation is participants have mostly questions and not many answers that they feel confident owning and internalizing. But partly through this personalized behavioral-based communication approach that we’re working on, we’ve continued to see progress on moving the savings rate up in plans. But we still think most participants are under-saving.
For the plans for which we provide recordkeeping, we see a savings rate across the board at over 10%, but we believe participants, individuals, need to be putting 12% to 15% into their plan.
How do you help plan sponsors determine whether their 401(k) is on track?
We offer tools to clients that help them know how their plan compares. There’s basic metrics on participant behavior, peer benchmarking, all the way to customized analytics and data visualization work. We have this thing called the Vanguard Plan Effectiveness Tool. It’s a proprietary tool that helps sponsors understand their plan’s effectiveness and assess their participants’ use of the plan – are participants maximizing what the plan makes available to them? It measures participation rates, total savings rates and portfolio construction, then boils that down into a weighted average that gives the plan sponsor a metric to compare and track how they’re doing.
How does it assess portfolio construction?
It shows how closely the participants are to having a balanced investment strategy. For purposes of this tool, that is deemed to be between 40% and 90% equity exposure, and no more than 20% allocated to company stock. A maximum total portfolio construction index score of 100 would indicate that every participant has a balanced investment strategy.
Then we look at savings rates, measured against targeted ranges. Between 12% and 15% is really is optimal. So a total savings score of 100 would mean all eligible employees are at or above their recommended target. Now as you can imagine, there are a lot of plans that don’t score a 100 in either one of those components, but this has been a helpful tool for plan sponsors to understand how their plan stacks up.
How can participants get individual advice?
We make advice solutions available on a couple of different forms. One is Vanguard Managed Account Program, which is available to participants and it’s powered by Financial Engines, that’s been available for years. Although 22% of Vanguard plans have made that available to participants, only about 4% of the 3.6 million participants on our recordkeeping platform use it.
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Advice is available in other forms as well. In certain plans, participants at a certain age can avail themselves of a financial plan through a Vanguard financial planner, which is more than just allocating assets a certain way.
But since the news earlier this year of Vanguard rolling out a more robust advice offering on the retail side, we’re getting more questions from plan sponsors who are interested in a Vanguard-powered solution. So we are looking at that to determine what it would take to make that kind of a capability available to defined contribution plan participants.
The interest level from plan sponsors doesn’t seem to [have] plateaued, it seems to be continuing to grow.
What about income solutions for retirees?
We have solutions outside of the plan today, but it’s challenging to put guaranteed annuity solutions inside of a DC plan. There is just a host of unresolved issues around the question of retirement income. Four percent of DC plans in the industry have adopted guaranteed retirement income options. We see that as an opportunity ourselves. Plan sponsors have different views on whether to make it attractive for their retirees to stay in the plan.
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It’s easy to tell someone what their income needs will be. The hard part is trying to figure out how to design a plan that provides it. In my opinion nobody in the industry has gotten this one all sorted yet.
Vanguard manages money for defined benefit plans. What are you hearing from DB plan sponsors?
Risk reduction discussions still around LBI [liability-based investing], lump sum windows, and group annuity purchases. We’ve seen increased interest in hybrid DB plans, cash balance plans. But we’re not doing DB plan administration, so our involvement would range from a simple, very straightforward investment-only relationship where they’ve selected Vanguard products to be part of their mandate, or to have us go so far as to provide ongoing advice on the investment of the portfolio where we would take on responsibility for the asset allocation recommendations of the entire portfolio.
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What’s ahead for the defined contribution plan world?
I think technology will help us make better use of data and understanding participant behavior, and that will allow us to help participants make better decisions in the future. Participants are getting easier and easier to interact with. That had been a real barrier before. Plan sponsors are more willing to have us outreach directly to their participants, and technology makes that more possible.
Also, I think we’ll see more focus on financial wellness and wellness solutions. Participant advice will continue to evolve in helping participants invest properly and then track their investing goals beyond retirement. I think that’s a very rich, rich area where we’ll see a lot of change in the industry. And the focus on fees and fee transparency will apply some pressure for some in the industry, but will be a very good thing for the participants and the plan sponsors.
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Richard Stolz is a freelance writer based in Rockville, Maryland.
