A colleague asked me how long target date funds have been around – he guessed five years. In fact, TDFs have been around for over 20 years invented by Barclays, now owned by BlackRock. But TDFs took off when the 2006 Pension Protection Act was enacted along with many elements of the ideal plans. T Rowe Price reviews the impact of the PPA along with shortcomings.
Since 2006, the impact of this legislation for defined contribution plans has been substantial.
- 61% of plans use auto enrollment, compared to 35% in 2006
- 73% of plans use target date funds, compared to 32% in 2006
- 9% of plans use auto increase, compared to 26% in 2007
- 6% of plans have incorporated Roth contributions, compared to 31.1% in 20074
So while TDFs had been around for a while, DC plan sponsors were reluctant to make them the default option for fear that participants would sue if the market valuations went down. The PPA provided safe harbor.
One of the shortfalls of the PPA is low deferral rates. Though not mandated, the suggested default deferral rate is 3%. The author of the legislation admitted that this is one of his main regrets but he wanted to be conservative to start which is reasonable. Today we know that starting at 5-6% is much more beneficial with very few employees opting out because of the higher rate. We also know that auto enrolment without auto-escalation is like peanut butter without jelly.
So what’s on the horizon? The beauty of the Ideal Plan made possible by the PPA is that everything can be done for employees without any engagement which is fine for accumulating assets where there is a common goal. The de-cumulation phase is different but can legislation really have the same impact?
Though Congress and regulators have been reluctant to force employers to step up and provide a company match, for example, to get more engaged in their corporate retirement plan, perhaps state initiatives sweeping the company mandating access to retirement savings at work will provide the foundation for government to get more aggressive and force greater engagement. 401k plans, which started as a supplement savings plan, have grown to become the major savings and retirement vehicles for most workers. Perhaps it’s time on the 10-year anniversary of the hugely successful PPA to take another look to improve ERISA plans beyond the focus of fees, funds and fiduciaries.
