401(k) Trends - Where We've Been and Where We May be Headed–Part 1

As presented to attendees of the NAPA 401(k) Summit April 15-17.

In February, the Plan Sponsor Council of America (PSCA) released the results our 60th Annual Survey of 401(k) and Profit Sharing Plans.  This week, I attended the National Association of Plan Advisors (NAPA) Summit for the first time to present on 401(k) plan trends.     

Much has changed during the 60 years PSCA has been surveying plan sponsors. Forty years ago, on November 6, 1978, President Carter signed Pub.L. 95-600 into law – the Revenue Act of 1978 – creating section 401(k). The Joint Committee on Taxation’s (JCT) General Explanation of the Revenue Act of 1978 confirms that Congress believed the 401(k)’s new non-discrimination rules would discourage deferrals. The federal budget impact projection: “This provision will have a negligible effect upon budget receipts.” A miss! In 2017, the estimated tax expenditure for defined contribution retirement plans was $69 Billion. The projected 10-year tax expenditures (2018 – 2027) is $1.05 Trillion!¹ We’ve come a long way. 

Historical 401(k) Trends

Our 60th Annual Survey confirms that many of today’s trends in profit sharing 401(k) plans trace their origins to the Pension Protection Act of 2006 (Pub.L. 109–280), signed into law by President George W. Bush on August 17, 2006. My focus at NAPA was on a number of those trends, from 2007 to 2016. Our survey confirmed: 

1. A near doubling of plans that deploy automatic enrollment, from 36% to 60%.
2. A 47% increase in plans with automatic features that deploy automatic escalation, from ~50% to 73%.
3. A doubling of plans that use a default contribution percentage greater than 3% of pay, from 27% to 54%.
4. A 66% increase in the percentage of plans offering target date funds, from 44% to 73%. 
5. A 247% increase in the percentage of assets actually allocated to target date funds, from 6% to 22%! 
6. A more than doubling of plans that offer access to Roth contributions, from 30% to 63%, while only 18% of eligible participants made Roth contributions.

Other Trends of Significance to 401(k) Plan Participation

Hindsight is 20/20. Confirming the results of all the hard work done by plan sponsors over the last 10 years was relatively easy. My challenge at the NAPA Summit was to anticipate future 401(k) trends for attendees. That required me to identify a number of underlying economic, demographic, and other trends that I believe will impact 401(k) plan designs and activity. Here are five I identified:   

1. Eighty-five percent of plans with automatic enrollment only apply those provisions to new hires.
2. Equity market declines are commonplace; since 1945, we have had 77 drops in the S&P 500 index of 5% – 10%, 27 drops of 10% - 20%, 8 drops of 20% - 40% and 3 drops of 40% - the last during the Great Recession of 2008-2009.²
3. Median tenure of American workers is < 5 years, 2.8 years for those ages 25 – 34;³  the median tenure for all wage and salary workers ages 25 or older was 5.1 years.⁴  Individuals born in the latter years of the baby boom (1957-1964) are now age 50 – they held an average of 11.9 jobs from age 18 to age 50, half of those during the ages 18 to 24.⁵   
4. Automation, digital platforms, and other innovations are changing the fundamental nature of work – diverging between high - and low-skill jobs. There is significant underemployment. Incomes have stagnated.  Many of today’s work activities have the potential to be automated. Digital platforms, like Uber, have created “independent” workers. We’ve seen an abrupt end to income advancement and a decline in the share of national income that is paid to workers, the so-called wage share.⁶ 
5. In 2018, 115MM (60%) of all American households are expected to earn < $86,000/year and will pay, as a group, in total, little or no federal income taxes.⁷

What is past is not prologue⁸ - Part 1

In The Tempest, Antonio states, “what is past is prologue.” All that has happened before (yesterday, the past) is expected to prompt “tomorrow.”  “What is past is prologue” is engraved on the National Archives Building in Washington, DC. Not so in our 401(k) marketplace. 

Assuming the current statutory and regulatory framework continues without significant change (big assumption), I expect some past trends will evolve. I also anticipate plan sponsors may consider and pursue different strategies over the next ten years.  Here are four new trends I believe may emerge:

A. Beyond new hires. Many past trends will continue – increases in automatic enrollment, escalation, and higher default contribution rates. However, once plan sponsors identify contribution/participation gaps among longer tenured employees, expect the nature of automatic features to change to apply to those who were hired before automatic enrollment was adopted.      

B. Target Maturity Models. Because target date funds qualify as Qualified Default Investment Alternatives (QDIA), expect the adoption and utilization of target date funds to continue. However, we are past due for a significant market correction. Given turnover rates and median tenure, many of today’s participants did not experience the market collapse of 2008-2009, were not in a target date fund, or were in a different 401(k) plan at that time. Some investment managers maintain significant equity weightings in 2020 target date funds.⁹ As a result, plan sponsors may not want to wait for the next market correction “surprise.”  Instead, they may want to reconfirm equity weightings with participants in target date funds. An alternative some will pursue is to change their QDIA to a series of target maturity models (electronic investment allocations across the plan’s core options based on a target retirement date). Here’s why: such options often feature less cost, an active/passive blend, an open architecture structure, white label/non-proprietary investments, along with fully transparent allocations.¹⁰ Further, a target maturity model structure:
- Improves participant understanding – fewer choices improves familiarity and reduces “choice blindness,”
- Reduces investment errors - participants never allocate only part of the account to a target date fund,
- Leverages a plan sponsor’s investment in fiduciary compliance concerning core investment options, and
- Lowers cost by concentrating assets in those core options – potentially creating economies of scale. 

C. Roth. I expect the trend to add Roth features will continue. However, the next ten years may see a significant increase in participants using Roth. In 2018, the majority of American households will pay little or nothing in income taxes. So, Roth contributions (and/or Roth conversions) might be fortuitous. And, because those who are automatically enrolled are often lower paid, shorter service, younger workers, many will be in as low of a federal marginal income tax bracket as they will ever experience. We’ll know this is a new trend should plan sponsors decide to change their automatic enrollment default from pre-tax contributions to Roth contributions.  

D. Competitive Advantage, Not Retirement Outcomes. Tenure/turnover trends show no signs of abating. Only a small minority of workers are expected to serve a full career with a single employer.  Coupling the tenure/turnover trends with qualification requirements (eligibility, discrimination, vesting, etc.), it seems clear that more plan sponsors will conclude, in the future, that broad-based benefit plans like the 401(k) are not differentiators of talent. So, some plan sponsors may change how they define success for their 401(k) plan:
- From:  An “industry standard,” or “competitive” 401(k) plan, or a plan mostly focused on “successful retirement outcomes/preparation,”¹¹  
-To:  A “Competitive Advantage,” where the new metric is the effectiveness of the 401(k) within a total rewards strategy (attraction, retention, engagement, wealth accumulation, etc.) versus what would be achieved by a comparable level of spend on salary, incentives, and/or other benefits.  

In Part 2 of this series we will identify other 401(k) plan trends.    

^1. Treasury, Office of Management & Budget, October 2017, Accessed 4/17/18 at:  https://www.treasury.gov/resource-center/tax-policy/Documents/Tax-Expend...
^2. Guggenheim, Putting Pullbacks in Perspective, Ned Davis Research Group, 2017, Accessed 4/17/18 at:  https://www.guggenheiminvestments.com/putting-pullbacks-in-perspective 
^3. Census Bureau, Employee Tenure in 2016, 9/22/16, Accessed 4/17/18 at:  https://www.bls.gov/news.release/pdf/tenure.pdf 
^4. Craig Copeland, Employee Tenure Trends, 1983 – 2016, Employee Benefits Research Institute, September 2017, Accessed 4/17/18 at:  https://www.ebri.org/pdf/notespdf/EBRI_Notes_v38no9_Tenure.20Sept17.pdf
^5. Bureau of Labor Statistics, Number of Jobs, Labor Market Experience and Earnings Growth Among Americans at 50:  Results from a longitudinal survey, 8/24/17 Accessed 4/17/18 at:  https://www.bls.gov/news.release/pdf/nlsoy.pdf   
^6. James Manyika, Technology, jobs, and the future of work, McKinsey Global Institute, May 2017, Accessed 4/17/18 at: https://www.mckinsey.com/global-themes/employment-and-growth/technology-...  
^7. Laura Sanders, Top 20% of Americans Will Pay 87% of Income Tax, Wall Street Journal, 4/6/18, Accessed 4/17/18 at:  https://www.wsj.com/articles/top-20-of-americans-will-pay-87-of-income-t... citing a study of the Tax Cuts & Jobs Act of 2017 by the Tax Policy Center.   
^8. With apologies to Shakespeare, The Tempest, Act II, Scene 1 
^9. As of March 31, 2018, Fidelity Freedom 2020 (58%), Vanguard Target Retirement 2020 Fund (54%), T. Rowe Price Retirement 2020 Fund (56%).   
^10. Jack Towarnicky, Default Is Not Mine — I Only Live Here, Considerations regarding target-date funds as the plan QDIA. DC Insights Leadership Letter, Winter 2017, “…  The 2008–2009 market decline during the Great Recession exposed significant differences in TDF allocations.  One study of 2010 target date funds had equity allocations that spanned: “…a startling range … — from 72 percent to 26 percent.” That certainly was a surprise — many participants had little inkling of their QDIA’s equity risk exposure — triggering Congressional and Agency hearings.”  Accessed 4/17/18 at:  https://www.psca.org/download/default-is-not-mine-i-only-live-here 
^11. Anne Lester, Daniel Oldroyd, Helping improve participants’ retirement outcomes – Three practical steps still apply, JP Morgan, 12/15/17, Accessed 4/17/18 at:  https://am.jpmorgan.com/us/institutional/library/ltcma-defined-contribut... See also: Joe DeSilva,  Improve retirement outcomes for your employees, 3/8/17, ADP, “…  Reviewing plan metrics like "Percentage of employees on track to replace 80% of their income" and "Income replacement ratio" provide insight into participant preparations to retire, plan effectiveness, and how you are doing as plan fiduciary. …”, Accessed 4/17/18 at:  https://www.adp.com/spark/articles/2017/03/improve-retirement-outcomes-f...   See also:  Helping drive positive retirement outcomes, A Plan Sponsor Checklist, April 2017, Accessed 4/17/18 at:  https://www.tiaa.org/public/pdf/C31196_Driving_positive_retirement_outco...