Over the past half century, defined contribution plans have taken the American retirement landscape by storm. They are now the foundation of the private-sector retirement system with assets above $7.5 trillion and over 100 million American workers participating in one. (1)
Vanguard, a leader in the field that manages over $1.4 trillion in defined contribution plan assets for 5 million plans, recently came out with their How America Saves 2019 annual study. They looked at where retirement savings and plans are today and also compared them across 15 years’ worth of data. What they found were two major shifts for defined contribution plans, along with a number of smaller trends.
Automatic Enrollment
One of the greatest changes that defined contribution plans have experienced over the past 15 years is the introduction and use of automatic enrollment. Automatic enrollment, also called negative election, simply means that workers are automatically enrolled in their employer’s retirement plan once they become eligible. The worker does not have to take any action to enroll, rather they have to take action to disenroll.
The advent of automatic enrollment has increased worker participation in retirement plans significantly. Studies have found that new hire participation rates increase from 47% to 93% in plans that utilize automatic enrollment. (2)
Why is automatic enrollment so popular? It’s because increased participation by rank-and-file employees helps qualified plans pass their coverage and nondiscrimination tests. When not enough non-highly compensated employees participate in a defined contribution plan, it can limit the amount that the highly compensated employees are able to save for retirement; it can trigger mandatory employer contributions on behalf of the employees; and it can also jeopardize a plan’s qualified, or tax-advantaged, status.
Target Date Funds
The other big change that defined contribution plans have seen is the use of target date funds. Target date funds are well-diversified mutual funds that automatically shift their level of risk as a target retirement date approaches. They free employees from the need to constantly monitor their investments, rebalance their accounts, and reassess their risk tolerance. This is important because most employees do not have the knowledge or skills to manage their own investment accounts well.
According to Vanguard’s research, 77% of plan participants in 2018 made use of a target date fund and 52% had their entire account balance invested in a single target date fund. By the end of 2018, 9 out of 10 plan sponsors were offering target date funds, up by a third from 2008.
One of the driving factors in the growth of target date fund use is the growth of automatic enrollment plans as discussed above. Many plans that automatically enroll participants use target date funds as their default investment option. Now, half of all investors in target date funds were placed there through automatic enrollment.
Other Lesser Trends
While automatic enrollment and target date funds are the big news in defined contribution plans, there are some other notable trends happening.
Use Of Roth Options
The Roth option for 401(k)s and IRAs allows participants to save for retirement with after-tax money and earn tax-free growth. Offering a Roth feature as a part of a 401(k) plan has increased in popularity, with 71% of Vanguard plans now offering them. Plan participants enjoy having the option to use a Roth within their 401(k) because Roth IRAs have low income limits for participation and low contribution limits as well.
Passive Core Offerings
With the increasing focus on fees and the skyrocketing popularity of index funds, many defined contribution plans have begun offering a “passive core” of low-cost index funds that span the global markets. In 2018, 63% of Vanguard plans offered a core set of passive investment options, which represents a two-thirds growth over the past decade.
Shift Away From Company Stock
While we are getting close to 20 years after the infamous Enron scandal, the lessons it taught are still fresh in many investors’ minds. One of those lessons was the danger of investing retirement funds in your own company’s stock. From 2009 to 2018, the number of investors holding concentrated positions (over 20% of the entire account balance) in company stock fell from 30% to 19%. Only 4% of Vanguard plan participants held concentrated company stock positions, down from 11% in 2009.
As you can see, there are some very clear trends in defined contribution plans, and for good reason. The major trends, automatic enrollment and the use of target date funds, are beneficial to both employers and their employees.
Are any of your plan-sponsor clients behind the times? If they don’t keep up with these current trends, their best employees could seek better benefits elsewhere or their plan could be placed in jeopardy. If your clients need help keeping their plans competitive, I’d love to partner with you to help them. Email me today at info@ff401k.com.
All statistics, unless otherwise noted, and graphs are retrieved from
https://institutional.vanguard.com/iam/pdf/HAS2019.pdf.
About Kenny Phan
Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses around the nation, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.
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