This article originally appeared in the Fall 2014 issue of Plan Consultant. To view a PDF version, including accompanying charts and sidebars, please click here.
Plan sponsors continue to seek ways to simplify the investment decisions of their participants and improve the manner in which investments are allocated. While putting new employees on the right path to retirement success can be accomplished relatively easily through automatic enrollment, plan sponsors face a unique challenge in motivating existing participants to make changes to their investment options that may be highly beneficial for them in the long run.
Though many plan sponsors have engaged in robust participant education efforts, inertia has persisted and there is a general lack of confidence that participants are appropriately diversified within their 401(k) portfolios. As Fig. 1 illustrates, only about one-third of plan sponsors are highly confident that the majority of participants has an appropriate asset allocation. Plan participants themselves are even less confident, with only 25% of them highly confident in their ability to appropriately allocate their savings across available options.
Fig 1 - Lack of Confidence in Participants’ Ability to Allocate
Plan sponsors have sought to address this issue by incorporating target date funds into their investment menus. These vehicles, which provide age-appropriate diversification, can potentially provide participants and plan sponsors alike a greater comfort level with how assets are allocated.
Evaluating Options That Can Help Simplify Participant Asset Allocation Decisions
Generally speaking, there are three basic approaches plan sponsors can use to increase participant adoption of TDFs, which are usually the QDIA of choice.
- Add-to-the-menu: Add TDFs to a plan’s investment lineup and allow participants to choose for themselves.
- Investment re-set: Transfer, or “map,” participants’ existing assets and subsequent contributions into TDFs and allow changes only after the transfer has taken place.
- Re-enrollment: Move participants’ existing assets and subsequent contributions to the age-approprate TDF. As a result, assets are automatically moved on a certain date unless the participant opts out or makes a different investment election before the designated deadline.
In the past, many plan sponsors selected the add-to-the-menu strategy because they believed participants should decide on their own how to invest their savings. This approach has left many plan sponsors disappointed with the results. Based on J.P. Morgan’s research, the typical adoption rate for adding TDFs to the menu is only 1% to 5%.
Alternatively, plan sponsors that choose to directly re-set em¬ployees into a TDF typically enjoy substantially greater adoption rates of 80% to 90%. But one major drawback to this process has been that a re-set does not provide safe-harbor protection to the plan sponsor since the participant was not given the option to opt out or make a new investment election before the assets were moved.
Understanding the Benefits of Re-enrollment
Of the primary options available to plan sponsors seeking to increase the use of TDFs by participants, a plan re-enrollment offers the most appealing combination of potential advantages to both plan sponsors and participants.
Allocation and Diversification
A re-enrollment helps to overcome participant inertia by helping those investors who may benefit from professional management and defaulting their savings into age-appropriate portfolios (while still giving other more sophisticated and active participants, the opportunity to make their own investment decisions). At the same time, it provides plan sponsors with greater confidence that participants’ assets will be more appropriately diversified within their 401(k) plans.
Implementation Strategy
It’s not enough for plan sponsors to simply add a suite of TDFs to their plan and expect participants to allocate funds to these options. Instead, plan sponsors need to execute an implementation strategy that encourages greater usage of the TDF.
Research has shown that implementing a re-enrollment strategy can have a dramatic impact on improving the overall asset allocation of many participants in a short period of time. For instance, J.P. Morgan research shows that many plan sponsors who conduct a re-enrollment see significant TDF adoption rates, regardless of the type and size of the plan (see case study below).
A re-enrollment can be implemented regardless of whether a plan sponsor is converting to a new record keeper or staying with its current one. Plan sponsors can also use the strategy when making changes to the plan’s investment menu or simply as a way of encouraging shifts in invest¬ment allocation.
Safe-Harbor Protection
Regardless of when it is conducted, a re-enrollment can offer safe-harbor protection to plan sponsors for the assets that are defaulted into a QDIA. Though re-enrollment has been used successfully by many plan sponsors, many other plan sponsors are either unaware of its availability or unfamiliar with the potential benefits. In fact, J.P. Morgan’s plan sponsor research revealed that 56% of plan sponsors are not aware they would receive fiduciary protection for participant assets defaulted into a plan’s QDIA during a re-enrollment (see “Fiduciary Considerations” sidebar on page X.).
Making a Difference with Re-Enrollment
Re-enrolling participants into investment options such as TDFs, which provide professional management and increasingly conservative risk/return profiles as retirement approaches, can not only help improve asset allocation, but also maintain an appropriate allocation over time. These options also help minimize extreme outcomes by providing participants with a more consistent investment experience than the portfolios individually constructed by most “do-it-yourselfers” or brokerage users (see Fig. 2).
Fig. 2 Standardized 5-Year Returns — Highs, Lows and Medians by Investment Strategy
Plan sponsors that have not yet conducted a re-enrollment may want to consider this strategy for improving their participants’ asset allocation. Ultimately, a re-enrollment can offer sponsors a dual reward: the opportunity to benefit from safe harbor fiduciary protection, while providing a well-diversified investment experience for participants seeking a secure retirement.
Case Study
Consider the experience of one plan sponsor with roughly 1,650 partici¬pants and more than $60 million in assets. The sponsor was concerned its participants were making poor asset allocation decisions that would diminish the investment results of their retirement accounts.
After careful analysis, the plan sponsor decided to:
- Introduce target date funds (TDFs) as part of its investment lineup as one way participants could more appropriately diversify how they were investing their retirement funds.
- Conduct a re-enrollment in which participants who failed to make investment elections would be defaulted (unless they opted out) into an age-appropriate TDF designated as the plan’s Qualified Default Investment Alternative (QDIA).
- Execute a multi-channel communications strategy to clearly outline the re-enrollment process, how it will affect participants, and any actions they need to take.
As the exhibit below illustrates, prior to the availability of TDFs, roughly two-thirds of the plan’s assets were invested in equities. Following re-enrollment, however, 57% of the plan’s assets (representing 63% of participants) were invested in an appropriate TDF based on the participants’ ages. After the process was complete, the plan sponsor received very positive feedback, with relatively few participants — only 2% — raising questions about the re-enrollment.
One year after completing the re-enrollment, 57% of the plan’s assets (now representing 61% of participants) remain invested in TDFs, and both the plan sponsor and its participants continue to reap important benefits:
In addition to continuing to offering a wider range of investment choices to participants, the plan sponsor is receiving safe-harbor protection for the defaulted assets.
Many participants are continuing to invest in professionally managed and broadly diversified investments that offer the potential for improving their chances of replacing more of their income at retirement.
Fig. 3 - Re-enrollment Case Study: A Dramatic Shift in Asset Allocation
Catherine Peterson is the Global Head of Insights Programs at J.P. Morgan Asset Management.
IMPORTANT DISCLOSURES FOR PERSONAL RATE OF RETURN METHODOLOGY. Rate of return is calculated for active participants by an investment strategy using the Modified Dietz method and is based upon volatility between the highest rate of return and the lowest rate of return associated with each investment strategy among such participants. Services associated with the identified investment strategies were available as of the last day of the measurement period, but may not have been available throughout the measurement period.
Target date fund users are participants with at least 70% of their account balance invested in target date funds as of the first and last day of the measurement period. Do-it-yourselfers are participants with less than 70% of their account balance invested in target date funds as of the first and last day of the measurement period and also includes participants using online advice services, if applicable. Managed account users are participants with at least 70% of their account balance managed by a discretionary investment service as of the first and last day of the measurement period. Brokerage users are participants with at least $1 in a brokerage account as of the last day of the measurement period.
TARGET DATE FUNDS. Target date funds are funds with the target date being the approximate date when investors plan to start withdrawing their money. Generally, the asset allocation of each fund will change on an annual basis with the asset allocation becoming more conservative as the fund nears the target retirement date. The principal value of the fund(s) is not guaranteed at any time, including at the target date.
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Contact JPMorgan Distribution Services at 1-800-338-4345 for a fund prospectus. You can also visit us at www.jpmorganfunds.com. Investors should carefully consider the investment objectives and risks as well as charges and expenses of the mutual fund before investing. The prospectus contains this and other information about the mutual fund. Read the prospectus carefully before investing.
Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
JPMorgan Funds are distributed by JPMorgan Distribution Services, Inc., which is an affiliate of JPMorgan Chase & Co. Affiliates of JPMorgan Chase & Co. receive fees for providing various services to the funds. Products and services are offered by JPMorgan Distribution Services, Inc., is a member FINRA/SIPC.
J.P. Morgan Asset Management is the marketing name for the asset management businesses of JPMorgan Chase & Co. Those businesses include, but are not limited to, JPMorgan Chase Bank N.A., J.P. Morgan Investment Management Inc., Security Capital Research & Management Incorporated and J.P. Morgan Alternative Asset Management, Inc.
© JPMorgan Chase & Co., 2014. Used by permission.
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