403(b) Plan Investment Lineups Have Changed

Annuities were the only investment type 403(b) plans were allowed to use prior to passage of the Employee Retirement Income Security Act (ERISA) in 1974. ERISA added custodial accounts, i.e., mutual funds, as permissible investments.

Historically, there was little plan sponsor involvement in 403(b) plans, with participants meeting directly with investment providers and setting up accounts. Plan sponsors often merely facilitated the transfer of funds to participants’ accounts from payroll. This resulted in plans with multiple providers and, for many larger plans, hundreds of annuity contracts.

However, as a report from BrightScope and the Investment Company Institute (ICI) points out, since IRS regulations passed in 2007—which encouraged more plan sponsor responsibility—403(b) plan investment menus have drastically changed.

The BrightScope Defined Contribution Plan Database, which contains detailed information from audited Form 5500 reports for large ERISA 403(b) plans that filed Schedule H (typically plans with 100 participants or more), shows mutual funds were the most common investment vehicle in large ERISA 403(b) plans, representing 60% of assets in 2017. Variable annuities held an additional 21% of assets, and fixed annuities held 19%.

According to the BrightScope/ICI report, participants had 40 investment options, on average, in 2017. Not including legacy options—prior participant investment options that no longer accept new contributions—the average number of core investment options was 26 among large ERISA 403(b) plans. The report primarily focuses on investment options that hold at least 0.5% of total plan assets to define core options and leave out legacy options.

Domestic equity funds, international equity funds and domestic bond funds—including both index and active investment styles—were the most likely core investment options to be offered in large ERISA 403(b) plans in 2017. Nearly all plans offered these types of funds, which can be mutual funds or variable annuities. In addition, 53% of plans offered money funds in their core investment lineups.

Nearly half of plans offered non-target-date balanced funds, and more than eight in 10 plans offered target-date funds (TDFs) in their core investment lineups. Eighty-three percent of plans offered fixed annuities, and 60% of plans had other core investments.

Participant Investment Allocations

Looking at where participants’ 403(b) assets are allocated, the report says that in 2017, equity funds (including both index and actively managed funds) held the largest share (43%) of assets in the BrightScope database, with the bulk invested in domestic equity funds. Balanced funds held the next largest share with 27% of assets—which were divided between TDFs (24% of assets) and non-target-date balanced funds (2%).

Fixed annuities held 19% of ERISA 403(b) plan assets. Bond funds (mostly domestic) held 6% of assets, and money funds held 2%.

Costs Decreased

With the move to more mutual fund use and the trend of fee compression in the mutual fund industry, 403(b) plan sponsors and participants saw plan costs decrease. According to the BrightScope/ICI report, mutual fund expenses decreased between 2009 and 2017 in large ERISA 403(b) plans across all asset classes. For example, domestic equity mutual funds—which include both index and active investment styles—had an asset-weighted average expense ratio of 0.4% in 2017, down from 0.56% in 2009.

Similarly, domestic bond mutual fund expense ratios—which include both index and active investment styles—declined by 13 basis points (bps), from 0.47% of assets to 0.34%, between 2009 and 2017.

The report, “The BrightScope/ICI Defined Contribution Plan Profile: A Close Look at ERISA 403(b) Plans, 2017,” is available here.