Lifecyle Funds Can Help Companies Mitigate Risk and Boost Employee Savings

    But when the chemical distribution company’s 401(k) plan provider, Fidelity Investments, launched a pilot program that would automatically sweep a percentage of employees’ pay into so-called lifecycle funds, Bloch didn’t hesitate to be one of the first to sign up her company. Lifecycle mutual funds periodically rebalance between stocks and bonds based on the investor’s retirement age, and for Bloch, "it was a no-brainer."

    "It’s amazing to me that more people aren’t doing it," she says.

    For Bloch and a growing number of 401(k) plan administrators, deciding whether to be a parent or teacher is becoming an increasingly fine line. On one hand, they don’t want employees to feel that they are being forced into financial decisions, but on the other hand, if employees aren’t signing up to participate in the 401(k), "it means they don’t understand the consequences of their inaction," Bloch says.

    Univar, based in Kirkland, Washington, was one of the first companies to make lifecycle funds a default option in its 401(k) plan. It’s a trend that now is emerging as more executives decide that the risk of employees not having enough saved for retirement is more of a danger than the risk of them losing all of their money by investing in equity funds. Lifecycle funds seem to address both potential fears. As of January, 1,517 of Univar’s 3,200 plan participants were invested in lifecycle funds, 39 percent through the default.

    At any conference or meeting on retirement benefits, employers can be heard fretting about how their workers aren’t saving enough for retirement. Their concerns aren’t unfounded. According to a 2003 Hewitt Associates study, 49 percent of employees surveyed said they were contributing less or much less to their retirement savings than they probably need to.

    "Employers recognize that at this rate very few people are going to be able to retire at 65 and play golf," says Martha Tejera, a principal at Mercer Human Resource Consulting. "You want people working because they want to, not because they have to. You don’t want people hanging around because they can’t afford to retire."

"On autopilot"
    The adoption of automatic enrollment, by which employees are placed in a 401(k) plan and must opt out if they don’t want to participate, has partially solved this problem, but not entirely. Most workers just stay in the default option, which is usually a fund that invests so conservatively that it has little chance of providing them with enough savings for retirement. Sixty-seven percent of plans have money market or stable-value funds as their default option, according to Hewitt.

    This is where lifecycle funds come in. These investment portfolios, which are mutual funds that invest in a group of mutual funds, name the date of retirement and automatically adjust the balance of stocks and bonds as time passes and the employee gets closer to the date of retirement.

    "Employers just have to look at the employee’s birth date and put them in the right fund," Tejera says. "It puts the whole thing on autopilot and they don’t have to rebalance." In the past year, Putnam Investments, MassMutual Financial Group, Russell Investments and TIAA-CREF have launched these funds, joining the likes of Fidelity and T. Rowe Price, which have been in the market for years. Lifecycle funds, also known as target-date funds, were the most rapidly adopted automatic plan features last year, according to a Fidelity survey, which found that 1,200 employers added its lifecycle products in 2004.

    There is a problem with how employees use them, however. Some defeat the purpose of the funds by putting only a portion of 401(k) savings into them while also investing in other funds, says Lori Lucas, director of participant research at Hewitt Associates. That negates the automatic rebalancing feature of the funds. While 38 percent of 401(k) plans offer lifecycle funds and 37 percent of plan participants use these funds when they are available, only 13.2 percent of those participants have all of their noncompany stock investments in a single lifecycle fund, according to Hewitt.

    "Employers really need to make it clear that there is a fork in the road and that you either choose one lifecycle fund or you choose a bunch of other funds," Lucas says.

    This is where Bloch, as a pension administrator, puts her foot down. While she recognizes that there are participants in her plan who are misusing lifecycle funds, she does not have the time or resources to alert each of them to the fact that they are doing it wrong, she says. "I don’t believe in being a parent; I believe in education," she says.

    To this end, Univar, with help from Fidelity, periodically distributes information about its lifecycle funds and how they work. And that’s where the involvement ends.

    Parsons Brinckerhoff, a New York-based engineering consulting firm, is another company that is considering making its lifecycle funds a default option in its 401(k) plan. The company began offering T. Rowe Price’s lifecycle funds, called the Retirement Funds, in July. It already has about 200 of its 5,000 participants using the funds, says Mary Buckley, the company’s human resources administrator for retirement plans.

    The company views it as a natural progression to consider replacing its stable-value selection with these funds, Buckley says. "We want people to have the best rate of return with the least amount of risk," she says. "The stable-value option is great for no risk, but the rate of return is less than stellar." Parsons’ 401(k) committee expects to make a decision about the default option this year.

Awaiting guidance
    Many other companies, meanwhile, are waiting on the sidelines. Their hesitation is warranted, given that companies have been given little or no guidance from regulators about their liabilities if they offer these funds as the default option, say attorneys and consultants.

    "As a fiduciary, the government has made it easy for me to warn on one thing regarding default options: risk of loss," says Steven Friedman, an attorney in the New York office of Littler Mendelson. The liability implications of being too conservative in the selection of a default option are unclear. Sixty-seven percent of plans with automatic enrollment default to a money market or stable-value fund, according to Hewitt.

    Given the tenor of the times, it’s not hard to imagine employees filing suit against former employers because they were placed in low-yielding money market funds, stayed there for 30 years and now don’t have enough money for retirement.

    "Plan sponsors are clearly split on this issue of growth versus preservation," says Sam Campbell, a consultant at Financial Research Corp., a Boston-based firm. He says the pendulum is swinging toward the idea that employers could get in more trouble if they lean toward preservation .

    Cadmus Communications, a Richmond, Virginia-based publisher and printer, confronted this issue head-on last year when it adopted T. Rowe Price’s Retirement Funds as the default option for its 401(k). For benefits manager Cindy Ellis and the attorneys with whom she consulted, the choice seemed clear. The main concern for employers like Cadmus is that employees will come to them in 30 years saying, " ‘You should have told me to do this,’ " Ellis says.

    Lifecycle funds may be the solution because they provide investment options that make sense for the young worker in his 20s as well as the older employee who needs to have a more conservative portfolio, Ellis says. Cadmus, which used to have both a traditional defined-benefit plan and a 401(k) plan, froze the former in August 2003. The following month, it implemented a 2 percent default into T. Rowe Price Retirement Funds for employees who had not already invested in the company’s 401(k) plan. The company also offers a 2 percent match into its 401(k) plan. There were no changes for employees who already were contributing to the plan, which now has $133 million in assets and 3,500 participants.

    Cadmus has started to track the behavior of the participants in the plan, and Ellis says there has been good feedback so far. Initially, some employees were splitting up their 401(k) accounts between two lifecycle funds because T. Rowe Price only had funds with retirement dates in 10-year increments and they didn’t know exactly when they would retire, she explains. This became less of an issue last year when T. Rowe launched target-date funds in five-year increments. "We advised employees to choose the date they turn 65," she says. Cadmus held a series of employee meetings when the new funds were added to the plan, and continues to explain them and answer questions in mailings and statement inserts.

    While education will help lifecycle funds become more popular as default options, consultants say there won’t be a widespread adoption until regulators address the liability issue.

    The Internal Revenue Service has issued guidance saying that it would be appropriate for employers to make balanced funds, which are equity investments, a default option in their 401(k) plans. But there is still ambiguity about the use of lifecycle funds as the default, Lucas says. Financial Research Corp.’s Campbell believes that it’s only a matter of time before the IRS or another government body addresses the liability of having default funds that can’t outperform the market. The IRS or Department of Labor will likely provide more specific guidance on the question as early as this year, Campbell says.

    There is one encouraging sign for companies that are offering lifecycle funds as the default: The Bush administration’s Social Security reform proposal also calls for them to be the default option for investors over 50. If adopted, that would be a fairly good informal seal of approval.

    "If this happens, it would certainly send a signal to private-sector employers that you might want to do that," says Patrick Purcell, specialist in social legislation for the Congressional Research Service at the Library of Congress. Still, he says, "it’s not the same thing as legislators saying this is OK under ERISA."