Once a worker, always a participant

Corporate defined contribution plan executives are increasingly looking to keep participants in their plans after they retire as a way to keep costs down for both the retiree and the sponsor.

This “participant for life” strategy, if successful, creates economies of scale: The higher the total plan assets, the lower the administrative costs the plan sponsor pays and the cheaper the fees borne by participants. The retirees also get access to investment options and tools that are often superior to those available outside the plan, experts say.

And while some large DC plans have been trying to retain retiree participants for years, the industry is only recently accelerating its shift away from focusing just on asset accumulation to the distribution phase as 401(k) and other DC plans are now the main retirement vehicle for most workers. New investment options embedded with annuities or income guarantees have only further piqued DC plans executives' interest in holding on to their former workers.

Most 401(k) participants still quit their employer-sponsored plans when they retire. In 2007, $230 billion in assets were taken out of defined contribution plans by retirees, and 80% to 90% of that was rolled over into individual retirement accounts, according to researcher Cerulli Associates.

“The big pot of money here is the rollover business,” said Richard Davies, head of product strategy at AllianceBernstein Defined Contribution Investments, New York. “Every financial adviser is in the rollover business. Fifty percent of mutual fund sales are rollovers. Bundled 401(k) providers encourage participants to roll over. And salesmanship will continue, presenting plan sponsors with a serious challenge.”

Large plan sponsors seem committed to retaining their participants past retirement. A recent survey by money manager consultant Casey, Quirk & Associates LLC, Darien, Conn., found executives at nearly two-thirds of DC plans with $1 billion or more in assets said they are trying to keep and service employee accounts post-retirement.

“Keeping participants in the plan after they retire is definitely beneficial to the plan sponsor,” said Ross Bremen, a partner at Cambridge, Mass.-based investment consultant NEPC LLC. “It helps cover the costs of administering the plan. And for participants, the DC plan is probably the best option they're going to get: institutionally priced funds; no transactions fees; well-selected options.”

Pete Apor, director of retirement for Fujitsu America, Sunnyvale, Calif., said retirees account for 50% of the company's $1.1 billion 401(k) plan. “Our plan provides lower costs and generally better performance (than what participants would get outside the plan).”

William F. Quinn, chairman of American Beacon Advisors, Fort Worth, Texas, which oversees the $17 billion in retirement plans of American Airlines Inc., said his firm has been actively trying to keep retirees in the plan past retirement. “We try to educate folks on the fact that the plan options are higher quality and lower cost than IRA alternatives,” he said. “You can also get investment tools through the plan.”

The participant-for-life strategy might get a boost from the IRS. The Internal Revenue Service has proposed new rules that next year would require defined contribution plan executives for the first time to provide participants with several pieces of information before they can make cash distributions.

Under the rules, which implement provisions in the Pension Protection Act of 2006, DC plans must: explain to participants the tax consequences of rolling over the 401(k) account balance; disclose some of the investment options in the plan may not be available outside the plan; and explain that fees and expenses outside the plan may be different than those inside the plan.

Indeed, some plan executives claim the PPA allows them to be more paternalistic toward participants. “Let's face it, a lot of bad things can happen at retirement for participants,” said AllianceBernstein's Mr. Davies. “Costs go up, advisers provide uneven advice at best. You could see a pretty provocative scenario where keeping participants for life becomes adopted as a best practice for plan sponsors, and like most trends in this industry, it will start with the big plans.”

Robyn Credico, national director of defined contribution consulting at Watson Wyatt Worldwide, Arlington, Va., said keeping participants for life might appeal to employers that once had a defined benefit plan. “These companies already have a paternalistic attitude toward their employee participants.”

Not everyone, however, believes plan executives are pushing for participants to stay in their plans.

Christopher Tobe, a consultant at Breidenbach Capital Consulting LLC, Louisville, Ky., said that while a few big plans may want to keep participants, smaller plans would rather participants cash out at retirement because it costs them more to continue servicing their accounts. Indeed, according to the CaseyQuirk survey, less than one-third of DC plans with less than $1 billion in assets said they were trying to retain participant assets post-retirement.

Some employers also worry about the added fiduciary responsibility for carrying participants' assets into retirement, said NEPC's Mr. Bremen. “In theory there's more risk of litigation,” he said. “The more participants that remain in the plan, the more people there are that may be unhappy with your decisions.”

Ms. Credico said so far, employers most successful in retaining participants after retirement are those whose plans have high allocations to company stock, and that stock pays dividends, thus providing an income stream for retirees.

“Otherwise, there's a lot more interest and talk than action,” she said. “A lot of the interest is coming from the vendors who are pushing annuities and lifetime income solutions. It's too soon to tell if plans will be successful in retaining participants after retirement.”

Don Perrine, director of investment management at First Energy Corp., Akron, Ohio, which has a $1.9 billion 401(k) plan, said his company doesn't make any effort to keep participants after retirement. “Our plan is so big, and we use a lot of index funds, so we get a lot of breaks on fees and expenses regardless of whether or not retirees stay in the plan,” he said. “We don't really care one way or another.”