Retirement Plans

Seven 401(k) Strategies for 2012

Recent news and trends suggest some new directions for sponsors of defined-contribution plans.
David McCannFebruary 23, 2012

Some strategies for maximizing the performance of 401(k) plans, spurring greater participation levels, and achieving regulatory compliance are boilerplate at this point for many plan sponsors. But they should consider some other, specific measures in response to recent events and trends in the defined-contribution-plan space, says consulting firm Mercer.

For one, the newly required disclosures of service-provider fees and compensation that providers must make to plan sponsors, and the sponsors in turn to plan participants, almost surely will generate much greater scrutiny of fees. Plan committees should review and document the methodology for allocating fees to participant accounts, whether it’s through revenue sharing or other methods, Mercer says.

Revenue sharing refers to any portion of the expense ratio — or the total fees charged to an investment option as a percentage of assets invested in that option — that is used to pay administrative fees other than investment costs. As to “other methods,” more plans are now charging administrative expenses directly to participants’ accounts, says Bill McClain, Mercer’s defined-contribution intellectual-capital leader. Whereas revenue sharing doesn’t show up on account statements but rather is embedded in the fund’s returns, charging costs directly to accounts makes them more visible.

“It makes sense to charge investment costs pro rata based on account assets,” says McClain. “But administrative costs don’t depend on how much money you have; a $400,000 account costs the same to administer as a $4,000 account.” Making the expense ratio available to pay for administrative costs, which until now has been the prevailing practice, not only is somewhat illogical but also “has not led to a great deal of openness and scrutiny,” he says.

Other strategies suggested by recent news include the following:

Reconsider custom target-date funds. Custom target-date funds are tailored to a plan’s specific participant demographics rather than a standard target retirement date that a plan provider applies to all of its clients. These funds and other “default investments” are now cost-effective at much lower asset levels, owing largely to efficiencies gained from the growing number of plans employing automatic enrollment and automatic escalation of participant contribution levels, says Toni Brown, director of U.S. client consulting for Mercer’s investments business.

Monitor stable-value options. Most plans offer at least one capital-preservation option, which are usually either money-market accounts or stable-value funds. Both are designed to always trade at $1 so that participants don’t lose any capital; they are paid in the form of income on the investments. The income can be held until retirement or withdrawn at any time. The difference between the two types of capital-preservation options is that money markets trade in short-term fixed-income securities, usually maturing within six months, while stable-value funds invest in long-term instruments.

Stable-value funds have historically generated far higher long-term returns. Now, however, the stable-value market is under stress. The insurance companies that guarantee the investments will always trade at $1 (by valuing them at book value rather than market value) have grown increasingly risk-conscious during the three years since the last case of a fund “breaking the buck.”

In response, they are increasing the pricing for stable-value funds and adding new investment restrictions. These investment vehicles’ popularity is also depressed by their complexity. “Stable-value options deserve the same care and prudence as other investment options, including evaluation of the team, process, constraints, competitive advantages for the provider, and consideration of alternative capital-preservation options,” according to a Mercer report.

Consider adding a diversified inflation option. Such options are intended to continue performing well when inflation increases. The availability of “compelling, institutional-quality, diversified inflation options is growing,” Mercer says. They offer access to asset classes not normally available in defined-contribution plans, like treasury inflation-protected securities, commodities, real estate, and inflation-sensitive equities and bonds.

Use “expected monthly retirement income” to inform and drive participant behavior. Plan sponsors and record keepers are increasingly expressing expected retirement-age savings in terms of the monthly income it will generate. Participants, on their own, find it difficult to make that calculation. Making such a change “can get them to change their behavior, putting more money in or finding ways to change their asset allocations,” says Brown.

Keep pace with changing media. When it comes to communicating plan information, employees, especially younger ones, expect it to reflect the way they communicate when away from work. To respond, employers should consider offering virtual meetings instead of face-to-face ones; delivering information via mobile devices and apps rather than phones and PCs; using social websites and online communities rather than e-mail and static online content; using on-demand, interactive media rather than print; and using video (such as YouTube) rather than PowerPoint.

Refocus your retirement strategy by delivering more with less. Recent studies have shown that at least a third of the workforce is looking to change employers, with lackluster retirement programs cited as the second-biggest motivator, yet most organizations struggle to find funding to increase retirement contributions. In such an environment, there is no room for underperformance.

The aforementioned automated enrollment and escalation features are effective efficiency generators. Beyond that, some plan sponsors are identifying and engaging in dialogues with groups of employees who exhibit investment behavior that doesn’t produce strong results or who have low contribution levels, says McClain. Other strategies include targeted interventions with individual participants and new communications campaigns.

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