Plan sponsors, frustrated that they can’t get more employees to save more money for retirement despite decades of inducements, have come up with a new gimmick: They are automatically shifting existing participants into target-date funds.
Unlike traditional auto-enrollment for new employees, this approach is used for employees already in a 401(k). Plan sponsors automatically switch virtually all of the investment fund assets that their employees had previously chosen into a target-date fund. The auto-switched investors are put into a fund based on an assumed retirement age. The onus is on the participant to opt out.
The idea was that, once their accounts were switched from their original investment choices to their age-appropriate target date fund, inertia would keep the participants in the new investments, which generally perform better than the investments that employees choose independently. That assumption seems to have held up – for those who do not opt out of the change.
However, a large percentage of employees – perhaps as many as 40 percent – are saying no thanks and flipping right back to their old investments.
John Galateria, head of defined contribution investment solutions at J.P. Morgan Asset Management set up one of the first such efforts in 2005 for the Helzberg Diamonds chain. He recalled thinking, ““If inertia was really inherent in retirement plan investors, then this would get them into the target-date fund, and most of them would stay there and be better off than trying to pick investments on their own.”
Six years later, Galateria admits that many participants reject the switch. He and other advocates say that this is better than it seems, considering that this cohort is the least likely to succumb to inertia to start with. But if so, that may just cast doubt on whether the basic concept makes sense.
At first, companies piggybacked this move onto what’s known as a triggering event, such as a conversion to a new record keeper, a merger, or a major change in the plan’s investment menu. Helzberg, for instance, was switching record keepers. Employers justified auto reenrollment in target date funds as a new twist on what commonly happens if a triggering event eliminates an investment option. In such cases, plan sponsors must move participants to the most similar investment choice among the new lineup.
But now employers are taking this step without any obvious impetus. Some do it “during health care open enrollment, when they think they’ll have people’s attention,” says Troy Saharic, Mercer’s head of investment consulting for the Pacific Northwest, Southwest, and Northern California. Companies may even repeat the practice every few years, Galateria says.
Typically, an employer will simply give the work force 90 days’ notice, with follow-up warnings.
Although Helzberg was a pioneer, this trend got a big push from the 2006 federal Pension Protection Act, which specifically allows target-date funds to be the default option for traditional auto-enrollment. By now, Galateria asserts, the idea of auto reenrollment into target date funds has spread to “well over” 500 companies of all types and sizes. Saharic says he’s discussed it with nearly all of his clients, although only two have taken the plunge so far. “A lot of plan sponsors don’t want to be on the front end of trends,” he points out.
Galateria says that any company with less than 80 percent of its plan participants in target-date funds should use this tactic. With just 33 percent of all 401(k) participants in such funds as of 2009, according to the Employee Benefit Research Institute, that would mean a lot of potential switchers.
There’s some debate about the mechanics of a wholesale switching of participant funds. One issue is whether all assets must be switched. Illiquid investments may need to wait until maturity, and employers aren’t thrilled about participants pulling out of company stock en masse. But Robyn Credico, a senior consultant at Towers Watson, warns that plans may jeopardize the funds’ status as a default option if they leave any assets behind.
Nor does there seem to be any standardized system for deciding where to put employees whose sixty-fifth birthday doesn’t fall conveniently in a “5” or “0” target-date year.
But the biggest problem with this strategy is whether the basic concept is working. Galateria says that 15 to 40 percent of participants reject the switch and stick with their original investments. For instance, 30 percent opted out at a large equipment and services company that merged two plans in 2009 and that J.P. Morgan uses as a case study.
Such results are worse than the 10 percent that typically opt out in a traditional auto-enrollment, according to a recent analysis of 120 large plans by Aon Hewitt.
However, pension experts claim the numbers are better than they look.
With traditional auto-enrollment, “maybe you’re hiring younger people or people that don’t have as much investment experience,” Saharic says. Most likely, they have never thought about retirement, and they’re willing to be led into the 401(k). By contrast, the participants who are auto-switched into target-date funds were already active investors. “They say: ‘I made active elections, and I want to keep them,’ ” Credico says.
In any case, the more important yardstick is whether target-date funds produce better returns than other types of investment decisions.
According to the Aon Hewitt analysis, from 2008 through 2010 participants with target-date or similar lifestyle funds (collectively known as premixed portfolios) consistently enjoyed a higher median rate of return than did those without such portfolios. The difference in 2008’s bear market was minuscule, and in fact many 2040 and 2050 funds actually underperformed the market that year. Last year, those with all their assets in a target-date or lifestyle fund had a median return of 14.7 percent, compared with 11.6 percent for those with no premixed assets.
“Target-date funds are no panacea,” Saharic says. “But they’re making the decisions that people should make but don’t on their own.”
