Data & Research April 9, 2013

Altering Plan Design Can Mitigate Costs

With the right combination of plan design and automated program features, retirement plan effectiveness can often be improved within reasonable budget levels, a paper asserts.
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In “Getting Beyond Ordinary—Managing Plan Costs in Automated Programs,” T. Rowe Price notes that many plan sponsors have turned to automatic program features to help employees achieve better retirement outcomes. However, others have been reluctant to fully embrace these features, perceiving that more comprehensive automatic programs will result in unacceptable cost increases. This perception can become reality if other plan design elements are not taken into account and adjusted to meet plan and company cost objectives.  

The paper contends plan design can be structured to manage costs to the desired level generally by changing or adjusting employer contributions, vesting and/or eligibility.  

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According to the report, in looking at possibilities for modifying the employer contribution design, there are four potential types of changes: 

  • Change the match percentage while leaving the basic structure intact by changing the match percent or changing the deferral percent eligible for a match; 
  • Change the structure of the matching formula by applying a different match to different groups of employees or by changing which deferrals are eligible for the match; 
  • Change the timing of when the contribution is made such as moving to an end of year contribution with a last day rule; and 
  • Move to a different type of contribution such as a profit sharing or nonelective contribution. 

(Cont’d…)

There are three primary ways to alter vesting design: 

  • Create multiple vesting schedules—one for each type of contribution that is utilized such as a different vesting schedule for a match versus a profit sharing or nonelective contribution; 
  • Change the timing of when vesting occurs for new contribution types and/or new hires such as lengthening the time on a cliff vesting or shifting to an incremental vesting schedule over a longer time period; and 
  • Change the method by which vesting is calculated by utilizing hours of service versus elapsed time of employment. 

In addition, there are three primary ways to alter eligibility design: 

  • Change who is eligible for each type of contribution utilized such as increasing tenure or age requirements for a profit sharing contribution; 
  • Change the timing of eligibility such as a provision for a new hire to immediately participate in the plan but not be eligible for a company contribution for a year; and 
  • Change the nature of eligibility calculations such as moving from an elapsed time to an hours-of-service method. 

A previous paper from T. Rowe Price discussed how advanced use of automatic features in plan design can achieve improvement in plan success measures. (See “Improving the Automatic Plan Design.”)

“Getting Beyond Ordinary—Managing Plan Costs in Automated Programs” is here.

Data & Research April 9, 2013

Target-Date Funds ‘Structurally Unsound,’ Paper Says

Though a worthy idea, the target-date (TD) fund concept appears to have been implemented hastily and poorly, a paper asserts.
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In the paper, “Target Date Funds: Structurally Unsound,” Marc Fandetti with Meketa Investment Group says, “The presence of serious structural flaws in the current generation of TD mutual funds suggests that most but not all such funds should be avoided by plan sponsors and investors, or at the very least used with extreme caution.” Fandetti argues that TD funds are expensive due to heavy reliance on active equity managers, and as such are priced (and behave) like actively-managed equity funds, and, actively managed TD funds likely cannot, on average, add alpha over time.  

“TD fund excess return (positive or negative, relative to a benchmark) can result from asset-allocation decisions, underlying manager decisions (both security selection and varying asset class or ‘beta’ exposure), or both. It is difficult for all but the most sophisticated plan sponsors and advisers to conduct rigorous enough performance attribution to truly get to the bottom of realized returns. And if such analysis is beyond the capability of many plan sponsors, it is almost certainly not possible for the vast majority of plan participants. In this sense, TD funds are opaque,” the paper says.   

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Fandetti advises that plan sponsor should understand the causes of under or overperformance relative to the TD fund manager’s chosen benchmark. If, for example, a TD fund manager’s over- or underperformance is attributable to asset allocation and not manager performance, the plan sponsor may want to look for similarly allocated TD funds that are less (or not at all) reliant on active management.  

When speaking about TD funds’ glide paths, Fandetti argues that “to quibble today about asset allocation decades hence is probably a distraction,” and “[c]urrent risk should probably weight (far) more heavily in plan sponsor or participant TD fund decision-making.”  

The paper can be downloaded from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2243185.

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