Investing March 27, 2019

Impediments to Widespread Adoption of ETFs in DC Plans

Despite their advantages, the purpose of defined contribution plans and ability of recordkeeping systems to handle exchange-traded funds' unique traits keep them from being widely adopted by plan sponsors.
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Art by Daniel Shaffer

With lawsuits continuing to be lodged against defined contribution (DC) retirement plan fiduciaries over what the plaintiffs claim are excessive fees, it may be incumbent on retirement plan sponsors to consider offering exchange-traded funds (ETFs) in their investment lineup.

However, experts are mixed as to whether ETFs that charge single-digit basis point fees offer an advantage over institutionally priced index funds. They say recordkeeping systems lack the capacity to handle ETF trades; the advantages of ETFs are negated in a qualified, long-term account; and making intraday trading an option for participants could serve as a distraction at work.

Currently, 91.7% of retirement plans have traditional ’40 Act mutual funds on their investment lineup, according to the 2018 PLANSPONSOR Defined Contribution Survey Benchmarking Report. A mere 13% of retirement plans offer ETFs in their lineup.

But it is worth considering participants’ growing interest in ETFs and their explosive growth in assets in the past decade. Assets in ETFs in the U.S. increased seven-fold from $716 billion in 2008 to $5.02 trillion in 2018, according to Statista, a provider of statistics, consumer survey results and industry studies.

Two retirement plan platforms that were launched with the express interest in offering ETFs are from Vestwell and Betterment. Aaron Schumm, chief executive officer of Vestwell, based in New York, specifically wanted to offer ETFs on the Vestwell platform that went live in 2018 because ETFs have “become household names, and are more liquid and lower cost than mutual funds. Plus, you don’t have to worry about the share class issues you have in the mutual fund world, such as 12b-1 or other back-end revenue-share fees.”

Betterment launched its recordkeeping platform in 2010, starting off exclusively as an ETF investing platform, says Adam Grealish, director of investing, based in New York. The reason Betterment wanted to offer ETFs is because its platform supports savings goals other than retirement.

“Many people are saving for retirement in a taxable account, or saving for other goals in a taxable account,” Grealish notes. “The tax efficiency that is structural to an ETF product is a major benefit. For the qualified accounts, this is not going to matter, but for the taxable accounts, it does.”

ETFs incur substantially less capital gains than mutual funds, he explains. “Mutual fund shareholders’ taxes are influenced by redemptions from other shareholders,” he says. “The fund has to sell shares to meet redemptions, which in turn hits investors with capital gains. ETF shares, on the other hand, are bought and sold on the secondary market.”

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There are a few reasons why industry insiders think ETFs offer benefits to retirement plan participants other than their growing interest in them. Fund accounting and plan administration provider Nottingham, in Rocky Mount, North Carolina, has ETFs in its own retirement plan. The firm included them to offer participants exposure to niche sections of the market that some ETFs track, specifically “different parts of the economy, different geographic areas of the world, and different industries,” says Kip Meadows, chief executive officer.

“If you want to be diversified, these solutions make a lot of sense,” he adds. “Now that the ETF market has become mature, as more employers hear from their employees that they want to invest in them, their plan administrators will make that happen.”

Small plans that do not have access to the low-cost institutional share classes of mutual funds could also benefit from including ETFs in their lineup, says Mitch Reiner, chief operating officer of Capital Investment Advisors in Atlanta.

Issues with recordkeeping ETFs

Other than these upsides, it is important for plan sponsors to realize that the many of the benefits of ETFs are cancelled out when included in qualified accounts, Brian Kraus, head of investment consulting and internal sales at Hartford Funds, says. “They ability to trade throughout the day, their tax advantages and their transparency to their underlying holdings are less of an advantage in the defined contribution world, because [DC retirement plan] accounts are long-term and buy-and-hold driven.”

Reiner also contends that if participants were to day-trade ETFs, that would be a major distraction from their work.

Vestwell and Betterment aside, industry insiders say that traditional recordkeeping platforms are ill-equipped to handle ETF trades.

Global X, an ETF provider in New York, has a few clients that manage money on behalf of retirement plans, says Rohan Reddy, a research analyst with the firm. However, most of the interest is coming from international pension funds, rather than U.S.-based pensions or retirement plans.

“The biggest hesitancy to offering ETFs in a retirement plan is that ETF trading can be difficult to manage,” Reddy says. “ETFs offer fractional shares, limit orders and intraday trading.”

Kraus agrees that the recordkeeping infrastructure that was built mainly to support end-of-day net asset values (NAVs) for mutual funds is a major impediment to the adoption of ETFs in retirement plans. “The infrastructure of the recordkeeping business was effectively designed prior to the launch of ETFs,” he says. “It was not set up for some of the schematics of ETFs, so I would say there are more headwinds than tailwinds.”
Participants March 26, 2019

Shorter Employee Tenure Demands Progressive Plan Design

A worker’s tenure plays into his eligibility to join and his level of engagement with retirement plans, and for this reason, shorter average employee tenure is a plan sponsor issue.
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Art by Jackson Joyce

Decreasing average tenure in segments of the U.S. workforce is impacting more than company productivity—it also impacts the success of employer-sponsored retirement plans.

A recent Employee Benefit Research Institute (EBRI) brief examined employee tenure among American workers, finding that in the past 35 years, the median tenure for workers of all wages and salaries, ages 25 or older, has remained at five years. However, for men ages 25 to 64, the median tenure stood at 10.2 years in 2018—a stark drop from the 15.3 years measured in 1983 but not as low as the 9.5 years measured in 2006. Women in the same age group held a median tenure of 4.9 years in 2018, a slight decline from 5.0 years in 2016.

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While there are some positive interpretations for shorter tenures associated with a low unemployment rate, the EBRI report warns that there are also clear negative consequences of a shorter median tenure when it comes to the financial health of employees. Among these is the fact that lower levels of employee tenure may reduce the percentage of the working population that is eligible for or contributing to a defined contribution (DC) plan at any given time. In addition, even when shorter-tenure employees join a DC plan, they may face vesting periods and they may need to draw on retirement assets to meet emergency savings needs.

A 2018 Investment Company Institute (ICI) study, conducted in collaboration with EBRI, looked at average account balances and compared “consistent” participants with those participants that had at some point paused (and potentially restarted) their contributions. The study reported that for “consistent” participants, the median account balance was three-times the median across all participants.

Neal Ringquist, executive vice president and chief sales officer at Retirement Clearinghouse, suggests figures like this underscore how employee tenure can impact retirement plan performance. While automatic enrollment provisions popularized since the Pension Protect Act (PPA) have improved the retirement system overall, it is still very common for workers to stop saving for retirement when they leave one job for another.

“When a worker has greater tenure, the individual tends to not demonstrate destructive savings behaviors, such as cashing out, stopping contributions, and so forth,” Ringquist says. “When an individual does change jobs, the retirement system tends to drive some decisions that are destructive to their preparation for retirement and so forth, such as cashing out and delaying retirement.”

Plan Sponsors Can Help

Experts agree sponsors can make progressive plan design changes to ensure new workers are joining retirement plans and are reaping the benefits sooner rather than later when it comes to things like matching contributions. As two examples, implementing immediate eligibility and automatically enrolling participants to the plan can drive great plan performance, says Spencer Williams, founder, president and CEO at Retirement Clearinghouse. He says most plans still offer eligibility only after six months to a year of employment.

Something else to consider is that, even if a new employee is automatically enrolled into a retirement plan, this doesn’t mean he will be defaulted at the same savings level he may have been using at a previous job. Craig Copeland, senior research associate with EBRI and the author of the tenure study, suggests plan sponsors may want to consider automatically enrolling participants at their prior contribution rate.

“If you go from a plan with auto-enrollment and auto-escalation, and you’ve escalated up for the past years, now that you started a new job, are you going to go back to the typical 3%?,” he asks. “If there were a way to auto-enroll people at the rate they used in a previous plan, assuming this is higher than the default percentage of the new plan, this would potentially help people stay on that track.”

Joe Connell, partner at Sikich Retirement Plan Services, says this type of capability, while appealing, would also be hard to put into practice. Instead, he suggests employers can use onboarding questionnaires to get new employees thinking about the right level of retirement savings.  

“It’s going to be hard to automate that process because you can’t auto-enroll at different rates for everybody,” Connell says. “But, you can ask as part of the onboarding process and help an employee opt in to where they want to be, versus the auto-enrollment rate that you’re going to give them.”

The Role of Auto-Portability

Aside from considering these design features, plan sponsors may want to look into auto-portability solutions as well, says Copeland, in particular to minimize cash out behavior. Rather than transferring their retirement plan balance to a new company, an action that comes with complexities unfamiliar to participants, workers often find themselves cashing out their retirement savings and paying the hefty penalty tax that comes with doing so. Auto-portability solutions, though, automate this transfer process by finding the new employer’s plan and transferring the balance for participants, essentially leaving no complicated work for the participants to navigate.

“Auto-portability will play an increasingly important role because it helps with balance preservation,” Copeland says. “It automatically gets that money into your next employer’s plan, and it makes that jump from one employer’s plan to the next so much easier. It’s a cumbersome process to do it on your own.”

Ringquist and Williams agree with this notion. They note how creating a plan design which encourages roll-ins, not just from other plans but also from individual retirement accounts (IRAs), will decrease cash outs.

“If we make it easy, we preserve it, and if we make your savings experience continuous, we’ve actually created synthetic tenure,” Williams concludes. “It’s not real tenure, but you get the same outcome from the retirement plan perspective. That’s the exciting principle behind auto-portability.”

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