COLUMBUS, Ohio - When executives at the Ohio State Teachers' Retirement System unveil their new 401(a) plan July 1, some participants will be offered a guaranteed 7.75% annual rate of return backed by the defined benefit plan.
This novel investment option, suggested by the system's investment staff, will be available only to employees with less than five years of service and to new participants.
About 40% of eligible participants are expected to choose the Total Guaranteed Return Choice. Those who do will get a portfolio with an asset allocation parallel to that of the system's $55 billion defined benefit plan. They will, however, have to leave their money in that option for five years to be guaranteed the 7.75% return, said Herbert Dyer, executive director.
"It's clearly intended this choice is to be a long-term investment," said Robert Slater, deputy executive director.
If the system is unable to reach its goal, the defined benefit plan will fund the shortfall, said Mr. Dyer.
If the STRS Total Guaranteed Return Choice exceeds its projected 8% return (7.75% plus 25 basis points for administrative costs), the excess assets will be placed in the defined benefit plan, Mr. Slater said.
Attorneys inside and outside the system have examined the plan and approved of the idea, he said.
No formal studies
Executives at the Columbus-based fund chose the 7.75% guarantee after the investment staff predicted the system will earn an 8% compound annual return over the next five years. No formal actuarial studies were conducted, he said.
Participants who elect this option in subsequent years may get a guaranteed rate of return higher or lower than 7.75%.
Asset allocation will parallel that of the defined benefit plan. Currently, the allocation is 46% domestic equities; 20% global fixed income; 20% international equities; 12% real estate; 1% alternatives; and 1% cash.
And, like the defined benefit plan, the option with the guaranteed return will be internally managed.
If a participant withdraws from the option before the five years, a 10% penalty will be charged. At the end of the five-year period, participants will be able to decide if they want to stick with the allocation in effect at that time or if they want to create their own allocation from the options available.
For participants choosing the guaranteed-return option, only their contribution for the first year will be allocated automatically to that option. In subsequent years, their contributions can be allocated to the guaranteed option or to any of the other eight options the new 401(a) plan offers.
Those options, all managed in-house, are: money market; indexed bonds; stock funds indexed to the Standard & Poor's 500 and the S&P 400; a large-capitalization growth fund; a large-cap value equity fund; a real estate investment trust fund; and an international equity fund indexed to the Morgan Stanley Capital International Europe Australasia Far East index.
There are risks
Consultants say no other 401(a) plan offers such a guarantee.
"I have not seen anything exactly like this," said Steve McElhaney, consultant with William M. Mercer Co Inc., New York.
"There's some risk to the system in that if the actual return is less than the guaranteed amount, the system would have to make it up from somewhere else," he said. "The fact that the money would stay for five years mitigates that risk because volatility risk is more over the short term than over the long term."
Participants, meanwhile, won't have to make investment decisions. "From a participant's view, it sounds pretty attractive," Mr. McElhaney said.
Some public funds offer variations of Ohio's program.
Oregon, for example, has a money purchase arrangement in which all of the assets get the rate of return that the pension plan gets without a minimum guarantee, Mr. McElhaney said. It's not a separate defined contribution plan but a subaccount within the defined benefit plan.
Washington state's two 401(a) plans, with $1.7 billion in assets, have a fund mirroring the defined benefit plan that has received mixed reviews. One problem: The mirrored portfolio (called the Total Allocation Portfolio) is valued monthly, whereas the remainder of the options offer daily valuation. It is managed in-house by the Washington State Investment Board, Olympia. Assets in the portfolio will be commingled in a pool with assets of the $42 billion Washington defined benefit retirement plans. A new 401(a) for all state employees to be launched in 2002 also will contain the TAP option.
About 50% of the participants are invested in the TAP option, more than any other single fund, said Scott Huntley, legislative and communication coordinator for the Washington State Investment Board. However, that portfolio is the default option.
The biggest challenge was the pricing of the TAP fund because it contains investments such as its 16% allocation to private equity and 8% allocation to real estate that are not meant to be in defined contribution plans, Mr. Huntley said.