Optimizing Plan Design in the Investment Menu

While streamlining plan investment menus has become more of a trend among plan sponsors in recent years, in order to avoid overwhelming or confusing participants with too many options, David Blanchett—portfolio manager and head of retirement research at PGIM DC Solutions—says providing fewer options may not necessarily be the smartest strategy. 

“I think there is a desire to get more participants inside of professionally managed solutions, which is changing the role of the core menu,” Blanchett says. “I don’t think the core menu needs to get smaller; it just needs to be more intelligent.” 

Blanchett emphasizes that it is more important to allow participants to create diversified portfolios that include things like long bonds, U.S. Treasury Inflation-Protected Securities, commodities and real estate. He says it is not necessary to have equity investment options like a large value fund, a large growth fund, large blend, mid-cap and mid-growth all on the same menu, for example. 

“When you don’t have a broad menu of funds that an adviser can use to build a portfolio, the knee-jerk reaction is going to be [to] roll over to an IRA that [the adviser will] manage,” Blanchett says. “I really wish that would be less of an impulse.” 

Providing Conservative Options 

From a compliance standpoint, according to ERISA Section 404(c), even though fiduciaries are shielded from employees’ poor investment choices, they are still responsible for providing a wide range of diversified investment options.  

Blanchett argues that a plan can “cover the bases” by offering 20 fund options, excluding TDFs, but it is important that plan sponsors consider how they are picking those funds. 

He also explains that while there are a “dearth of options” for people who want to build conservative portfolios, equity funds tend to dominate core menus, with defined contribution plans offering roughly three times as many equity funds as bond funds. Those core menus are mainly used by older participants likely to prefer a conservative approach, because the majority of plan participants are defaulted into target-date funds, Blanchett argues. 

David O’Meara, head of defined contribution investment strategy at Willis Towers Watson, says many plan sponsors are streamlining their core active funds and adding passive funds where they may have gaps in their investment menu. He says plan sponsors are also realizing that there is minimal uptake on anything beyond traditional equities and bond funds. 

“Participants tend to be unengaged, and they tend to rely on the default,” O’Meara says. “New [investment] options don’t get a whole lot of traction.”  

As a result, O’Meara says, plan sponsors are thinking of ways they can use this lack of engagement to the participants’ advantage by, for example, using the plan’s default option to either harness the value of investment diversity or incorporating a lifetime income solution within it.  

“The products that are coming out now, I view as either version 1.0 or 2.0, but there’s future versions of those solutions that will have better user experience interfaces and greater flexibility to meet the needs of a growing number of participants,” O’Meara says. “So lifetime income is definitely a place where we expect some significant innovation in the future.” 

Incorporating Lifetime Income in the Menu  

Blanchett says there has already been increased activity adding lifetime income options to investment menus, but plan sponsors remain hesitant, and the industry is “a ways away” from mass adoption. 

One innovation being used more often is a TDF with an annuity embedded—also called a hybrid annuity TDF. This investment vehicle’s goal is to default participants into a TDF, as in most defined contribution plans, then give participants the option to annuitize a portion of their assets at a certain age prior to retirement. One example of a hybrid annuity TDF is BlackRock’s recent launch of LifePath Paycheck. 

However, Blanchett argues this will not necessarily become a trend in investment menu design, as he believes many participants will not choose to annuitize 30% of their assets, for example, when given the opportunity. If a plan sponsor is offering a hybrid annuity TDF, but the annuity portion gets very little utilization, Blanchett argues that the sponsor is putting itself through unnecessary fiduciary risk. 

On the other hand, Kevin Crain, executive director of the Institutional Retirement Income Council, argues that because participants in hybrid annuity TDFs are only annuitizing a portion of their portfolios, not all of their assets, it could make them more comfortable with the solution.  

Crain says there is a need for more plan sponsors to work with consultants and professional investment advisers to understand and become more comfortable with hybrid annuity TDFs.  

“Annuities and hybrid target-date funds have a level of complexity which begs for plan sponsors [to] get professional help,” Crain says. 

But even before offering any sort of in-plan annuity, Blanchett says plan sponsors should consider other strategies like Social Security bridging.   

“The most disturbing statistic that I reference all the time from [PGIM’s] last plan sponsor survey [is that] only 13% of plan sponsors were aware of or acknowledge that they offer a Social Security optimization planning tool,” Blanchett says. “That should be 100%. Before a plan sponsor actively thinks about adding an annuity to a default investment, delaying Social Security payments is actually more advantageous.” 

Blanchett says plan sponsors should be actively giving participants guidance and information on Social Security optimization or bridging, rather than jumping to offering an in-plan annuity, which can be complex to implement and educate participants about.  

Plan sponsors should also consider the possibility that adding an annuity to the plan will have “residual effects,” because such options will be harder to remove in the future, Blanchett says. 

“If you add an investment to your plan, and then you don’t like the investment, there [are] no residual effects,” he says. “But if you add an annuity to your plan—a current committee might think an annuity is the best thing ever—once it’s there, it’s going to kind of always be there. If it’s in the default, it’s really sticky. … There’s residual effects of adding lifetime income solutions.”