The aging bull market has had an impact on retirement plan portfolios that you may not have realized. Plan participants, especially older participants, may have too much equity exposure in their 401(k) accounts. In fact, based on June 2015 data of 13.5 million plan participants at over 21,000 employers, Fidelity Investments found that 27% of participants aged 55 to 59 had equity allocations that were 10% higher than what they recommended.
The existence of poorly diversified 401(k) portfolios is nothing new. However, there is an ongoing assumption among plan sponsors that providing participants with investment education has equipped them to make appropriate allocation decisions in their 401(k) plan. But, survey results continue to indicate that participants are overwhelmed by the amount of education materials they receive about their retirement plan choices and may prefer their employer to take a more active role. Further, participant inertia is a big problem, even if an employee is making maximum contributions to the 401(k) since most people fail to monitor or change their investments once initial elections are made in a 401(k).
The Fiduciary Challenge for Plan Sponsors
This creates a challenge for plan sponsors. As fiduciaries, they are responsible for having plan assets invested according to generally accepted investment principles and to have those assets meet the needs of the participant while minimizing losses. The fastest and most profound way to rehabilitate a retirement plan and address this fiduciary responsibility is through a plan re-enrollment.
Despite numerous case studies illustrating highly successful outcomes, very few plan sponsors have undertaken a re-enrollment or have plans to do so. Of the 756 U.S. corporate plan sponsors participating in J.P. Morgan’s 2015 Defined Contribution Plan Sponsor Survey, only 7% indicated they had ever engaged in a reenrollment and about 3% plan to do so in the future.
The following are some of the most common reasons for their reluctance:
- Plan sponsors fear they will get strong resistance from participants. In reality, the opposite may be true. Most people don’t have the knowledge or interest to direct their own retirement plans, despite their access to educational materials. These employees are the target audience of a reenrollment.
- Fiduciary liability issues are a big concern. The Pension Protection Act provides fiduciary liability relief via the use of a qualified directed investment alternative (QDIA) in a reenrollment which can help.
- Many plan sponsors are content with their current plan’s overall asset allocation. Most plan providers or recordkeepers should be able to supply the plan sponsor with allocation data for each participant. The individual allocations may reveal poorly constructed individual portfolios.
- Communication and education efforts can be expensive. There are costs associated with administering a reenrollment and creating the education materials. That’s why many companies initiate a re-enrollment at the same time that other changes are occurring such as an update to the investment menu. Bundling changes allows any expenses to be leveraged across activities.
- The re-enrollment process can be time-consuming. Typically, it is the plan provider that is responsible for the majority of the work in a re-enrollment. The plan sponsor’s responsibilities are limited to selecting an appropriate QDIA if one is not already in place and facilitating the distribution of materials and notices.
Conducting a Re-enrollment
First, make sure that your default option meets QDIA requirements. According to the Department of Labor, there are three investment vehicles that are considered QDIAs – balanced funds, target date funds and managed accounts. Target date funds are the most common type of QDIA since they are age-based, while managed accounts are rarely used.
While only one legal notice is required 30 days in advance of the reenrollment date, most sponsors provide much more communication and education to participants. This is an opportunity to promote the QDIA to participants as a way to be appropriately diversified without having to build, monitor or rebalance their portfolios. It is also important to emphasize to participants that by taking no action, they will be choosing the QDIA even if they have made investment selections in the past.
The Benefits The most immediate benefit of initiating a re-enrollment is that it requires employees to revisit their retirement plan selections. According to the Boston Research Group, 80% of plan participants never reallocate from their initial investment selections. Introducing a re-enrollment also helps to move more of the plan’s participants to suitable allocations and very few participants who are defaulted to a QDIA opt out.
A Re-enrollment Case Study
The State of Illinois Deferred Compensation Plan underwent a re-enrollment effective April 22, 2015 after the sponsor found that around 29% of the plan’s assets were allocated to small-cap value investments. As is the case with many participant-directed investment selections, the plan’s small-cap value manager had a long track record of good performance, making it a popular choice among participants.
After the re-enrollment, the share of plan assets in small-cap value declined to the more appropriate level of approximately 5%, while the percentage of assets in the plan’s QDIA target-date funds went from approximately 11% to 60%. The State of Illinois’ results are representative of the outcome that most plans experience. As more plans successfully employ re-enrollment, confidence in the concept should expand in the plan sponsor community. Your local ABG representative can help you evaluate whether a re-enrollment makes sense for your retirement plan and its participants.