Two academics from the Wharton School of Business have produced a paper suggesting one large plan's effort to streamline its defined contribution plan created potential savings of $20.2 million for participants over a 20-year period, or $9,400 per participant.
Previous research has been mixed on how the number of lineup options influences participant behavior and outcomes, but none of that research has examined how participants react to a substantial reduction in options, claim Donald Keim and Olivia Mitchell in the paper, prepared for Wharton's Pension Research Council.
Before 2013, the studied plan, a large nonprofit "research and teaching institution," offered almost 90 mutual fund options, ranging from equity to target-date funds, to bond index funds, REITs and commodity funds.
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The investment committee of the sponsors ultimately eliminated 39 funds. Participants who didn't move their assets from the eliminated funds were defaulted into target-date funds, and a brokerage window also was offered in lieu of the eliminated funds.
The committee chose to eliminate funds based on their expense ratios, the number of participants in the funds, and overall assets.
Additionally, the committee set up four tiers within the lineup. Tier one was considered a default tier for those less-engaged participants, comprising 13 low-cost target-date funds. Each subsequent tier offered greater diversification options, with the fourth tier being access to the brokerage window.
Of the plan's nearly $1 billion in assets, about 20 percent were held in funds that were ultimately deleted from the lineup.
Participants in funds that remained in the plan made little change to their accounts after the menu was streamlined, the report shows.
But for those who'd been invested in the funds that were cut, the new menu showed they significantly reduced allocation to international funds, bond funds, and stock and sector funds, as 27 percent of those participants contributions were shifted to target-date funds.
By comparing data before and after the streamlining, Keim and Mitchell were able to track noticeably lower turnover in participants' account activity, resulting in lower transaction costs to the plan and participants, and lower expense ratio in the plan's accounts, as more expensive options were pared from the lineup.
Only 9 percent of the participants moved assets into the brokerage window, representing 0.2 percent of total plan assets.
Streamlining also resulted in lowering the plan's overall risk exposure, as a much lower exposure to stocks was held after the lineup was halved.
That means a potential accumulated savings of $20.2 million over 20 years, or $9,400 per participant, "based on reasonable assumptions," write the academics.
"Our work implies that plan sponsors would do well to recognize that the length and complexity of the plan menu matters," they said.
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Nick Thornton
Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.
