Although the retirement system in the United States appears
to be stable, the system is actually quite vulnerable to financial disruptions
and economic shocks. This is according to the inaugural Retirement Plan
Landscape Report produced by Morningstar.
Loss of thousands of plans yearly
The report findings indicate the retirement system loses
thousands of plans and billions in assets each year and depends on the creation
of new plans to balance out those losses. Between 2011 and 2020, the U.S.
defined contribution plan system lost 380,000 plans, almost all from plans with
fewer than 100 participants, which accounted for 93 percent of plan
terminations and 97 percent of newly created plans, the report said.
Cash-outs, IRA roll-outs reducing assets
During that time, $4.61 trillion flowed out of plans in the
form of rollovers to IRAs and cash-outs, and the retirement system was able to
retain just $395 billion of those outflows through roll-ins and shifts to other
DC plans. A reduction of plan assets can impact the ability of plan sponsors to
negotiate favorable fee structures, the report said.
The pandemic did not dramatically impact retirement
security, although more plans were terminated in 2020 than in previous years
and fewer plans were created, the report said. But policymakers and plan sponsors
should be aware of the potential for financial disruptions and economic shocks
to destabilize overall retirement security, Morningstar said.
2,000 employers cover half the population of DC
participants
“The retirement system relies on a few thousand employers to
cover most people saving for retirement,” said Brock Johnson, president of
Morningstar Retirement Services. “An economic downturn or even a systemic shift
to different kinds of employment could mean even fewer people have the
opportunity to save for a secure future.”
According to the report, 2,115 companies cover half the
population in terms of DC participation. This dynamic has made mega plans –
those with more than $500 million in assets – more important to the retirement
system over time. In 2011, mega plans covered 34 percent of participants, but
by 2019 that percentage was closer to 43 percent. Not only do many trends
originate with these larger players, including fee contraction and target-date
fund defaults, but many plan innovations must gain traction within the large
plan segment in order to succeed broadly. These include lifetime income options
and more customization in default investments, the report said.
Not only small plans pay more fees, but their
participants do too
A less surprising but equally important finding of the
report is that most small plans carry higher investment fees than their larger
counterparts, Johnson said. People who work for smaller employers and
participate in small plans pay around double the cost to invest as participants
in larger plans. Congress recently established pooled employer plans (PEPs) to
help give smaller companies access to institutional pricing but so far those
plans have not gained much traction, the report said.
In addition, the fee spread among the smallest plans is
wider than among larger plans, which means employees in small plans are much
more likely to pay higher fees than those in large plans. However, the report
found that plan assets drive costs more than the number of participants. With
more assets, plans can negotiate lower fees and are more likely to offer
institutionally priced investment options, the study said. As a result,
benchmarks that use the number of plan participants are therefore often
inappropriate when estimating the likely plan fees for smaller plans.
Rise of less-regulated asset types
The study also found that larger plans have shifted away
from mutual funds as their investment vehicle of choice in favor of collective
investment trusts, which now represent about 45 percent of large plan
investments. These pooled trusts are similar to mutual funds but are less
regulated and often less expensive.
Overall, CITs have grown from 19 percent of assets in DC
plans in 2011 to 33 percent of assets in 2020, demonstrating the increasing
appeal of the CIT structure to plan sponsors. During that time CIT assets more
than quadrupled from $370 billion to $1.76 trillion in 2020, while DC plan
mutual fund assets doubled from $1.32 trillion to $2.92 trillion in 2020.
Despite the benefits, plans with fewer than $500 million in
assets have not shifted to using CITs in their investment lineups. The study
speculated that the CIT minimums might be too high for smaller plans and
sponsors may feel less comfortable with the plans or work with consultants,
advisors and providers that have less incentive to offer them.
Plans of all sizes continue to invest the majority of their
assets in actively managed funds, with smaller plans typically holding more
assets in active strategies. Across all plans, the study found that 58 percent
of DC plan assets are invested in off-the-shelf target-date funds.
Decline of DB plans
Finally, the report found that although their overall
importance in the retirement ecosystem is declining, defined benefit plans
continue to contribute meaningfully to retirement security, accounting for
nearly one-third of distributions in 2019. Total DB plan distributions continue
to rise as more participants reach retirement age.
Employers are shifting DB plans to DC plans through soft
freezes – not allowing new employees to join – or hard freezes – stopping
accruals for all participants. Both strategies create complexity around helping
participants figure out how much to save in new DC plans and adjust for
inflation. Personalized advice will be important to facilitate these
transitions, said the report.
Click here for the
original article.