BOSTON - The 401(k) market shrank last year, the first time in its 20-year history, a soon-to-be-released report from Cerulli Associates Inc. reveals.
`This is as good as it gets' is the underlying message," said Peter Starr, a Cerulli consultant. "Everyone thought the money would grow and there is no stopping it."
If that's the case, everybody thought wrong. According to Cerulli, the 401(k) market lost about $72 billion in 2000, and more is expected to leak out this year.
A major reason for the change in fortune: Service providers are not retaining assets when participants cash out their accounts - either when they retire and roll over the assets into IRAs, or when they take lump sums when they change jobs.
Indeed, 401(k) plan executives and their service providers are beginning to struggle with the same problem that has plagued defined benefit plans for years: More money is being withdrawn than is being contributed.
The 401(k) market is not growing as fast as most people thought it would, Mr. Starr said. In 2001, the net flow, the difference between contributions and distributions, is projected to be $40 billion. Last year, the net flow was $39.8 billion.
Net flows into 401(k) plans are projected to remain flat until at least 2006, Mr. Starr said. When the masses of baby boomers begin to retire sometime in the next decade, that number will decline precipitously, he said.
By the end of last year, 401(k) plans had $1.77 trillion in assets, down 3.8% from $1.84 trillion the year before.
Close to 80% of the increase in 401(k) assets over the last five years was due to market appreciation, the report stated. Between 1995 and 2000, assets in 401(k) plans showed a net increase of $1.1 trillion. Some $846 billion was due to market appreciation. Participant contributions of $832 billion during this time were offset by $638 billion in distributions, said Lisa B. Baird, a Cerulli consultant and the study's author. This placed total net new money into 401(k) plans at only $194 billion.
Participants, meanwhile, suffered sticker shock, as the average account balance shrank to $41,919 last year from $46,740 a year earlier.
In 2000, for every dollar contributed to a 401(k) plan, nearly 74 cents was distributed through retirement or job change, Ms. Baird said. This will increase by nearly a dime in the next six years.
The Cerulli study shows 77% of defined contribution assets distributed to job-changers and retirees as lump sums are rolling over into individual retirement accounts, while 20% are simply cashed out.
And of the rollover money, only 19% is invested an IRA with the service provider for the 401(k) plan, according to Cerulli.
Cerulli is not the only consultant projecting declines. Just last week, Spectrem Group, a Chicago-based consulting firm, released a report done for the National Defined Contribution Council that found only a $2 billion growth in 401(k) plans last year. The previous year, they grew $327 billion.
Service providers have been wrestling for several years with how to retain assets withdrawn from 401(k) plans. Sometimes a financial services firm's institutional side - which deals with 401(k) plans - is so separate from the retail side, which handles IRAs, there's no chance they'd work together to prevent the 401(k) assets from leaving the company.
According to the Spectrem study, mutual fund companies are continuing to dominate in providing 401(k) plan record-keeping services, up to a 35% market share in 2000 from 33% the year before. Yet mutual fund companies historically have not had the retail marketing channels such as a network of broker-dealers required to sell IRAs, he said.
Now, many of these providers are scrambling to add such a channel. For instance, CitiStreet, Boston, has joined with CSFBdirect, Jersey City, N.J., to offer IRAs through an online brokerage service and with Salomon Smith Barney, New York, to offer a full-service one-on-one brokerage relationship to retirement plan participants. CitiStreet also is working with Financial Engines Inc., a Palo Alto, Calif.-based online investment advice provider, to offer advice for 401(k) plan participants seeking to roll over their assets.
And CIGNA Corp., Hartford, Conn., will be offering IRAs through a new entity, CIGNA Bank & Trust Co.
What this means to the 401(k) industry is that plan sponsors and service providers are going to have to change the way they provide plans to participants, Cerulli's Mr. Starr said. With reduced net flows into 401(k) plans and uncertain market returns, bundled service providers with asset-based revenue might have to switch to an investment-only approach, he said. If 401(k) assets fail to grow, full-service providers no longer will be able to subsidize their record-keeping business with revenue from assets under management, the study concluded.
But an investment-only approach is not a panacea, the study cautioned.
No 401(k) key
The theory a decade ago among financial service providers - that the key to capturing 401(k) assets was to build in-house administration - has proven untrue, he said.
The top five players that currently dominate the 401(k) marketplace - controlling 43% of all 401(k) assets - will continue to do so, Mr. Starr said. First, of course, is Fidelity Investments, Boston, whose $418 billion in record-keeping assets is more than twice that of Hewitt Associates LLC, Lincolnshire, Ill., which placed second. Rounding out the top five are CitiStreet, The Vanguard Group Inc., Valley Forge, Pa., and Merrill Lynch & Co., Plainsboro, N.J.
Keeping up the pressure to change is that when the baby boomers retire in the next decade, 401(k) assets are expected to drop precipitously, Mr. Starr said. And retirees need a lot of services.
"If you want to manage long term, you'll need to think retail," Ms. Baird said.