Data & Research June 27, 2008

401(k) Equity Allocation Out of Whack, Study Says

A Vanguard study said that 43% of 401(k) plans lack the correct equity exposure.
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The study from the Vanguard Center for Retirement Research (CRR) found only 43% of the nearly three million 401(k) accounts examined had the proper amount of equity exposure.

CRR researchers classified the accounts as “green’ portfolios because the proportion of equity holdings was consistent with expert asset allocation advice. Among the remainder of the accounts examined, about a quarter were considered “yellow’ portfolios, because, while they had significant equity investments, their equity exposure was too aggressive or too conservative.

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Researchers Gary Mottola and Steve Utkus said 30% were “red’ portfolios with serious asset allocation problems ranging from no equity holdings at all to too much of a single stock issue.

Many participants failed to take advantage of additional diversification opportunities, such as diversifying holdings with international or small-capitalization stocks or high-quality bonds when offered, the study said.

“By not having green portfolios, participants are losing anywhere from 60 to 350 basis points in expected real return per year,” Mottola said.

Equalizing the Equity

The Vanguard research report suggested steps plan sponsors to could take to help alleviate the problem:

  • Encourage participants to consider target-date or balanced funds as well-diversified, “all-in-one” investment portfolios for retirement.
  • Enroll participants automatically into new qualified default investment alternatives, such as target-date funds or balanced funds.
  • Introduce a managed account investment advisory service.

“Regardless of the strategy you adopt, CRR research suggests that plan sponsors who pursue these approaches can help their participants improve expected returns or diversification levels (or both), thus enhancing their prospects for financial security in retirement,” the researchers wrote.

The paper will be published as a chapter in a research volume on financial literacy to be issued by the University of Chicago Press. A summary of the report is available here.

Compliance June 27, 2008

EBRI Testifies to Congressional Committee about IRAs

The CEO of EBRI testified to the Committee on Ways and Means that IRAs are an important part of the retirement landscape.
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“IRAs have become the largest single vehicle for retirement assets in the United States,’ said Dallas Salisbury, president and CEO of the Employee Benefit Research Institute (EBRI), in testimony to a subcommittee of the Committee on Ways and Means in the House.

Speaking to the Subcommittee on Select Revenue Measures, Salisbury said 23% of workers age 21 to 64 owned an individual retirement account (IRA) at the end of 2005. However, he pointed out: “The goal that ERISA set for IRAs in 1974 as a way for all of those outside of an employer-based plan to save for retirement has not been realized.”

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Salisbury said the EBRI agreed with a recent Government Accountability Office (GAO) study that concluded employer-sponsored IRAs may sound like a good idea for workers without traditional retirement savings programs, but federal regulators cannot evaluate the option effectively because of a virtual lack of data on workplace IRA trends (see GAO Finds Pressing Need for Workplace IRA Study).

The GAO asserted in its report that the U.S. Department of Labor (DoL) does not collect information on workplace IRAs and, while the Internal Revenue Service (IRS) gathers limited data as part of its tax reporting systems, the workplace IRA information is not routinely shared with the DoL because it is considered confidential. Therefore, neither the DoL nor the IRS can now effectively figure out whether payroll-deducted IRAs are bridging the retirement savings gap for workers without employer pension coverage, or whether regulators should be given workplace IRA oversight similar to what they now have with traditional retirement savings plans.

Salisbury agreed with these conclusions and added that the GAO report also points out the lack of success in encouraging automatic IRA plan development among small employers “due to lack of resources, unsteady revenues, and lack of knowledge and/or misconceptions in how plans operate.” Small employer surveys conducted by EBRI have also found the lack of employee demand for the retirement plans, where higher pay and/or health insurance were deemed to be more important.

In his testimony, Salisbury noted that previous EBRI research has suggested ways in which an automatic IRA could be made available to all workers if accessibility and accumulation are the primary objectives. “It could be done with lower administrative expense and lower business burden than proposals that are more limited in their scope, but rely on payroll deduction,’ Salisbury said.

He noted that EBRI is working on an IRA information database to help with decision-making and encouraged making IRS data more widely available in a timely fashion.

More information is at www.ebri.org.

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