The new year is a time to make resolutions and predictions. I'll leave the resolutions to you, but I will venture forth with some predictions about what's in store for 401(k) plans in 2010 and beyond.
Despite the continuing recession, 401(k) providers will still be engaging in what I call the 401(k) "arms race" - that is, offering more and more features to plan sponsors. In the early 1980s, when 401(k) plans began to evolve, plan features were pretty basic.
But as they grew more prevalent and competition became more intense, plans became more robust with the addition of daily valuations, loans, self-directed brokerages, Web access, investment education tools, multishare classes and fiduciary assistance.
Here are three more plan features that you are likely to see more of in 2010 and beyond:
Individually managed accounts
This is a plan option through which a 401(k) participant can elect to have his or her account professionally managed. A new survey by Hewitt Associates shows that more midsized-to-large employers are increasing their efforts to help employees meet their retirement income needs by adding outside investment advisory services. Approximately 50% of employees use such services (including advice, guidance and/or managed accounts), an increase from 40% in 2007, and 37% in 2005.
Maybe the 2008 meltdown was a wake-up call that investment education programs simply haven't worked and that employees have done poorly on their own. A DALBAR study showed that while the S&P 500 earned an average return of 8.41% from 1988 to 2008, the average equity investor earned a mere 1.87%.
Regardless of the reason, more employers - particularly smaller employers - will be adding a managed account option that has two components. The first is personalized one-time investment recommendations. After that, participants are responsible for ongoing account monitoring, rebalancing and management.
This appeals to participants who like to take an active role in managing their retirement account, and there is usually no cost. The second component of a managed account is ongoing discretionary investment management for a fee, paid for by the individual participant.
401(k) interfaced with payroll
The second 401(k) trend is employers interfacing their plans with their outside payroll provider. The U.S. payroll market is dominated by three major players with approximately 44% of the market: ADP, Paychex and Ceridian. The rest of the market is shared by mostly small, regional players that cater to employers at the very local level.
The industry's growth is coming from the small employer market since the propensity to outsource continues to be tied to organizational size: The smaller the firm, the more likely it is to outsource. The three major payroll companies have offered a payroll-401(k) package that includes recordkeeping and investment funds. Now providers in the small plan marketplace are forming strategic alliances to stay competitive.
The appeal should be obvious. It allows employers to reduce their administrative involvement with both payroll and 401(k) plans. An interface allows employee and 401(k) participant data to be shared and updated in the course of the employer's normal payroll processing function. How this translates into cost-savings is an analysis that has to be done on an individual basis.
Distribution planning help
The third trend is employers putting programs in place to encourage terminating employees not to cash out.
While the good news is that the cash-out rate hasn't changed much since 2005 despite job losses, according to a recent Hewitt study, the bad news is that almost 50% of terminated participants take cash distributions.
It's a costly decision in terms of ultimate retirement income, particularly for those in their 20s. Terminated employees who cash out will miss out on years of tax-deferred growth in their account.
Here is an example using a recent study on cash-out trends by the Employee Benefit Research Institute. The average amount taken was $32,000, although most distributions were smaller, with about a quarter of them $2,500 or less. Let's assume that a 25-year old terminated employee cashes out his or her account. The worker will wind up with only $1,500 after paying $250 in penalties and $750 in taxes. If rolled over to an IRA, however, that $2,500 account balance could grow at 7% earnings to $37,436 at 65.
Fortunately, more employers are starting to recognize that they can do more to increase participants' retirement readiness by providing resources for the distribution planning phase, including information on the costs of cashing out, education about distribution choices and access to independent investment options beyond IRAs.
Helping employees make better decisions is more important now than ever before. It's a 401(k) world now for employer-sponsored retirement plans, and the majority of future retirees will never participate in a defined benefit plan that provides a guaranteed income for life. For them, it will be a defined contribution plan, personal savings and Social Security.
Best wishes for a healthy and prosperous New Year.
Contributing Editor Jerry Kalish is the founder of The Retirement Plan Blog and president of National Benefit Services, Inc., a Chicago-based employee benefit consulting and administrative firm.
