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Morningstar Takes Deep Dive into State of the Retirement System

Industry Trends and Research

The inaugural report from Morningstar’s new retirement research center explores DC plan trends, fees, investment strategies and the continued role of DB plans.

One noteworthy area is the broad divergence of plan costs, the 43-page Retirement Plan Landscape Report says. Even though investors pay less today than ever, participants who work for smaller employers and participate in small plans pay around double the cost to invest as those at larger plans, according to the research. Smaller plans pay around 88 basis points in total compared with 41 basis points for larger plans. Smaller plans also feature a much wider range of fees between plans, with more than 30% of plans costing participants more than 100 basis points in total, the report notes. 

Morningstar found that more than 95% of plans in the U.S. qualify as “small” by its definition (plans with $25 million or less in assets), although just 27% of workers are covered by these small plans. To put this in another context, workers at employers with smaller plans who are saving just as much as those at employers with larger plans could have around 10% less in assets at retirement because of higher fees, notes Aron Szapiro, head of retirement studies and public policy at Morningstar. 

“This is an issue industry leaders and policymakers must address because these differences in fees can add up, leaving participants with fewer assets at retirement and less ability to achieve their retirement goals,” the report emphasizes. And while Congress recently created pooled employer plans, which could help close this gap somewhat, the report observes that so far, there has been little uptake.  

Investment Strategies

Turning to investments, the report explains that plans of all sizes offer similar strategies, but the largest plans have shifted away from mutual funds as their vehicle of choice. The largest plans in the U.S. started to abandon mutual funds 10 years ago and today hold nearly 45% of their assets in collective investment trusts (CITs), while plans of other sizes have not increased their use of CITs at all, the report observes. 

In addition, plans of all sizes continue to invest most of their assets in actively managed funds (more than 50% of assets are in actively managed funds across all plans), with more assets in active strategies among smaller plans. 

In terms of sustainability, the Morningstar researchers note that plan sponsors appear to have shied away from considering environmental, social and governance (ESG) factors, in part because of regulatory uncertainty. In doing so, they note, DC plan sponsors have left the system in the aggregate tilted toward investments with more ESG risk—which, the report explains, is the degree to which companies fail to manage ESG risks, potentially imperiling their long-term economic value. With few plans having investment options that account for these risks, plan sponsors may wish to reexamine their investment choices using an ESG lens, the report suggests. 

Retirement System Fragility

Morningstar’s report also raises alarms about the current state of the retirement system. “At first glance, the U.S. retirement system appears to be stable, but that obscures the fragility of a system that loses thousands of plans and billions of assets every year,” it states. 

The report goes on to explain that the DC system relies on new employers to offer retirement plans every year to compensate for the more than 380,000 plans that closed over the period from 2011 to 2020. Similarly, the system relies on new contributions and strong returns to mask outflows of more than $400 billion a year since 2015, reported by plans in their annual filings. 

In fact, plan assets actually shrink in years without strong investment returns. “A few years of poor returns would reduce many plans’ assets, their market power, and thus their capacity to offer institutionally priced investment options,” the report warns. More assets in the DC system would help more sponsors gain the leverage to demand lower fees from asset managers and drive down costs for end investors, the researchers suggest. 

Policymakers and plan sponsors must also be on guard for future economic disruptions that could result in the system not adding plans fast enough to replace the tens of thousands that close every year, the report further suggests. As the retirement system only covers around two thirds of workers, such headwinds could mean more workers fall behind in saving for a secure retirement, the report observes. “Expanding access to employer-sponsored retirement plans is essential to ensuring Americans are saving enough for the future, but it’s also essential to make sure the current system addresses its weakness to not lose ground,” the report states. 

DB Findings

While much of the report focuses on DC plans, the Morningstar researchers note that more than 33 million people are or will receive benefits from DB plans as of 2019, which is the most recent year with current data. 

What’s more, DB plans accounted for more than 30% of distributions paid to participants in 2019 and they do not appear to have peaked. In fact, between family beneficiaries and retired participants, 12.8 million people are collecting these benefits today— a number that will continue to grow, the report notes. In addition, approximately 8.8 million people who are no longer working are still entitled to future benefits and 11.7 million people who are still working will eventually receive benefits.  

As such, employers should provide investment options in their DC plans that can also help those with traditional pension benefits attain a secure retirement through a mix of their own savings and these benefits, the researchers suggest. In addition, policymakers should not lose focus on the DB system and should help participants transition by encouraging personalized investment recommendations.

VanDerhei Joins New Research Center

The Workplace Solutions group within Morningstar Investment Management announced the launch of the Morningstar Center for Retirement and Policy Studies on March 1. According to the announcement, the Center will provide the industry with “unbiased, actionable data and insight” for decisionmakers seeking to improve the U.S. retirement system. 

The Center’s primary research team includes Szapiro, as well as Jack VanDerhei, director of retirement studies for Morningstar Investment Management, and Lia Mitchell, senior analyst of policy research for Morningstar.

VanDerhei, who joins Morningstar after 34 years at EBRI, will be responsible for modeling the impact policy changes and proposals might have on U.S. retirement preparedness, as well as the effects of plan sponsors’ decisions on participants. “It’s an honor to join Morningstar and be a part of an organization that is known for its independence, investor-first focus, and overall commitment toward improving the retirement space. With the opening of the Center, it’s a terrific opportunity to try to expand access to, and participation in, the retirement system by helping more Americans save for the future they want,” he said.