‘Sea Change’ Coming to Target Date Funds: Callan Survey

Callan’s Defined Contribution Trends survey released in January reveals that meaningful shifts occurred in the defined contribution landscape in 2014—many of which point to more institutional approaches to DC plans. This includes changes to target date funds (TDFs), increased use of automatic enrollment, and a rethinking of the ways that plans pay fees.

At the same time, there has been a surprisingly muted response to some of the recent regulatory changes and litigation around money market funds, longevity insurance, and company stock.

A sea change for target date funds: Last year’s DC Trends survey showed indications of a coming sea change in target date funds, as more than a third of plan sponsors in 2013 said they intended to make changes to their target date fund in the next 12 months. Indeed, one in 10 plan sponsors noted that they’d replaced their target date fund/balanced fund manager in 2014. The replacements often came at the expense of the plan’s record-keeper.

The proportion of plans that offer their record-keeper’s proprietary TDF declined precipitously in 2014, from 47.5 percent in 2013 to 28.7 percent in 2014. Plan sponsors expect this number will decrease even further to 23.6 percent in 2015.

In another major development, use of custom TDFs surged from 11.5 percent in 2013 to 22.3 percent in 2014.

Automatic enrollment becoming the norm: The survey illustrates that automatic enrollment is becoming the norm, with prevalence increasing for the fourth year in a row, reaching 61.7 percent of plans in 2014. Only one-third of plans offer both automatic enrollment and automatic escalation, and the defaults generally remain far from robust — 3 percent of pay is the most common contribution rate default under automatic enrollment, and 6 percent of pay is the most common cap under automatic contribution escalation.

Plan sponsors rethinking the way fees are paid: A key step plan sponsors took over the past 12 months was to review plan fees. One outcome of this review was a noticeable spike in changes to the way fees were paid. More than twice as many plan sponsors changed the way fees were paid in 2014 as in 2013 (17.5 percent in 2014 vs. 7.7 percent in 2013).

Lukewarm response to changes in the regulatory and legal landscape: Plan sponsors are taking a wait-and-see approach to changes in the regulatory and legal landscape. The Supreme Court’s ruling against using presumption of prudence as a DC stock-drop case defense did not spur immediate changes among plan sponsors. It appears that many are waiting to understand the full implications of the ruling.

Few plan sponsors are making changes to their investment fund lineup despite the Securities and Exchange Commission’s recent amendments to money market regulations. Even though the U.S. Treasury issued regulations in 2014 facilitating the use of longevity insurance in qualified DC plans, very few plan sponsors say they are very likely to add longevity insurance in 2015.

Other trends of note:

• The prevalence of Roth contributions in Defined Contribution plans increased sharply, from 49 percent in 2013 to 62.3 percent in 2014. This is largely driven by 401(k) plans, 75.8 percent of which offer a Roth contribution feature. In addition, more than one in five plan sponsors are considering adding a Roth option in 2015 (22.6 percent). This figure is significantly higher than previous years.

• More than a quarter of plan sponsors (27.3 percent) increased the proportion of index funds in the plan. This trend should continue in 2015.

• Many plan sponsors are providing a retirement income projection to participants, and communicating about retirement income adequacy is a high priority; however, few sponsors use retirement income adequacy to measure the success of their plan. 

See allso:

John Sullivan
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With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.

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