Low interest rates bedevil state plan default options

Some state-facilitated retirement plans are scrambling to address a problem that low interest rates are stirring up in the money market funds they offer as default investment options.

With yields dipping to a level where they no longer cover the funds' fees, executives of state-run plans fear a situation they once brushed aside as unlikely: workers at risk of seeing their hard-earned savings post net negative returns in what many take to be an uber safe investment.

To spare savers such disappointment, the nation's largest state retirement programs — OregonSaves, Illinois Secure Choice and California's CalSavers — have been working with their service providers to lower fees and in some cases change the structure of their default options to ensure that fees do not exceed fund yields.

Illinois Secure Choice waived both the program management fee and state fee of 5 basis points for its default 90-Day Hold Fund investment option, while OregonSaves reduced the administrative fee for its Capital Preservation Fund, the default investment for workers' first $1,000 of savings.

CalSavers, meanwhile, worked with its service providers to waive the underlying fund fee for its default Capital Preservation Fund and offset the program administrator's fee by reallocating money from the provider's marketing budget.

"We didn't want to be defaulting people into essentially a guaranteed negative performance in a fund that we call capital preservation," said Katie Selenski, the Sacramento-based executive director of the $18 million CalSavers program, which rolled out statewide in July 2019.

Like OregonSaves, the CalSavers program defaults savers' first $1,000 of contributions to the Capital Preservation Fund with subsequent contributions invested in an age-appropriate target-date fund. Roughly $14 million, or 71% of CalSavers' total assets, are in the Capital Preservation Fund.

CalSavers' fix, however, is unsustainable over the long term as the program grows to scale, Ms. Selenski said. "We've been able to work with our business partner and we found a way to reallocate marketing funds to support savers in this option so that none of them have actually had losses in that fund, but it's not a sustainable approach," she said.

Indeed, if yields remain low over the next three years, the annual cost of supporting the money market fund would grow to more than $1.5 million by 2022 and if yields were to stay at or near zero, the annual cost could exceed $4 million, according to an analysis by the program's investment consultant, Meketa Investment Group.

CalSavers, therefore, is moving to change the structure of its default investment so that contributions are in the money market fund for just 30 days, rather than waiting for them to hit $1,000, and then swept into a target-date fund where all new contributions will be directed. The measure would greatly reduce the cost of supporting the Capital Preservation Fund even if yields fell further, according to the Meketa analysis.

"It was the most challenging design decision our board has had to face," Ms. Selenski said.

The measure, which was approved at a board meeting in October, will likely go into effect at the end of the first quarter of 2021, she said.

Unlike CalSavers, neither the $77 million OregonSaves program nor the $42 million Illinois Secure Choice program are planning any immediate changes to the structure of their default options. Initial contributions in the Illinois Secure Choice program are held for 90 days in the 90-Day Hold Fund, a money market fund, and then swept into a target-date fund where all future contributions are directed. In March, Illinois Secure Choice began waiving both the state fee of 5 basis points, which covers the state's administrative costs, and the program management, or record-keeper fee, for the 90-Day Hold Fund. In April, the program waived the same fees for its Capital Preservation Fund, a stand-alone fund option offered as part of the program's investment menu.

The state fee was waived in its entirety, while the program management fee, which ranged between 57 and 65 basis points, was waived as needed to ensure yields stayed positive, said Courtney Eccles, the Chicago-based director of the Illinois Secure Choice program.

The waivers will remain in place as needed throughout the low-yield environment, Ms. Eccles said, adding that the program will continually assess the market and re-evaluate the waivers as necessary. "We feel like we're in a structurally good place as all of us are trying to figure out the best way to work with our savers," she said.

OregonSaves, too, does not currently have plans to change the structure of its default capital preservation money market fund into which savers' initial $1,000 are directed. In March, its board authorized the executive director of the Oregon Treasury Savings Network to adjust fees and charges applicable to the fund to reduce the impact of reductions in interest rates.

The program lowered fees to a point where even if rates went to zero, savers wouldn't go negative in the capital preservation fund, said David Bell, the Portland, Ore.-based deputy director of the Oregon Treasury Savings Network, which administers the OregonSaves program.

That's not to say that OregonSaves will not change its structure in the future, Mr. Bell added. OregonSaves, which is negotiating the termination of its contract with its record keeper, Ascensus, is currently covering Ascensus' program management fees on the Capital Preservation Fund to keep savers from going negative, he said.

The challenges facing state-facilitated retirement plans are part and parcel of the growing pains that more mature state-run investment programs, such as 529 college savings plans, have been through, said Andrea Feirstein, a managing director at AKF Consulting Group in New York.

"This is something we have seen over time. It's not a new phenomenon," she said. "It's just that it's hitting our Secure Choice plans for the first time now given the historic low-interest-rate environment."

State administrators and program and investment managers of other state-run investment programs, including 529 plans, for example, have in many instances over the past decade waived fees on underlying investments, she said.

The challenge with Secure Choice programs, she added, is that the fees are much higher than they are for 529 plans. Management fees in Secure Choice programs range from 60 to 75 basis points, compared with less than 30 basis points for the majority of direct sold 529 plans.

The higher fees for Secure Choice programs are due to the fact that they are "start-up" plans that have not yet achieved the scale — and therefore the negotiating ability — of 529 plans.

While negotiating and working with service providers to reduce and waive fees is not easy, not doing so would be unconscionable, Ms. Feirstein said. "You never want to see an investor hurt," she said. "You want to be doubly sure that you're not jeopardizing their investments."