Financial wellness? Better off getting back to basics

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Fixing auto enrollment and TDFs should be the priority

Plan design for 401(k)s is falling short, and record keepers shoulder some of the blame, according to some executives at retirement plan record-keeping and administration firms, who say that record keepers have the means to fix some of the problems.

There’s a broad consensus that automatically enrolling employees into workplace retirement plans and defaulting them into investments like target-date funds, which help plan participants achieve a proper asset allocation, are best practices in 401(k) plan design. But few plans use automatic enrollment and many investors misuse TDFs to the detriment of their savings.

Read more: 10 things to know about TDFs

Rather than addressing these gaps, however, record keepers have focused on building services such as financial wellness programs that aren’t widely used and may not be helping participants who most need them, executives said at InvestmentNews’ recent Retirement Plan Adviser Recordkeeper Think Tank in New York.

“There are a whole bunch of people with very low account balances who are invested incorrectly; and as an industry, we still can’t get asset allocation right for participants,” said Jerry Bramlett, head of third-party administrator FuturePlan, which is owned by record-keeping firm Ascensus. “We’re talking about all this other stuff. Why can’t we focus on getting people allocated based on their risk-tolerance profile, so they have the best outcome in retirement?”

Automatic enrollment uses the inertia of retirement savers to their advantage. According to Vanguard Group data, plans with automatic enrollment have 52% higher participation rates than those with voluntary enrollment. That’s significant since, according to Vanguard data, plan participation is the broadest metric for gauging 401(k) plan performance.

OFFERED TO NEWLY HIRED

It’s perhaps not surprising, then, that use of auto-enrollment by 401(k) plan sponsors has increased 55% over the past decade, according to the Plan Sponsor Council of America. Still, just 61% of 401(k) plans have incorporated the plan design feature, and most plans only use it for newly hired employees rather than all employees.

There’s also a large disparity between large and small plans. About 70% of plans with at least 5,000 participants use auto-enrollment, but that’s true for only 27% of plans with fewer than 50 participants, according to the PSCA.

“[The gap in] adoption rates between large plans and small plans shouldn’t be that big,” said Matt Gulseth, a partner at advisory firm Channel Financial.

Additionally, record-keepers data suggest many investors are misusing target-date funds, and perhaps diminishing their investment returns as a result. One in 10 target-date investors are invested in more than one of the TDFs in their plan, according to record keeper Alight Solutions. Similarly, Vanguard data show that more than 30% of participants use more than one TDF, or a TDF in tandem with other investment funds. Those approaches could prove harmful, according to experts, since TDFs are meant as an all-in-one investment product. Using additional funds could skew asset allocation.

Asset allocation is responsible for 90% of the variability in investment returns over the long term, according to a 2017 Vanguard report.

“The maximum return [participants] can get, they’re not getting,” Mr. Bramlett said.

The misuse is especially troubling since TDFs are the most popular investment vehicle in 401(k) plans, and are projected to capture even more investor money. TDFs currently capture about 58% of 401(k) contributions, according to consulting firm Cerulli Associates, which projects that figure to increase to more than 80% in 2023.

Some advisers and record-keeping executives have suggested various ways to improve some of the flaws around auto-enrollment and TDFs.

CREATING INCENTIVES

For example, record keepers could sell 401(k) plans with auto-enrollment as a default feature or provide a price break to plan sponsors that implement auto-enrollment. Record keepers could disallow TDF investors from contributing to more than one fund. Employees could also, for example, be re-enrolled into a TDF annually to try reducing the number of participants allocated incorrectly.

Record keepers seem to be diverting their attention elsewhere – to financial wellness, student loans and health savings accounts, for example, participants in the InvestmentNews roundtable said.

“Doesn’t [financial wellness] feel like it’s the next shiny object?” asked Sandra McCarthy, president of OneAmerica Retirement Services.

Some executives suggested that retirement savers who could most benefit from financial wellness programs don’t use them and that the financially better-off, more sophisticated participants are taking advantage.

Some plan design ideas sound good in theory but would be challenging to implement in reality, said Philip Chao, a retirement plan adviser.

Some plan sponsors would likely not want to assume the fiduciary risk of re-enrolling participants into a TDF annually, for example, he said.

“What’s ideal on paper may not be pragmatic in practice,” said Mr. Chao, principal and chief investment officer at Chao & Co. “There are plan designs and there are ivory tower plan designs.”