What 401(k)s Can Learn from 403(b)s

However, as the corporate retirement plan landscape is shifting and new trends are emerging in 401(k) plans, those plan sponsors are looking to 403(b)s for insight.

For one thing, notes Tim Walsh, managing director for Institutional Investment Product at TIAA-CREF in Boston, 401(k)s have become the primary retirement vehicle for corporate employees as more corporations have frozen or terminated their defined benefit plans and shifted to defined contribution plans. Many nonprofit organizations have never offered a defined benefit plan to employees, and 403(b)s have been the primary retirement savings benefit offered. “Sponsors of 401(k)s  are recognizing that 403(b)s have always been the core plan for those entities that offer them, so now that 401(k)s are the core plan for the corporate sector, they are looking to 403(b)s for best practices,” Walsh tells PLANADVISER.

“We get questions all the time, especially from consulting firms that work with 401(k)s and want to build their 403(b) business, about how 403(b)s are different, especially when it comes to lifetime income, and what are 403(b) best practices,” he adds. Walsh notes that TIAA-CREF has done a great deal of research and documentation about 403(b) best practices, as it has in excess of four million 403(b) participants on its platform.

Traditionally, 403(b) plans have included, or have been entirely comprised of, annuity contracts. Before the regulations were passed, these were serviced by separate vendors with little plan sponsor oversight. However, the regulations require oversight by plan sponsors, and as a result, many have consolidated their plans to one recordkeeper that keeps track of all participant accounts. Walsh says this transition has not been difficult. “TIAA-CREF can recordkeep annuities alongside mutual funds. It makes communications so much easier for participants.” The experience of 403(b)s lets 401(k) plan sponsors know they can have solutions that address accumulation as well as retirement income on one platform, he adds.

Walsh says many consultants ask TIAA-CREF for best practices for in-plan income solutions, and the firm suggests plan sponsors do not just offer annuity windows, or access to rollovers to individual retirement account (IRA) products that offer income, because in-plan solutions typically cost much less. Offering in-plan solutions improves participant behavioral patterns, as they are more likely to annuitize in low-cost products, he explains. In addition, in-plan annuities offer participants security—a guaranteed carve-out— and they improve overall portfolio efficiency because they allows participants to manage downside risk while leveraging higher income investments.

According to a TIAA-CREF report, “Helping participants generate a lifetime of income,” from a fiduciary perspective, the process for selecting annuities is not that much different from selecting mutual funds or making any other decision that can affect participants’ retirement readiness, although the metrics might be slightly different. To begin with, the plan sponsor must undertake an objective and thorough search of potential annuity providers. It must pick a provider that has consistently demonstrated the financial strength to make the agreed-on future payments. The plan sponsor should review expenses and features and prudently explore an effective trade-off (weighing fees and commissions against benefits and services). If the sponsor does all of these things (and a few others, such as working with an expert on the selection of an annuity provider), the plan will likely have fulfilled its fiduciary duty.

The trend of vendor consolidation in 403(b)s can also offer a lesson to 401(k)s. Prior to the 403(b) regulations, some 403(b) plan investment menus included hundreds of investments with different vendors. With new requirements, 403(b)s realized this was unmanageable and began consolidating to one vendor (recordkeeper) and paring down investment menus. Walsh notes that in the 1990s, 401(k) plans had smaller investment menus, but with a bull market, plan sponsors got comfortable with open architecture and increased the size of their investment menus. However, the trend now is to simplify investment menus for participants, and 401(k)s are also paring down, so they are looking at 403(b)s for best practices, he contends.

According to a TIAA-CREF report, “Preparing for a lifetime: Managing your plan to driveretirement readiness,” a prudent approach to menu construction should help ensure a safe and secure retirement for all participants—the 80% who require a simple menu and the 20% who want a variety of choice—so they can build their own portfolios. At the same time, it should provide 100% of participants with easy access to choices for lifetime income as well as asset accumulation. It makes sense to offer an easy-to-choose Qualified Default Investment Alternative (QDIA), as well as a lifetime income option, as soon as the employee begins to engage with the menu. Then, you can offer core options for investors who want to build their own portfolios, and possibly a brokerage window for even more expansive choice and alternative investments. The key is to provide a simple menu, with basic building blocks, that reflects the way people make decisions and makes it easy for them to understand their options and make choices that make sense for them.

Lessons in Participant Education

According to Walsh, one thing 401(k) plan sponsors can do that 403(b)s are doing is offer specific advice. “Communication and education do not go far enough, participants want specific advice,” he says. “As participants get older they pay more attention to communication and education, but they want to be told what to do—how much to save, what funds to choose. Among TIAA-CREF’s book of business, 68% of participants provided advice make changes to their asset allocation or improve savings rates, Walsh notes. With just one advice session, 46% increased savings rates—26% by more than 10%. Why? “Because they now feel good about their decision, they didn’t know what to do, but they do now,” Walsh says.

Another key functionality that 401(k)s are starting to offer that 403(b)s have offered for a long time is offering monthly income projections on statements, Walsh contends. “Participants’ accumulation balance may seem like a lot of money, but translating that balance into retirement income is a much better measure of readiness,” he says.

“What 401(k) fiduciaries are starting to recognize is these plans are not just supplemental plans anymore—not just for saving. With that in mind, and the fact that the primary objective of a retirement plan is to offer a steady stream of retirement income, plan sponsors want to make sure participants can adequately replace a portion of their income in retirement,” Walsh concludes.