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The 401(k) Today

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.

I recently attended the Dimensional Fund Advisors Defined Contribution Conference, and I had the opportunity to sit down with David Wray. David is the president of the Profit Sharing/401(k) Counsel of America, and he discussed some of the trends he sees in the 401(k) market.

David you are in a unique position to observe trends that are going on in the 401(k) marketplace. One thing I would like to talk about with you is the uptake of the Roth option in plan. So, first of all, are you seeing more plans install the Roth option, and second our participants taking advantage of it?

David Wray: Well, there is no question that this is a change in the system. In our most recent survey data, 40% of plans now offer a Roth option. It's a fairly substantial change over a 10-year period when they've been available, or talked about.

So, employers want to give employees the maximum opportunity to customize their programs, and one way to do that is to let them customize their tax diversification, if you will. So, companies are putting Roth in, and interestingly enough the usage is also coming as well. So, it's certainly not 40% of employees who have Roth, but clearly an increasing percentage of participants who can use Roth are using them.

Benz: Can you tell does, it tend to be participants with higher balances, higher incomes taking advantage of that?

Wray: It's the more sophisticated participants, which typically are older participants with higher balances, as you would expect. Younger people, they just want to go with whatever the flow is, and that's typically the deferred arrangement.

Benz: Right. So, let's talk about how 401(k) participants behaved during the bear market. I think there was a lot of hand-wringing about whether we would see mass exodus out of 401(k) plans--people doing wholesale withdrawals. What did you see when you observed participant behavior?

Wray: What I saw was a remarkable stability. Participants--we lost very few people actually leaving the system. To the extent you actually had actively employed participants stepping back, it was where their companies dropped their match. The match is really critical to participation in the system.

But where the matching contributions continued, and that was still at most companies, participants stayed the course. They didn't change their asset allocations all that much. They didn't stop saving in the plans. They didn't take a lot of hardship withdrawals. The loan--everything ticked up a little bit, but it's sort of at the top of the normal range. I mean, if you go back over many years, you would see some volatility in the percentage of employees doing these various things. So, it's ticked up, but it's still not massively different than it's been historically.

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Benz: So, we've seen a move to try to nudge 401(k) participants in various directions to help them make better choices, so by auto-enrolling them, by moving them into the target date option versus keeping them in the stable value or cash option. Do you foresee any other changes in that area, any other attempts to kind of nudge 401(k) participants further?

Wray: Well, I mean, the whole nudging concept is actually an evolution. Initially it was thought, well, we'll just automatically enroll people, we'll put them in some kind of diversified investment, and we are done. And I think what everyone sees is that that's not a complete solution. You can't automatically enroll somebody at a percentage of pay that is going to get them out of the plan. I mean, you have to be something that's comfortable. But clearly getting them in the plan, which it does very well, is not still saving adequately. So, if we're going to save adequately, we need to build on to that with additional layers of change, and one of the things that's happening is we see companies with automatic enrollment adding escalation. In our survey, 40% of the companies with automatic enrollment now have escalation.

Benz: So, when people get a raise, their contribution gets bumps up?

Wray: Their contribution bumps up, it so goes from 3% to 4%, 4% to 5%, 4% to 6%. And most plans don't stop at the amount to get the match. They actually go to 10% or even higher, so the participant can kind of just let this run until they get to pretty substantial savings rates.

The other thing is that companies continue to offer more and more other kinds of support. The educational programs have been enhanced. The Internet is great at that, because you can provide all kind of modeling programs. The Internet is a huge support, because 24x7 people can get information, and you know when you're going to reach a participant is when they want to be reached--not when you shove something on their desk. So, the Internet has really helped.

The use of advice, more and more companies offering advice to participants so that everyone gets additional support. So, the idea is, yes, we have sort of a generic bottom line, a baseline, but we got to get people off the baseline, and that's where we get them to start saving. Then we need to take additional steps. I think you're seeing the system recognize that, and change to a more adequate level.

Benz: So one big area of concern has been when people leave the workplace and pull out of their 401(k) what they do with those assets. So, even though there are a lot of academic papers that point to annuities a being a good choice for retirees--there was a recent GAO study that I think said something like 6% of retirees actually choose an annuity once they exit the 401(k) plan. Do you have any thoughts on how we could give more hand-holding or provide more guardrails for folks once they leave that 401(k) setting?

Wray: Well, it's important to recognize the reason 401(k) plans are popular and successful is because people believe that the money in the 401(k) is theirs, they are in control--even if they're being passively managed, they are in control. So, right now, participants still, they still want the sense of control that a lump sum gives them, but what's happening, I think, is we're seeing an evolution in the approach to this.

If you go back a few years, a lot of the philosophical conversations was, "Well, participants need to annuitize a 100% of their balance because otherwise they're going to blow their money and they make all these mistakes." And I think there's an emerging recognition that what you need is a combination solution. Annuities are maybe part of the solution, so partial annuitization based on your customized need arrangement, maybe you have legacies or you have other investments or whatever. So, the idea of a customized level is clearly emerging, I think, as a best practice. Then the question is, so how do you deliver that? And what I think is emerging is the availability of purchasing platforms where the participant can determine what kind of annuity amount they need, and then they could go and get a competitive priced annuity product from great insurance companies, and then they could chose. But they are not restricted to one company and one outcome.

So, I think we're seeing a lot more flexibility develop in the purchase of annuities. I think that that's how this is going to go. Probably what the employer role here will be is more help in making that decision. I don't see the employers wanting to make the annuity decision. They don't want to decide how much the annuity should be, and they don't want to pick the provider. They feel that that has to be a responsibility of the participant who is going to live with that decision for the next 30 years.