New research from Cerulli Associates points to two primary factors triggering the 401(k) market’s current environment of negative net flows.
According to the firm’s report, “U.S. Retirement Markets 2018: Creating Opportunity Amidst Net Outflows,” it basically comes down to demographics and maturation of the 401(k) market, as big accounts exit, only to be replaced by smaller accounts.
The 401(k) reached a 40-year milestone in 2018 and the market is experiencing mostly flat organic growth – based on employee, employer and other contributions – and it is reliant on market returns to generate future asset expansion, Cerulli notes.
From 2012 through 2017, total 401(k) market outflows or distributions expanded at a five-year compound annual growth rate (CAGR) of 8.4%. In contrast, total contributions or inflows to the market expanded at a slightly lower, five-year CAGR of 6.4%, the research shows.
Not surprisingly, the increasing rate of outflows from DC plans can be attributed to the Baby Boomer generation. As members of this generation enter retirement, they are beginning to draw down on their 401(k) account or they are rolling their entire account balance to the IRA market, Cerulli explains. And as presumed, this cohort of 401(k) investors is more likely to have higher account balances than those just entering the market.
“While Baby Boomers are being replaced by Millennials, these younger investors are typically deferring a smaller percentage of a smaller salary to the 401(k) plan,” explains Jessica Sclafani, Cerulli’s U.S. Retirement practice leader. “This creates a big accounts out/small accounts in dynamic in which large balance 401(k) accounts are exiting the 401(k) market for the retail IRA market and are being replaced by small starter-balance accounts.”
As an example of the negative flows, Sclafani notes that it would take 10 Millennials earning $50,000 and contributing 3% of salary to replace one Baby Boomer earning $100,000 and contributing 15% of salary.
Asset Retention?
To stem the tide, 401(k) plan sponsors may want to assess their preference for what retired and separated participants do with their account balances, but of course, that hinges on plan sponsors’ attitudes regarding retaining the assets and their ongoing fiduciary liability, the report suggests.
In posing the question of what plan sponsors prefer, a fourth quarter, 2018 survey of 800 401(k) plan sponsors by Cerulli found that most respondents (59%) favor retired/separated participants taking their savings and leaving the plan.
This finding was split among three options:
- roll over assets to an IRA (22%);
- roll over assets to another employer-sponsored retirement plan, if possible (20%); and
- take a full cash distribution (e.g., a lump sum withdrawal).
“Keep assets in company’s 401(k) plan,” however, was the most commonly identified survey response, capturing 27% of all respondents.
But as Cerulli observes, this data is more significant when broken down by plan asset segments. In particular, the report shows that the large plan asset segment tells a somewhat more optimistic story.
According to the findings, one-third (33%) of large 401(k) plan sponsors – defined as plans with $250 million or more in assets – prefer that their retired/separated participants stay in the plan. Large 401(k) plans represent 64% of the nearly $5.5 trillion total 401(k) market, meaning that their preference will have an “outsized impact on whether assets of retired/separated participants stay in the 401(k) system,” the report explains.
As such, the firm notes that, “if a relatively small number of large 401(k) plan sponsors implement proactive campaigns to retain the assets of retired/separated participants, total distributions could be significantly lessened, and eventually derail the 401(k) market from its current track of negative net flows.”
“Asset managers and recordkeepers that participate in the 401(k) market will need to be conscious that while the 401(k) market will continue to evolve in terms of plan design and ability to serve participants through retirement, it is now a mature segment,” Sclafani emphasizes. “Organic asset growth will require an outside catalyst(s) such as success in converting the largest of plans to position themselves as a final stop for retirees’ assets, and/or the passage of meaningful retirement legislation.”
Open MEP Opportunity?
One possible asset-gathering opportunity for many service providers, though still uncertain, is the prospect of an open MEP structure, according to the report.
Cerulli suggests financial services firms create cross-functional, internal working groups to begin formulating a strategic plan as to how their respective firms would participate in an environment that includes open MEPs.
The firm cautions, however, that it “remains to be seen whether open MEPs would increase the number of Americans participating in an employer-sponsored retirement savings plan (i.e., payroll deductions) or if they would cannibalize existing plans.”
