Data & Research October 23, 2015

Is DC Market Showing More Love for ETFs?

ETF asset growth is robust across a range of distribution channels—except one.
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Recent Cerulli data shows robust ETF asset growth across various retail and distribution channels, except in one area: private defined contribution (DC) plans, according to the October issue of “The Cerulli Edge – U.S. Monthly Product Trends Edition,” which examines institutional product use.

Historically, ETFs were not used in 401(k) plans, Cerulli says, because the very characteristics—intra-day trading, tax advantages and low costs—that make them appealing are either irrelevant or questionable when considered in the context of a DC plan.

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For larger plan sponsors with access to institutional shares of index mutual funds, the value-add of ETFs is immaterial, Cerulli contends, because institutional class shares of mutual funds’ expense ratios are often even more competitive than ETFs. If investors are seeking passive exposure, index mutual funds may be more suitable than index ETFs as they have the potential to incur expensive trading costs relative to mutual funds.

Mutual funds continue to be the most common investment vehicle within 401(k) plans, and collective trusts a distant second. ETFs make up just a fraction of a percent (0.02%) of the investment vehicles used in 401(k) plans.

But ETFs might be gaining wider acceptance. According the 2015 Plan Benchmarking Report from PLANSPONSOR, overall, 7.1% of DC plans use ETFs outside of brokerage windows, a substantial increase from the previous year’s 3.7% of plans. Plans with less than $1 million in assets have the highest uptake at 12%, a gain of five percentage points from the previous survey, and plans with $500 million to $1 billion have the lowest (2.1%). The largest increase in usage comes from plans with $1 million to $5 million in assets, rising from 2.2% to 9.7%.

NEXT: Robo-advice could also raise DC interest in ETFs

A few firms have begun offering ETFs to the DC market. In 2014, Schwab rolled out the Schwab Index Advantage 401(k) ETF platform. It comprises approximately 80 ETFs, a combination of Schwab proprietary ETFs and those from other sponsors, including PIMCO, Van Eck and PowerShares.

The platform has grown to more than 120 plan sponsors. Schwab also offers a managed account advisory service within the Index Advantage platform, which has ongoing investment management based on a variety of factors, including an employee's age, income, account balance, and savings rate in his or her 401(k) plan.    

Considering the vast size of the DC marketplace, though, Schwab’s success has been minimal. At more than $5 trillion as of year-end 2014, the pool of DC assets is one of the largest within the institutional channel. Based on the size of that asset pool, Cerulli believes the amount of recent media attention to ETFs within the context of the 401(k) space is outsized with respect to their marketshare and potential use.

Cerulli’s survey shows more ETF sponsors are focusing distribution efforts on small- and mid-sized defined contribution (DC) plans, with assets less than $250 million. Then, too, the market for automated online advice or robo services is also boosting efforts to bring ETFs to DC plans.

As more eRIA firms enter the market using ETFs as a primary investment, adoption in 401(k) plans could be in the foreseeable future. However, given ETFs’ current marketshare in the DC space, any meaningful impact is still a ways off. The concept of bringing ETFs into 401(k) plans through online advice service may be the next trend that will further catapult ETF growth, which has the ears of sponsors ringing. Cerulli believes true success will stem from support and awareness from recordkeepers to offer ETFs to plan sponsors.

More information about “The Cerulli Edge - U.S. Monthly Product Trends Edition, October 2015” is available on their website.    

Compliance October 23, 2015

A Peek at a Pre-Approved Cash Balance Plan Submission

James E. Turpin, with The Turpin Consulting Group, has one concern with the submitted document he’s seen.
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The Internal Revenue Service (IRS) has expanded its pre-approved plans program to include defined benefit plans with cash balance plan features, and it is currently accepting prototype document submissions.

James E. Turpin, president of The Turpin Consulting Group, said he has seen one of the submitted prototype documents, and he shared a few features with attendees of the American Retirement Association’s 2015 ASPPA Annual Conference.

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“If dealing with a uniform plan design, I haven’t seen any problem with the prototype,” he said. However, he is concerned with an open box for plan sponsors to input their plan’s interest crediting rate.

Interest crediting rates are highly regulated, and rates outside of the IRS’ approved list cannot be used in cash balance plans. “If the document doesn’t use a list of approved rates, with a box for the plan sponsor to check beside the one it is using, I think it would be hard to depend on the reliance of the IRS approval letter,” Turpin said.

He also noted some new rules included in the listing of required modifications (LRM) for cash balance plans that plan sponsors will see in the new documents. For example, interest credits on participants’ notional accounts can be done quarterly, monthly, or more often.

Some cash balance plan sponsors, upon conversion from a traditional defined benefit (DB) plan, established a beginning balance for the cash balance plan that was based on the accrued benefit in the traditional DB discounted for present value. This resulted in a period of time—called “wear-away”—during which new accruals would not increase the benefit to which a participant was already entitled. Turpin said no “wear-away” formulas are allowed now.

Finally, Turpin noted that there is no requirement that plan sponsors have to limit contribution credits to participants’ notional accounts to the IRS 415 maximum annual addition limit.

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