Choosing the right target-date fund is critically important for plan sponsors, and yet it's a decision that gets made by default far too often, according to Mark Davis, senior vice president and financial adviser with CAPTRUST Financial Advisors. Davis made his remarks as part of a panel discussion at the ASPPA 401(k) Summit, held recently in Las Vegas.
Particularly in the smaller plan market, he noted, plan sponsors often choose their recordkeeper first, then default to the investment options offered by the recordkeeper when it should be the reverse.
Joining Davis on the panel were Steven Geisert, vice president with PIMCO, and Bob Benish, interim president and executive director with the Plan Sponsor Council of America. Here is an excerpt from their discussion, which was moderated by Samuel Brandwein of Morgan Stanley Wealth Management:
What do you see as the hot trends in plan design?
Benish: I think it's important to understand the [retirement] system is very, very strong, but I will tell you that plan sponsors are overwhelmed. They're overwhelmed and they don't have the resources to make decisions and develop services and products.
Davis: We've got a limited time to focus on retirement [because] there's going to be a giant sucking sound as our clients' focus gets pulled over to health care with the implementation of Obamacare over the next couple of years.
Another topic about which I'm very passionate is this notion of fee fairness, fee policy - whatever you want to call it - trying to help plan sponsors understand who is paying for what. How do they define what is equitable for their workforce? It's a conversation we're having with most of our clients right now. Some are writing it down and creating a fee policy, others are having a conversation about it. But I think it's critical that we all do that.
Geisert: We do a consultant survey every year and ask them a number of questions, what they're focused on. We asked them where the biggest growth was last year and, probably no shock to anyone, the two areas were fee analysis and recordkeeper searches. No. 3 was investment plan design. Now that we're getting past the fee side of the equation, people are starting to go back to the investment side of the equation and asking: "Is this the right menu?"
We also asked how many funds do you need in each asset class? The total number they came up with was 13, and that's counting target-date funds as one balanced option. One stable value, two fixed income, six equity, one inflation, one alternative, and one other. It's kind of interesting how that played out.
Another area that popped up was plan sponsors' desire to go back and review their target-date funds. I think at this point in the game, some folks have been in TDFs long enough, that they're starting to go back and re-evaluate.
Davis: We have to break the connection between manufacturer and recordkeeper in target-date funds. An awful lot of plans out there think: "Well, I have to take the X funds because the X fund manager is my recordkeeper." That connection has got to be broken. If you have clients who are taking X family of funds as their target-date solution just because X's fund manager is their recordkeeper and they get sued or litigated against and are asked "Why did you have that fund?" and they reply, "Because they were my recordkeeper" - that is probably not a defensible answer. As an industry, I think we're moving pretty quickly to break that connection. Just because company X is your recordkeeper, does not mean you have to use company X's target-date funds.
If we see more plan sponsors looking to add alternatives to their plan, do you think that will that take away from the number of slots being allocated to equity funds? Or will it cause that number, 13, to drift upward?
Davis: I think we would argue that should be done through a brokerage window capability.
Benish: In terms of the average number of funds, it's like going on a diet. We talk about it - we should lose weight. But did you have that cookie? Did you eat those sandwiches? Talk is cheap. The same thing holds true with plan sponsors. They talk about reducing the number of funds but, according to our survey, the average number of funds in a plan is 19.
Everybody likes to talk about alternatives as something new, but nobody wants to be the first to do it.
Given that auto-features have become much more prevalent, what do you like about them and how can they be improved?
Benish: I think the growth in auto-enrollment has been a great thing for those large groups of employees that, through inertia, would never have joined the plan. I think the most effective auto-enrollment programs are ones that are tied into the deferral percentage. It's one thing to auto-enroll people, it's another thing to ensure every year it's going to go in.
When you look at the safe harbor, it is 3% and that is, by far, the largest percentage of plans that auto-defer [defer at 3%] - 53.9% [of plan sponsors surveyed by PSCA] default at 3%. I'm getting a little bit tired of hearing talk about how much people need for retirement but then they're afraid to say what the story is. The story is you have to save as much as you can for as long as you can. If you need 75% or 85% of your income [in retirement], we've got to get over this thing of deferring them or enrolling them at 2% and 3%. That's never going to cut it. Let's start talking about 10% or 15%, because that's what's going to help people achieve their goals.
I will say auto-enrollment and auto-deferral isn't for every company and every plan because it is very expensive. You're dealing with plan sponsors who have to manage up. When you're talking to CEOs and treasurers and saying, "This is a great feature, and it's only going to cost you an extra $2 million a year," good luck with that. They are looking at the bottom line and are absolutely concerned about health care. If they have a dollar to spend on health care or a dollar to spend on retirement, where's it going to go? Now we no longer have a choice - it goes to health care.
Davis: If you really want to do this, you have to go back and retroactively enroll and get everybody and do it every year, just like health care. It wouldn't surprise me to have something come from Washington at some point to make that mandatory.
Trying to track who defaulted, and who didn't, in a given investment - most recordkeepers still can't tell you that. They can't tell you who's in the target-date because they defaulted and who's there because they actively chose it. Recordkeepers need to start cracking that information. Who is in a fund because they chose to be there versus who's in it because they were defaulted into it is going to become a more important statistic to us.
Geisel: Twenty-nine percent of Vanguard's clients have implemented auto-enroll. Of that, 80% only enroll new employees. Seven percent of that 80% auto-escalate. You work your way down and it's not being implemented. It's not as prevalent as we think it is because we've talked about it for years. It hasn't fully taken hold.
Benish: According to our survey, 45.9% of plans have auto-enroll features, and it's most common in large plans with 5,000 or more employees and only 12.2% of the plans with under 50 employees have it. Now, among those plans that do auto-enroll, 81.7% use it only with new hires. We think it's like penicillin or the flu shot - get your flu shot and you'll never be sick again. But it's just not true.
The Pension Protection Act gave us qualified default investment alternatives, of which there are three primary vehicles - a balanced fund, a series of target-date funds and managed portfolios. Given these options, what trends are you seeing?
Davis: I'm a passionate advocate of target-date funds, so it's probably no surprise that my clients use target-date funds. I would be very hesitant to default anyone into a managed account that had an additional fee structure that I might be able to avoid with something else. To me, TDFs are still the best way to scratch that particular itch.
Geisel: [According to our survey] a little over 80% of plan sponsors are using a TDF as the QDIA, then balanced, and a very small sliver of folks are using managed accounts. When we put the question to consultants, it also fell along those lines. A very low percentage of them were pushing on the managed account side and the pushback on that was the added expense - they didn't necessarily see the value of it, and they figured most participants don't actually go into the managed account to do anything, so most of those managed accounts become quasi-TDFs anyway.
Benish: TDFs are become de rigueur. Are they perfect? No. Are there some questions? Yes. But they're relatively new. It's like buying a new car. You look in terms of some of these new cars and they have five-year, 100,000 or 200,000 [kilometer] guarantee [and yet] the company's only been around five years! So let's see what happens with TDFs over the years and do our due diligence and accept our fiduciary responsibility to ensure they are what they say they are.
What plan design mistakes have you seen out there in the marketplace?
Benish: It really is scary. I had a conversation with a 403(b) plan sponsor about fee disclosure, and they informed me they don't pay any fees. I thought that was very interesting. Assuming that if you have target-date funds those are a diversified offering and that's all you really need to offer is also sketchy.
Geisel: We've catered, quite honestly, to the squeaky wheel in too many cases. It's the 5% of participants who complain about not having XYZ fund and sooner or later, you end up having XYZ fund. There are a lot of issues with plan design but, in general, we've catered to the vocal minority.
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