Author: Patty Kujawa

Plan sponsors have historically been conservative and slow to alter 401(k) strategies, but now that results can be seen rapidly, plan sponsors have the confidence to make changes, said Rob Austin, Aon Hewitt’s director of retirement research and author of the biennial survey.

“Data can trump a lot of opinions,” Austin said. “A lot of plan sponsors don’t want to be doing things on their own. As we see data from early adopters, it’s easy for others to follow suit.”

This year, the survey found that nearly 40 percent of plan sponsors use a flat dollar fee to pay for administrative services compared with 14 percent in 2011. Four years ago, it was more common for fees to get buried in overall investment costs. In 2015, that strategy dropped to 40 percent from 83 percent in 2011.

Several drivers account for the flat, more transparent fee, Austin said. Employers want an easy-to-understand fee structure thanks to a 2012 U.S. Labor Department rule requiring companies to show workers their 401(k) operating costs. Also, several lawsuits and settlements exposing inflated fees have opened employers’ eyes to the issue.

“There is a growing mentality that it should be flatter and more transparent,” Austin said.

But unlike many of the large companies in the Aon Hewitt survey, small companies don’t have a large workforce to scale down costs or in-house experts who can help drive fees lower, said Tom Zgainer, CEO of America’s Best 401K, also known as ABk. Companies like ABk and FeeX offer services showing employers and workers how much they are paying for their 401(k).

“For the first 30 years of the 401(k), no fee disclosure was required,” Zgainer said. “Our Fee Checker is designed to raise questions and to proactively encourage you to find out more.”

AB401k and FeeX offer an online service that taps into the 401(k) data companies need to report to the Labor Department each year. Workers and employers can type in simple information and get a general idea on costs.

The more workers pay for 401(k) plans means less money in retirement, Zgainer said. AB401k data show that three people all 35-years-old with $100,000 to invest can have radically different outcomes as a result of fees. If all three get the same 8 percent annual rate of return on their investments but pay 1 percent, 2 percent or 3 percent in fees, the lowest fee would result in $761,225 at retirement, while the highest fee would produce only $432,194.

“That’s a major difference in retirement savings over a 30-year working period,” Zgainer said.

Savings Rates

Aon Hewitt’s survey showed employers making significant increases to employees’ automatic contribution rates as well as boosting company matching dollars to lift savings rates.

For years, employers had been automatically enrolling workers into 401(k) plans using 3 percent of pay, Austin said. This year, 52 percent of employers using auto enrollment used 4 percent or more, up from 39 percent in 2013.

“This was a prime example of data telling the story,” Austin said. “Companies realized that putting people in [the plan using] 3 percent wasn’t enough.”

Another feature dogging savings rates was employer matching contributions. Four years ago, the most popular employer match rate was an employer contribution of 50 cents for every dollar an employee contributed, up to 6 percent of pay. Now, 42 percent of employers match dollar for dollar, up from 25 percent in 2011.

Companies wanted to make sure workers who missed out on participating in defined contribution plans were given another chance in 2015. The term is called “back-sweeping” and 16 percent of employers pulled veteran nonparticipant workers into plans compared with 8 percent in 2013.

“This is really where employers wanted to focus their attention because these are the most career-oriented, long-term employees,” Austin said.

All these small changes can bring powerful results for workers, Austin said. Aon Hewitt data show that a 25-year-old worker would only save $482,000 at retirement using the older formulas. With a dollar-for-dollar matching rate, a higher employee contribution and a lower fee structure, retirement savings can more than double to nearly $1.3 million over time.

“Over time these changes can make a substantial impact on an individual,” Austin said. “It literally translates into tens of thousands of dollars.”

This story was updated on Feb. 18, 2016, to correct the shortened name of the online service AB401k.

Plan sponsors who are serious about changing worker behavior toward their 401(k) plans might consider injecting a little fun into their retirement programs.

Experts agree: Concepts like gamification are overdue in the 401(k) industry. Surveys show workers are worried about their retirement, and plan sponsors know it. Only 12 percent of 457 plan sponsors said their employees know how much to save for retirement, reported consulting firm Towers Watson & Co. in a November 2014 survey. Only 20 percent said their workforce is comfortable making investment decisions.

The same survey said employers are ready to change. While only 8 percent of plan sponsors surveyed said they use gamification strategies, 78 percent said they plan to increase their use of technology to deliver information over the next several years. The idea isn’t new, but its application in the digital world is exploding with leaders like Fitbit, which uses badge rewards and online interaction with other users to get people moving and living healthier lives.

“It’s just not that interesting going to a seminar or reading a pamphlet,” said Nick Maynard, senior innovation director at nonprofit D2D Fund. “Games have a significant ability to affect participants relative to other traditional means of communications.”

Increasing the use of technology may not exactly mean hitting the play button, but it does send things in a more positive direction.

“Gamification is more in its infancy stage” in terms of 401(k) development, said Heather Tredup, an associate partner at Aon Hewitt. “The question now is: How do we take what we see working and apply it across the benefits community.”

Fidelity Investments introduced its NetBenefits mobile app last year. Similar to leaderboards on many online games, participants can compare their 401(k) account balances and contribution levels with other anonymous Fidelity participants of the same age. They can also filter data by ZIP code, state, region or national statistics, as well as see how they’re doing compared with other age groups.

It’s not a game, but NetBenefits uses gamification strategies to get users to pay attention to what they are doing — or not doing.

Fidelity reported participants checking out their peers’ contribution rates were 17 percent more likely to make a change compared with overall NetBenefits users.

“The 401(k) world has a very challenging, motivational framework, because most people don’t have an emotional attachment with helping their future self,” said Charles Berman, Fidelity’s senior vice president for digital platforms. With NetBenefits, “We’re getting them to pay more attention and to make simple, but important decisions.”

Defined benefit plan sponsors can bank on one thing: uncertainty. They know it can’t be eliminated, but are fighting back by taking what they owe some participants off their balance sheets and having insurance companies take care of the payments.

The strategy is called an annuity buyout, and it’s becoming a popular way to strengthen what’s left of private employers’ $3.2 trillion defined benefit system — commonly known as pension plans. In February, Kimberly Clark Corp. announced its intent to purchase pension annuity contracts to reduce what it projects to owe 21,000 retirees by about $2.5 billion. Other large employers purchasing annuity contracts in the past three years include Bristol-Myers Squibb Co., General Motors Co., Motorola Solutions Inc. and Verizon Communications.

“There’s an element of fatigue and plan sponsors have had it,” said Richard McEvoy, leader of Mercer consulting’s Dynamic De-risking Solution group. “There are a number of factors combining to increase pension obligations.”

An annuity buyout is when a pension plan shifts its obligations (or what it has promised to pay a participant) to an insurance company. The insurance company then provides annuities for the participants affected. It’s called de-risking because by pulling participants and their pension promise out of company plans, sponsors no longer bear the risk of having to fund those obligations and are able to create smaller, more manageable plans.

The five mega-deals that have been completed since 2012 have totaled $40.5 billion in obligations transferred to various insurers covering 218,000 participants. Each deal involved a portion of each company’s pension plan participants, typically those who have already retired.

Annuity buyouts are not so much about cost savings as they are about decreasing the size of the company pension plan to reduce the number of participants and assets plan sponsors have to manage, consultants say.

“Everyone is looking to reduce risk, and they’re looking at all the tools in their tool kit to do it,” said Stephen Marshall, managing director at investment consulting firm Wilshire Associates.

For years, pension plans have had a problem: what they owed participants has grown relative to the amount of money they have held. In January, pension plans were only 79.6 percent funded compared to 84.9 percent a year ago, according to consulting firm Milliman.

Funding ratios are affected by several factors including longer lifespans for U.S. workers, increased payments to the federal insurance company that backstops pension plans and swings in interest rates. It can be quite the rollercoaster ride for plan sponsors. For example, Milliman data show that 2013 was a historic year for pension funds. Robust investment performance and other positive factors produced a historic $198.3 billion improvement in funding status over the previous year. 

Things were looking good at the end of 2013, but market shifts and new mortality estimates introduced in October 2014 helped drive down funded status by more than 5 percentage points. It may not seem like much, but that difference can mean millions in contributions that sponsors needed to make in order to keep plans afloat.

“Sponsors face a challenge between managing volatility through investments and/or transferring risks entirely,” McEvoy said. “If they do what they can to match assets to liabilities, they still have a big plan, and it can seriously unravel when there’s a financial crisis.”

While there are a number of strategies available, about 21 percent of 183 defined benefit plan sponsors said they are considering annuity buyouts in 2015 for some of their participants, a February survey by Aon Hewitt showed.

“A growing number of plan sponsors anticipate increasing pension plan costs,” said Ari Jacobs, global retirement solutions leader for Aon Hewitt, in a written statement. “Settlement strategies may be an appropriate approach for well-funded DB plans so that pension plan sponsors are able to honor the retirement benefits promised to participants while also considering the long-term financial outlook of the plan.”

In February, personal care company Kimberly-Clark announced its plan to purchase annuity contracts from Massachusetts Mutual Life Insurance Co. and Prudential Insurance Co. for about 21,000 U.S. retirees. The deal, when complete, is expected to reduce Kimberly-Clark’s pension promises by about $2.5 billion.  

In a buyout like this, participants receive annuity checks from the insurance company, and the obligation is no longer covered by the Pension Benefit Guaranty Corp. — the federal insurance agency for defined benefit plans.

It was the first mega-deal for 2015, and many observers expect more to follow. Last year, the annuity purchase market was valued at $8.7 billion compared with $4 billion in 2013, according to Towers Watson & Co. data.

While the retirement industry has seen the massive shift to 401(k) and other defined contribution plans, consultants say de-risking strategies like annuity buyouts are helping companies strengthen and sustain their defined benefit plans.

“It’s responsible risk management,” McEvoy said. “It’s a way to bring down the size of the plan and focus on employees.”

The company that transformed the do-it-yourself home improvement revolution with its “You can do it. We can help.” theme takes its own advice and gets a good bit of assistance with its 401(k) plan.

The Home Depot Inc., with $4.5 billion in 401(k) assets and 160,000 participants throughout North America uses Aon Hewitt as its plan administrator and consultant. Home Depot also uses Aon Hewitt’s subsidiary, Hewitt EnnisKnupp, as its investment consultant.

‘To manage our 401(k) plan in-house would detract from what
our core business is.’
—Brant Suddath, director of benefits at The Home depot

Explaining the Various Retirement Plans
Here is an explainer of benefits plans available to employees, according to the Employee Benefits Security Administration and 401khelpcenter.com:

Defined contribution plans: These are account-based plans and are typically 401(k) plans. All participating employees have an account where they contribute pretax salary dollars and choose from an investment menu provided by the employer. Employers can choose to match employee contributions up to 6 percent. Also, the Internal Revenue Service places a ceiling on how much employees can contribute each year. In 2013, the limit, which doesn’t include the employer contribution, is $17,500. People 50 and over can make $5,500 in catch-up contributions for a maximum of $23,000 this year. Nearly all final payouts are in lump sums.

Defined benefit plans: These are employer-sponsored plans, often pensions, where the employer defines the benefit paid out for life to the employee. The final benefit is determined by a formula, usually based on years of service and final year or years of pay. The plan is funded and invested solely by the employer. The final payout is in the form of an annuity.

Cash balance plan: These are defined benefit plans, but like defined contribution plans, are account-based. In each account, employees get two different types of credits established by the employer: a pay credit and an interest credit.

Brant Suddath, director of benefits for the Atlanta-based company, said outsourcing the daily administration of the plan to retirement experts helps the plan function at a high level while allowing Home Depot workers to concentrate on what they do best.

“The goal for our organization is to focus on our core competencies. For us it is to be the best home improvement retailer in the world,” Suddath said. “To manage our 401(k) plan in-house would detract from what our core business is.”

Managing a 401(k) isn’t easy. There are daily operations to monitor, complicated forms to fill out, money to collect and pay out, and plenty of communication strategies to execute. There’s a lot of pressure on plan sponsors to have highly successful 401(k) plans to help attract and retain workers. Now that 401(k) plans have grown to become the No. 1 way U.S. workers save for retirement, it’s no secret many plan sponsors turn to experts to run the entire plan or certain parts of it.

“Plan sponsors just can’t develop these kinds of processes in-house,” said Andy Miller, director of retirement and investor services at The Principal Group. “They are looking to run a business but want to take advantage of our expertise.”

The service provider universe is a lot like looking at a fast-food restaurant menu. You can order drinks or a side of fries a la carte, or you can go for the whole meal.
It just depends on what you want, and how much you can contribute.

There are three main categories of service providers: bundled, unbundled and alliance. There are pros and cons to each strategy, but the best type really boils down to the needs of the 401(k) plan and its participants, said Brian Murphy, owner and partner of Pathways Financial Partners in Tucson, Arizona.

Some plan sponsors “don’t know what they want or need, and that’s why it’s important to use a process to help plan sponsors truly understand what will work for them,” Murphy said.

Bundled providers are for plan sponsors who want the convenience of one-stop shopping. Record keeping, administration, investment, and education and communication services are done by one company. Just like buying the value meal at a fast-food restaurant, fees tend to be lower because all the work is in one package. Small plans looking to offer a 401(k) but keep costs in line typically look to bundled providers.

“For a lot of our clients, we give them peace of mind,” said Phil Chisholm, vice president of product management at Fidelity Investments, adding that Fidelity’s services can come directly from the company or through a local adviser.

Next is the unbundled approach where the plan sponsor goes out and hires different companies to do each job required by the 401(k). The advantage to this strategy is having the ability to hire the best provider for each task. Plan sponsors can also choose to expand or customize services such as education depending upon the needs of their participants. A common issue with unbundled providers is that the plan sponsor deals with multiple providers, which can be challenging.

A third method is the alliance model where one provider offers the main services like administration and record keeping, and pulls in other vendors or uses staff employees for other needs. One of the benefits to this strategy is that the plan sponsor is still able to get the best services while the main provider of the alliance coordinates the various vendors so the plan sponsor doesn’t need to keep in constant contact with everyone.

Home Depot’s Suddath said the company uses Aon Hewitt as its administrator and plan adviser to leverage the consulting company’s experience managing hundreds of plans. As of December 2012, Aon Hewitt managed 211 plans covering 5.4 million participants with $311 billion in assets. Like several providers, Aon Hewitt routinely surveys its population or combs its record-keeping data to pinpoint 401(k) trends.

“This way we learn from our peers and understand what has worked and hasn’t worked,” Suddath said.

Growing With Growth
In many ways, plan providers have become more sophisticated as the defined contribution market has grown. As of September, 401(k) assets have more than doubled to $3.8 trillion from $1.7 trillion in 2000, according to the Investment Company Institute.

As plans have grown, in terms of participants and assets, services have expanded as well. Until the mid-1990s, plans typically had eight to 10 mutual funds that were valued on a quarterly basis, said Fidelity’s Chisholm. Deciding where to invest retirement dollars at this time was generally the plan sponsors’ job. In the Plan Sponsor Council of America’s 56th annual survey, reflecting 2012 plan experience, plans averaged 19 investment fund options, which are valued daily.

With daily valuations and growing options, plan sponsors shifted the investment job over to participants, creating new service lines for providers. The first was for investment education: Participants needed help in learning basic investment information. The second was helping educate plan sponsors on the dangers they faced if they didn’t provide more than fund brochures.

After a few years, the industry saw that education tools weren’t worth much if workers didn’t participate in plans. In 2006, President George W. Bush signed the Pension Protection Act, giving plan sponsors the leeway to automatically enroll workers into 401(k) plans as well as annually bumping up what they put into their accounts.

It wasn’t a new service, but because of the law, providers — in particular record keepers — expanded their line to offer the service. While it took a few years to gain acceptance, the Society for Human Resource Management’s “2013 Employee Benefits” report showed 41 percent of plan sponsors used automatic enrollment this year compared with 35 percent in 2009. Automatic contribution increases weren’t recorded by the human resources association until 2010, where it was at 18 percent, and which climbed to 21 percent this year.

The automatic features gave way to yet another service explosion: target-date funds. These are professionally managed accounts that have a mix of investments that automatically shift to more-conservative strategies as participants near their retirement date. While they have been around since the ’90s, their need became more apparent when the Pension Protection Act allowed plan sponsors to use the investment fund when automatically enrolling workers.

According to the Plan Sponsor Council of America, nearly 65 percent of plans offer target-date funds. On average, about 13 percent of plan assets went to this investment in 2012, up from 4.5 percent in 2007.

“Target-date funds solved a critical asset allocation issue, because participants would’ve been befuddled in figuring this out,” said Rick Meigs, president of the online resource 401khelpcenter.com. “Target-date funds are a classic example of vendors seeing an opportunity based on a need.”
Another essential hit plan sponsors and providers took last year was when the U.S. Labor Department started a formal process requiring costs to be more transparent. First, all providers are required to tell plan sponsors how much they charge for services. Second, plan sponsors need to tell participants how much they are paying to be in the plan.

While the new rules created an extensive amount of new work for providers and plan sponsors, participants seemed more concerned about getting financial help than worrying about the fees they were paying. In an August survey by Schwab Retirement Plan Services, 61 percent of more than 1,000 participants surveyed said they want personalized investment advice for their 401(k).

Once again, the 401(k) provider universe is responding with increased services, and plan sponsors are signing up. A March WorldatWork and American Benefits Institute study on 401(k) trends showed that 53 percent of 356 plans surveyed said they provided investment advice to employees in 2012. For those that offer advice, 67 percent used an independent adviser compared with 47 percent in 2008.

“Today, plan sponsors are really looking at us in terms of what needs to be done,” said Principal’s Miller. “We host webinars, one-on-one advisory services through our Retire Secure program, and other education programs illustrating how much buying power [participants] have with their retirement balance.”

Mobile communication applications and other advances are being developed to expand the market once again. But one issue — lifetime income solutions — is quickly becoming the top puzzle to solve. Lifetime income is a way participants change their 401(k) savings into a stream of income lasting through retirement.

Like target-date funds and automatic features, lifetime income products already exist. Experts agree they aren’t widely used, mostly because neither the Labor Department nor Congress has weighed in on them yet. Earlier this year, the Labor Department asked for input on ways to show participants what their nest eggs might look like spread over time, and the industry responded with 120 comments.  

Winfield Evens, a partner at Aon Hewitt, said the lifetime income market is young, and while there are a range of solutions already in place, providers are competing to dominate the market.

“We are looking to solve retirement income,” Evens said. “If we can solve this dilemma, it’s the right thing to do for participants and it will be good for our business.”