5 Key DC Trends from New Morningstar Retirement Report
Retirement plans from just 2,115 employers cover fully half of workers with 401k plans in the U.S., and the defined contribution plan system adds close to 2 million new participants each year.
These are just a couple of the notable insights coming out of the Morningstar Center for Retirement & Policy Studies inaugural Retirement Plan Landscape Report, offering an in-depth look at the key trends and forces reshaping U.S. retirement plans.
Here we’ll take a closer look at the often-surprising key findings from the new report, the first from this new unit of Morningstar charged with a mission to improve the U.S. retirement system by arming decision-makers with unbiased and actionable data and analysis.
NEXT PAGE: 401k Churn Dominated by Small Plans
#1: 401k Churn Dominated by Small Plans
Over the 10-year period between 2011 and 2020, the Morningstar report more than 420,000 new DC plans were created and more than 380,000 (or about 38,000 per year) were terminated—mostly due to the employer going out of business. Almost all this churn was among plans with fewer than 100 participants, which accounted for 93% of plan terminations and 97% of newly created plans.
The total number of private-sector DC plans has been mostly stable, starting at about 628,000 in 2011 and steadily adding around 4,056 net new plans a year through 2020. The number of employers offering DC plans follows a nearly identical trajectory, with slightly fewer employers than plans, as some employers maintain multiple retirement plans.
The system also added around 1.8 million new DC participants each year, rising from 64.5 million participants in 2011 to 82.7 million participants in 2020.
While small plans account for almost all the churn, a relatively small number of large and mega plans—2,115—actually cover about half of those 82.7 million 401k participants in the U.S.
Plans with more than $500 million in assets—which Morningstar terms mega plans—have become more important to the retirement system over time. In 2011, these mega plans covered just 34% of participants, but by 2019, they had added almost 13.5 million more people and covered 43% of plan participants. Meanwhile, small and medium plans with $100 million or less in assets grew only modestly and covered a slightly smaller percentage of participants.
NEXT PAGE: Small Plans Pay Much Higher Fees
#2: Small Plans Pay Much Higher Fees
People who work for smaller employers and participate in small plans pay around double the cost to invest as participants at larger plans, around 88 basis points in total compared with 41 basis points, the Morningstar report reveals.
“It is clear that the industry needs to do a better job helping these employers so that their workers have the same opportunities to save for retirement as those who work for much larger companies,” the report states. “Based on these findings, people working for employers with small plans could easily have 10% fewer assets in retirement than they would if they saved just as much and worked for an employer with a larger plan.”
Small plans also feature a much wider range of fees between plans, with more than 30% of plans costing participants more than 100 basis points in total. Further, many plans are still outliers, with unusually high fees relative to their peers, particularly outside of the largest thousand or so plans. “In short, the U.S. system does not work nearly as well for people who are not fortunate enough to work for larger, established employers. Congress recently created pooled employer plans, which could help close this gap somewhat, but so far there has been little uptake,” the report states.
Not all small plans are expensive. Some employers with small plans report total costs that are competitive with larger plans. In fact, 23% of small plans cost participants less than the median cost for medium plans of 63 basis points.
Medium plans are less likely to consistently offer a good deal to their participants than larger ones. More than 20% of medium plans have total costs of more than 80 basis points, compared with just 1% of mega plans.
NEXT PAGE: DC Asset Growth Stable
#3: DC Asset Growth Stable
Plan assets appear stable and growing, steadily increasing most years over the past decade by an average of nearly $500 billion a year, rising from $3.76 trillion in 2011 to $8.25 trillion in 2020, albeit with some years in which assets declined relative to previous years.
In fact, plan assets actually shrink in years without strong investment returns. A few years of poor returns would reduce many plans’ assets, their market power, and thus their capacity to offer institutionally priced investment options.
The defined contribution system relies heavily on new contributions and strong returns to mask outflows of more than $400 billion a year since 2015, as reported by plans in their annual filings. Morningstar estimates that almost $4.61 trillion flowed out of retirement plans over this period in the form of rollovers out of the DC system to Individual Retirement Accounts and cashouts, including some benefit payments.
NEXT PAGE: Large Plan Shift from Mutual Funds to CITs
#4: Large Plan Shift from Mutual Funds to CITs
The largest plans in the U.S. started to abandon mutual funds 10 years ago and today hold nearly 45% of their assets in collective investment trusts—pooled vehicles that often offer similar strategies but are less regulated and can be much less expensive for participants. Morningstar also found that plans of other sizes have not increased their use of collective investment trusts at all.
Since 2011, CITs have grown from 19% of assets in DC plans, up to 33% of assets in 2020. Over that time, DC plan CIT assets more than quadrupled from $370 billion to $1.76 trillion in 2020, while DC plan mutual fund assets merely doubled from $1.32 trillion to $2.92 trillion in 2020.
CITs can offer a significant benefit to workers saving for retirement through reduced expenses, as they typically charge participants less than mutual funds. This difference in costs is mostly because CITs are not marketed nor regulated in the way that mutual funds are. When comparing the net expense ratio of CIT tiers and mutual fund share classes of the same strategy, CITs are cheaper 91% of the time, and even considering only the least-expensive CIT tier and mutual fund share class, CITs are cheaper 82% of the time.
Plans of all sizes continue to invest the majority of their assets in actively managed funds, with more assets in active strategies among smaller plans. “In terms of sustainability, we see evidence that retirement plan participants are exposed to higher-than-normal environmental, social, and governance risks, although some plans have investment options that account for these risks,” the report states. “In sum, most plan sponsors invest in similar strategies, but only the largest plan sponsors have adopted the vehicle that typically lets them offer the lowest cost, collective investment trusts.”
NEXT PAGE: Greater Usage of TDFs in Small Plans
#5: Greater Usage of TDFs in Small Plans
Across all plans, the Morningstar report found that 58% of DC plan assets are invested in off-the-shelf target-date funds.
“We do not see big differences between medium, large, and mega plans, but small-plan participants have two-thirds of their assets in TDFs,” the report found. “The greater usage of TDFs in small plans is probably due to the fact that these plans are most likely to use an off-the-shelf TDF as their default investment, while some larger plans may use a custom TDF or separately managed accounts.”
In terms of plan investment vehicles, CITs hold a higher percentage of assets in TDFs than mutual funds. A little under 50% of assets plans held in CITs are in TDFs, but just 30% of mutual fund assets are in TDFs.
To the extent they still use mutual funds, mega plans are much less likely to rely on them for a TDF and much more likely to select a CIT. Just 26% of mega-plan mutual fund assets are in a TDF, whereas 48% of these plans’ CIT assets are in a TDF.
Small plans rely on mutual funds for TDFs, probably because these plans have a harder time attaining the minimum investment size they need to offer a CIT of any kind.
NEXT PAGE: Bonus! Morningstar Investment Conference Lineup
Bonus Page: Morningstar Investment Conference Lineup
In addition to releasing the inaugural Retirement Plan Landscape Report, Morningstar this week also announced the agenda for its 2022 Morningstar Investment Conference, set for May 16-18 in Chicago.
The speaker lineup is highlighted by former U.S. Ambassador to Russia Mike McFaul and Franklin Templeton CEO Jenny Johnson. In the session, “Geopolitical Order Disrupted,” McFaul will talk about a forgotten source of uncertainty: global geopolitical risk.
Morningstar Director of Personal Finance and Retirement Planning Christine Benz will also be speaking, as will David Giroux, chief investment officer for equity and multi-asset, T. Rowe Price, and Karsten Jeske, chief economist, Valravn Capital.
Other featured speakers include Morningstar CEO Kunal Kapoor; Causeway Capital Management CEO Sarah Ketterer; game designer and author Jane McGonigal; University of Chicago economist and professor Raghuram Rajan; and Fidelity Institutional portfolio manager Sammy Simnegar.
Conference attendees will also hear from a panel of Morningstar equity and Sustainalytics analysts who will share their perspective on the outlook and ramifications of many companies’ commitments to net-zero carbon emissions by 2050.
New to the conference this year are eight 30-minute “idea sessions,” where financial professionals will explore hot topics in investing such as public policy with Morningstar’s Aron Szapiro, who co-authored the Retirement Plan Landscape Report.
“This year’s conference agenda presents another robust lineup of timely content for investors, from sustainable investing to digital currencies and geopolitical risk,” said Kunal Kapoor, chief executive officer at Morningstar. “These latest industry evolutions are arriving at a moment defined by investor engagement and opportunity.”
More information about the Morningstar Investment Conference is available at https://cvent.me/N9M9Vx.
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• Morningstar Launches Research Center to Improve U.S. Retirement System