More Plans Institutionalize Investment Lineups

The report, “2013 Trends & Experience in Defined Contribution Plans: An Evolving Retirement Landscape,” was conducted by Aon Hewitt to determine trends in Defined Contribution (DC) retirement benefit strategies, plan designs and investment structures. Findings show a growing number of employers are placing greater emphasis on improving and institutionalizing their 401(k) investment lineups to boost participant returns and increase savings levels.

The report shows the number of companies adding non-mutual fund alternatives—such as collective trusts and separate accounts—to 401(k) lineups has increased over the past seven years.

While 59% of employers offered at least one such option in 2007, that figure has increased to more than 90% today. Forty-four percent utilized these vehicles as their primary fund options in 2013, up from 19% in 2007. According to Aon Hewitt, plans with more than $1 billion in assets are more likely to have over half of their investment options in non-mutual funds than plans with less than $1 billion in assets (61% versus 21%).

“Lower-cost institutional funds can substantially benefit participants because their fees are usually 30% to 50% lower than retail mutual funds,” says Winfield Evens, director of outsourcing investment strategy at Aon Hewitt in Lincolnshire, Illinois. “Institutional funds have long been an integral part of defined benefit plans, but have taken longer to become common in DC plans. Additionally, institutional fund fees are typically designed so that the more assets invested by the plan, the lower the expense ratio—which directly benefits participants in the form of higher returns.”

Diversified Options

Data from the report also shows that a growing number of employers are diversifying their 401(k) fund lineups by offering participants access to a wider range of investment options. The percentage of employers offering emerging market funds has doubled in the past two years, from 15% in 2011 to 30% in 2013. The percentage of plans offering short-term bond funds has increased as well, from 8% in 2011 to 14% in 2013.

Employers are also offering index—or passively managed—funds across a growing number of asset classes. “The index approach has been a mainstay among large-cap equity funds, but now we are seeing the passive approach become much more common in other asset classes,” says Rob Austin, director of retirement research at Aon Hewitt.

According to Aon Hewitt’s report, widespread investment classes that had a large increase in the index approach include mid-cap equity (59% in 2013 versus 42% in 2011), intermediate bond (53% in 2013 versus 42% in 2011) and international equity (50% in 2013 compared to 31% in 2011).

Fees and Participants

In the report, Aon Hewitt examines recordkeeping fees and how they are passed on by employers to plan participants. Findings show these fees are now paid in full by employees in more than three-quarters of plans.

Today, 26% of plans charge recordkeeping fees as a periodic line item to participants, up from 14% in 2011. The number of plans assessing recordkeeping expenses via fund-based fees—such as using mutual funds with revenue sharing agreements—decreased from 83% in 2011 to 52% in 2013.

According to Aon Hewitt, charging a flat rate for administrative or recordkeeping fees can have a significant impact on a participant's balance over time. For example, when such fees are charged as a $50 flat rate every year, a typical participant with a starting salary of $75,000 ends up having a balance at retirement that is $200,000 more than he or she would if the fees were instead charged as 0.25% of assets each year.

“Plan sponsors are discovering there are many cost-effective ways to significantly increase participants’ savings through reviewing and improving basic components of the plan,” says Austin. “In many cases, relatively minor changes in plan design can greatly benefit plan participants’ efforts to improve their retirement future.”

Other Findings

Plan sponsors are focusing more on costs. More than three-quarters say they have made efforts to reduce fund or plan expenses in their DC plans over the past two years, compared to just over half in 2007. In terms of methods used to reduce fees, 62% of plan sponsors switched share classes to lower-cost alternatives and half said they swapped out funds for lower-cost alternatives.

The report shows that fees are a top way of selecting fund options, with historical investment performance and the fund investment process rounding out the top three. In contrast, name recognition and availability in public sources was at the bottom of the priority list with plan sponsors.

“One of the most direct ways to increase participant balances is to increase their returns, which can be done effectively by decreasing investment fees without sacrificing investment quality,” says Austin. “Even small changes in 401(k) fees can have a significant impact on employees' nest eggs over time. For example, decreasing fees from 1% to 0.75% per year has the same effect on a typical participant as contributing an additional 0.50% of pay. This ultimately translates into thousands of dollars more in retirement savings.”

For the report, Aon Hewitt surveyed more than 400 DC plan sponsors, representing over 10 million employees in plans that total $500 billion in retirement assets. Information on downloading report highlights, as well as how to purchase a copy of the full report, can be found here.

Aon Hewitt is a provider of global talent, retirement and health care solutions.