Data & Research June 20, 2019

TIAA Institute Relates Participant Behaviors to Default Investments

The study finds that participants who join plans with a TDF default contribute to fewer funds and are significantly more likely to choose only TDFs for their allocations.

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The TIAA Institute has released a report discussing the effects of changes in participant contribution decisions following the adoption of target-date funds (TDFs) after the Pension Protection Act of 2006 (PPA) was introduced.

Prior to TDFs, money market funds were the most common default investment option. With this in mind, the study asks three questions: “First, how do the changes in default investments and available numbers of funds in the plan menu affect the number of funds used by participants? Second, what determines whether participants use target-date funds? Finally, how do these regulatory and plan changes affect the percentages of equity in allocations?” 

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The study finds that participants who join plans with a TDF default contribute to fewer funds and are significantly more likely to choose only TDFs for their allocations. Additionally, participants will, on average, contribute to funds with greater equity exposure, and the study found there is “less cross-sectional variation in contribution equity exposure across participants.” Instead, both equity exposure effects are high in different age groups and genders.

The study was conducted with a cross-section of 600,000 TIAA participants, with each added into three distinct groups of participants: (1) participants who joined plans in their current combination before any of the plans had target date fund defaults; (2) those who joined after some, but not all, combination plans had target-date fund defaults; and (3) those who joined after all combination plans had target-date fund defaults.

In the first group, participants who allocate contributions to a larger number of funds were found less likely to utilize TDFs when available, and they also hold significantly less equity than participants in the third group, the study says. These participants’ allocations were also more varied and prone to positive plan investment menu effects. For those joining after TDFs were made the default, these effects were mitigated.

Participants who joined after target-date defaults were made the default were significantly more likely to invest only in a single TDF, and as a result, target-date only participants tend to hold substantially more types of mutual funds because TDFs are composed of a number of underlying mutual funds, the study reports.

The study concludes by noting that TDFs offer an effective solution for plan sponsors and participants, but they do not account for differences in income, wealth, risk aversion, and life expectancy. Additionally, while the higher equity exposure linked to TDF defaults can lead to higher expected returns, it is also associated with greater portfolio volatility.

More information on the TIAA Institute’s study can be found here.

Data & Research June 19, 2019

Employers Offer Diverse Range of 401(k) Investment Options

In 2016, the average plan offered 27 investment options, according to a report from BrightScope and ICI. 

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Employers offer a wide range of investment options, according to “The BrightScope/ICI Defined Contribution Plan Profile: A Close Look at 401(k) Plans” from BrightScope and the Investment Company Institute (ICI). On average, employers offer 27 investment options in their plans, including a mix of equity funds, bond funds and target-date funds (TDFs).

Employers also use simple matching formulas to encourage employee contributions, and plan fees continue to decline.

“Employers recognize the importance of being able to customize the design of their 401(k) plan to suit their workforces, which is one of the strengths of the 401(k) system,” says Sarah Holden, ICI senior director of retirement and investor research. “Employers use the flexibility of the 401(k) system—including a wide variety of investment options and the structure of employer contributions—to build plans that encourage employee participation and make it easier for participants to plan and save.”

The average total plan cost in 2016 was 96 basis points, down from 1.02% in 2009.

“The 401(k) marketplace is constantly evolving and with that, the overall costs of 401(k) plans for participants have declined,” says Brooks Herman, vice president of data and research at BrightScope, an Institutional Shareholder Services Inc. business. “There are a variety of factors contributing to the decrease of fees and expenses in plans, including increased competition, the growing size of the 401(k) marketplace and public disclosure of plan costs. All of these factors benefit participants and help them continue to grow their retirement nest eggs.”

The study also found that for large 401(k) plans with more than $250 million in plan assets, the average domestic equity expense ratio fell from 65 basis points in 2009 to 45 basis points in 2016.

In 2016, 85% of large plans covering more than nine out of 10 participants had employer contributions. Among these plans, 6% make contributions automatically, even if participants don’t contribute themselves.

More than half of the large 401(k) plans automatically enroll participants. For mega plans, with more than $1 billion in assets, automatic enrollment is used by nearly 60% of the plans. A mere 20% of micro plans with $10 million or less use the practice.

Essentially all large 401(k) plans included domestic equity funds, international equity funds and domestic bond funds. Eighty percent offers TDFs, 69% offers guaranteed investment contracts, 65% offered balanced funds, 44% offered money market funds and 30% offered international bond funds.

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