Rethinking Your 401k

It's easy, once your 401(k) plan is in place, to just leave it alone. But doing that could mean it becomes out of touch with the direction you intended. That's why you need to dust it off periodically and make sure it is still in alignment with what you hoped to accomplish when you established the plan.

One framework for approaching this task is described in an insightful research paper, "What's on the Investment Menu? A Recipe for a Better DC Design" issued by the Defined Contribution Institutional Investment Association (DCIIA). A few concepts from the document are introduced below.

For starters, assessing your goals can be facilitated by answering four basic questions, the report's authors suggest:

Have it Your Way "Just like restaurants where there is no one size fits all menu, some have long menus with many choices, whereas others offer only a few set meals, the DC [Defined Contribution] menu structure is a key component of ensuring participants understand the plan objectives and order a meal designed to satisfy their needs." ---From DCIIA.org

1. Is the 401(k) plan the primary retirement savings vehicle? Assuming the answer is yes, you are "more likely" to want to guide participants' investment selections.

2. How much guidance do you want to offer? The advent of Qualified Default Investment Alternatives (QDIAs), including target date funds, risk-based or balanced funds and managed accounts, makes the job of guiding participants easier, if that is your aim.

3. Do you want employees to stay in the plan after they retire or otherwise leave the company? Participants make their own decisions, but by not emphasizing the rollover option you might have an impact on employees' decision.

Many employers are happy to see former employees and retirees roll over their accounts. Yet others are content for them to stay in, assuming they contain a critical mass of assets. Why? They may simply believe those retirees will achieve better outcomes within the company plan, and care about it. An ancillary benefit when former employees and retirees stay in is that maintaining more assets in the plan achieves economies of scale with service providers, reducing per capita costs and/or making more services available.

4. Is it a priority for you to see that your participants achieve an adequate retirement income (as opposed to simply looking at contribution rates)? If so, focus information regarding plan choices on this question: "How does this decision affect our retirement replacement goal?" according to the report.

If you emerge from this review with a strong dedication to employees' financial security in retirement, where does it take you? Among other suggestions, the report proposes creating three tiers of investment menus, available to all participants but divided according to their level of interest in making investment decisions. Employees can focus on the tier that they most closely identify with, and choose from its options. You can choose investments for each tier according to the degree to which you want to guide employees ("guided plans"), versus emphasizing "self-directed choices," which boils down to offering more choices, the report suggests.

The three tiers and some examples of possible investment components:

Tier 1 for "do it for me" participants, who are the least engaged in investment decisions. Investments for this group might emphasize a target-date fund and managed account QDIAs, and perhaps also risk-based funds that allow participants to choose a desired risk level (such as conservative, moderate, aggressive).

Tier 2 "do it with me" participants. This group is willing to play a greater role in fund selection, but still seeks guidance. If you are more willing to guide such participants, their investment options might be limited to five asset classes: U.S. equity, non-U.S. equity, alternative assets, diversified bonds and stable value. If you fall into the "self-directed" plan camp, an expanded set of investment classes might include both small- and large-cap U.S. equities, developed and emerging market international equities, along with the other options offered by "directed" plans.

Tier 3 "Do it myself." Self-directed plans might offer this group a brokerage window for ultimate flexibility, with the caveat that it is only suitable for the most sophisticated investors.

The report offers many more details with respect to the construction of funds within those broad categories, and offers insights on menu design from the world of behavioral finance.

"Done right," the report concludes, "a [defined contribution plan] menu can shape expectations, direct behaviors and help participants feel confident that their retirement plan is secure."