As an initiative to save Social Security, the Bush administration has repeatedly proposed handing over the nation's retirement savings to workers to manage through the creation of individual accounts. But if the President examined the record on employee management of 401(k)s, he might want to reconsider.
The fact is many employees simply don't seem to want the job of providing for their old age. Despite efforts by (k) plan sponsors to fortify worker education and advice, there's a mounting realization that companies won't reach those employees who are too busy, too intimidated or just too lazy to take advantage of beefed-up offerings. "The shortcoming of both education and advice is getting those who need help the most to utilize it," says Ted Benna, president of the 401(k) Association and designer of the first 401(k) plan back in the early 1980s.
While no one is suggesting that plan sponsors give up on education or advice, these days experts in the field like Benna are encouraging sponsors to turn their attention to plan structures and tools that can help participants get the most out of 401(k)s without much effort on their part.
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A starting point is getting employees to sign up in the first place. The latest survey by the Profit Sharing/401(k) Council of America shows that just 78% of eligible employees participated in 2001. In a campaign to push that number closer to 100%, some companies now automatically enroll employees in plans, usually setting their savings rate at a modest level and putting the money in the least risky investment option. But research shows that employees who are enrolled automatically rarely boost their savings rate or switch to more appropriate investment choices. "Whatever the default and whatever the contribution [rate] will commonly remain the choices of employees for a long period of time," says Lori Lucas, a consultant at Hewitt Associates, an outsourcing and consulting firm. She adds that "a 25-year-old who has defaulted into a stable value fund at 3% for a long period of time, they're going to be retiring at a very late age."
Some big providers are working on increasing savings by getting employees to commit in advance to increasing their savings rate in the future. Both CitiStreet and Vanguard say they will start providing such plans this fall. Bert Dalby, a principal at Vanguard, says that while employees may feel they can't afford to save more right now, they may be willing to sign up to increase their savings rates in the future, when presumably their salaries will have risen. Dalby says a pilot of the program, called One Step(TM), that targeted participants with low savings rates at one Vanguard client found that after the first deferred savings rate change went into effect, the group's average savings rate rose to 4.6% from 3.4%, while that of a control group "increased minimally."
David Wray, president of the Profit Sharing/401(k) Council, says another way that plan sponsors can help participants is to offer them automatic rebalancing. "Experts believe that rebalancing actually improves performance over time, maybe by as much as 10%," Wray says. Defined benefit "plans rebalance almost universally. [Defined contribution] plans almost universally do not rebalance, with the result that participants are not getting the maximum return they could be getting from their plan," he says.
A Hewitt survey found that only one out of every six 401(k) participants did any kind of transaction in their accounts in 2002. "So five out of six people did not rebalance their portfolio in a volatile market," says Hewitt's Lucas.
If a participant chooses automatic rebalancing once a year or once a quarter, the plan provider brings the participant's fund holdings back in line with his or her asset allocation by taking money from funds that have outperformed and investing it in funds that have underperformed. Wray says that rebalancing would have helped 401(k) participants lock in their "extraordinary equity gains" in the 1990s. Because they didn't rebalance, "they gave a lot of that back through the last three years," he says.
Tina Wilson, assistant vice president of investment strategy at MassMutual Retirement Services, which has offered automatic rebalancing for a few years, says that rebalancing helps participants control the risk of their investments. "What we should be doing is selling high and buying low. Automatic rebalancing forces you to do that and keeps you on track toward your retirement goals." CitiStreet has offered automatic rebalancing for four years, and Ray Martin, president of CitiStreet Advisors, says a recent audit showed that for "the majority of participant accounts that had automatic rebalancing, the automatic rebalancing has had a positive effect on the financial performance of their accounts."
Hitting A Retirement Target
Hewitt's Lucas says that while automatic rebalancing is "an excellent feature," a more effective way to achieve that goal may be to get participants to use lifestyle funds or targeted maturity funds. Lifestyle funds, which are automatically rebalanced by a portfolio manager, include both stocks and bonds and are classified according to how aggressive the mixture of assets is.
Plan providers have come up with a further refinement of this idea, targeted maturity funds, in which the asset allocation is not only rebalanced regularly, but is revised over time. The funds are keyed to specific retirement dates and as that date approaches, they gradually shift to a more conservative asset allocation, with a bigger proportion of bonds. Benna says he's a "strong advocate" of this type of fund, but he sees a problem: Workers want to use them in combination with other investment choices, even though they were designed to be the only fund an employee invests in. The 401(k) Association's blueprint for improving 401(k)s suggests that employers limit a participant who chooses a targeted maturity fund or a lifestyle fund to just that one fund.
Some experts say that for employees who are hard-pressed to pay any attention at all to their 401(k) plans, a managed account option would be useful. Participants in managed accounts have their asset allocations chosen for them, based either on the data the plan sponsor has about their age and income or on information they provide to an advisor or Internet advice program.
Dano Bartolai, a director in product development at Mellon HR Solutions, says Mellon is working on a managed account option to offer its 401(k) customers and predicts that over the next six to 12 months other 401(k) providers will also move into this area. The one possible deterrent to success for the managed account option, according to Bartolai: It's pricey. He says fees for existing managed account products range from 30 to 50 basis points of the balance in the account. This fee would be in addition to the investment management charges on the individual funds.
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