Defined contribution (DC) plans used to be fairly low maintenance. A plan sponsor could pick a record-keeper, create a menu of investing options, and leave the rest to plan participants.
But times have changed. Once largely a supplemental program for top earning executives, 401(k) plans are now the primary retirement savings vehicle for the majority of American workers.¹ It's estimated that some 69 percent of current employees will depend entirely on their 401(k) – plus Social Security – for retirement.² Unfortunately, many participants don't save enough, others don't save at all, and many who have saved have inappropriate asset allocations.
At the same time, as their role has grown, many DC plans have found themselves facing growing legal and fiduciary hurdles. For several years, plaintiffs' lawyers have targeted DC sponsors for issues including administrative fees, share class issues, company stock performance, and inappropriate funds on the investment menu. Plus, in 2012 the U.S. Department of Labor issued rules requiring plan sponsors to provide detailed information about fees and expenses.³ The rules also require sponsors to actively monitor recordkeepers and other providers, and the scope of service providers who are fiduciaries may be expanding.
For some DC plans, auto-features such as automatic enrollment and auto-escalation can help get participants on track with their savings. Some sponsors may also elect to adopt investment options or educational tools that can provide more personalized asset allocation and education for participants.
Another attractive option is outsourcing. But many sponsors are still holding back, often raising three common objections to the outsourcing of DC plans:
"The existing staff can handle it." A total-benefits approach, in which the same team handles DC and DB plans can make sense in cases where a plan sponsor has a large DB staff and the skills and resources to handle DC plans as well.
Of course, not all plan sponsors have substantial DB staffs. And for those that do, it is worth noting that managing a DC plan requires particular proficiencies. The internal team will need to understand the structure of the sponsor's DC plan, and carefully monitor record keepers and other providers. In addition, a solid DC operation has a strong educational component, and the staff needs to be skilled at communicating with plan participants about investing and retirement strategies.
"My DC plan is good enough." For many companies, creating a "best-in-class" DC plan seems like an impractical use of resources. After all, isn't a "good-enough" plan, well, good enough? This thought should be closely examined. According to the Federal Reserve, the proportion of American families with a retirement account fell below 50% in 2013, and half of those accounts have balances of less than $60,000.⁴ Moreover, as workers near retirement, their healthcare cost tends to increase. Such forces can discourage workers from retiring.
Best-in-class DC plans work to address both of these issues through features like auto-enrollment of new employees, auto-escalation of employee contributions, and shifting investments into default options blessed by the Pension Protection Act (PPA) of 2006. Not only do employees benefit, sponsors reduce the likelihood of becoming a target of future litigation.
"Outsourcing will add costs and complexity while leaving me holding fiduciary responsibility." A DC vendor will charge fees. But that really isn't the full story. Keep in mind that an in-house DC staff already is incurring costs – some of which may be hidden.
By outsourcing DC plans, a company can actually reduce the complexity of oversight, so it can focus on core business needs, such as developing new products for customers. Instead of multiple vendors, attorneys and others reporting directly to a DC plan sponsor, outsourcing a plan gives a company a single, expert point of contact for all DC issues.
Plus, the notion that a plan sponsor can't transfer fiduciary responsibility and reduce legal exposure is incorrect. In fact, the Employee Retirement Income Security Act (ERISA) allows an outsourcing provider to accept most of the fiduciary liability for a DC plan.⁵
DC plans have a significant challenge ahead of them, and regulators, the media, academics, and plan participants are all watching closely. Many have already started asking whether the 401(k) is up to the task. If participant outcomes don't improve, plan sponsors could lose control to outside intervention
DC plan sponsors have an array of alternatives for helping improve the outcomes of their participants. Outsourcing is a valid and prudent choice for some. ERISA grants tremendous flexibility in how a firm can structure their outsourced arrangement. Many plan sponsors outsource investment discretion or administrative functions but retain responsibility for strategy functions, such as core menu design. A combination of outsourcing and in-house resources can allow sponsors to meet the higher standards now expected of DC plans while potentially reducing exposure to litigation risk.
¹ Source: "A 'good enough' 401(k) plan isn't good for participants' retirement security," Russell Communiqué, Fourth Quarter 2013
² Source: "A 'good enough' 401(k) plan isn't good for participants' retirement security," Russell Communiqué, Fourth Quarter 2013
³ Source: U.S. Department of Labor, Employee Benefits Security Administration, "Understanding Retirement Plan Fees and Expenses," 2011
⁴ "Changes in U.S. Family Finances from 2010 to 2013: Evidence from the Survey of Consumer Finances." Federal Reserve Bulletin, September 2014, Vol 100, No 4.
⁵ Source: "Between a rock and a hard place: DC plan fiduciaries are feeling the squeeze." Rod Bare. Russell Viewpoint (September 2013).
The information, analyses and opinions set forth herein are intended to serve as general information only and should not be relied upon by any individual or entity as advice or recommendations specific to that individual entity. Anyone using this material should consult with their own attorney, accountant, financial or tax adviser or consultants on whom they rely for investment advice specific to their own circumstances.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an "as is" basis without warranty.First used: December 2014