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Retirement Planning > Saving for Retirement > 401(k) Plans

401(k) Core Menus Are Not Retirement Ready

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What You Need to Know

  • For a participant to want to stay in a DC plan, the plan itself must be retirement ready.
  • Core menus need to adapt to meet the needs of both younger and older investors.
  • They also tend to lack several important asset classes.

There is an increasing emphasis among plan sponsors on keeping participants in the defined contribution (DC) plan post-retirement. The potential benefits associated with staying in-plan are many, such as fiduciary oversight and economies of scale, including access to institutionally priced investments, which can make the decision a smart one for participants.

However, for a participant to want to stay in a DC plan (versus roll out), the plan itself must be “retirement ready.” A retirement ready DC plan needs to have a variety of features, one of which is access to a robust set of funds that enable participants who choose to do so to build diversified portfolios from the core menu.

The role of the core menu in DC plans continues to evolve, especially given the notable growth in default investments, in particular target date funds, over the last decade.

In recent research, I explore data from 11,643 401(k) plans to better understand where asset class coverage gaps exist across core menus and quantify the portfolio implications associated with the gaps. Two shortfalls are noted.

  1. Core menus would benefit from a “rebalance” to better accommodate the participants who are most likely to use them.

Younger participants are much more likely to use default investments (e.g. target date funds) while older participants, who tend to invest more conservatively, are much more likely to use the core menu.

This is in direct contrast with common core menu design, where there are typically significantly more equity funds than fixed income funds (roughly three to one). The relatively high proportion of equity funds makes it not only difficult to build efficient conservative portfolios, but it may also lead to excess risk taking among participants (i.e., if the participant follows a naïve allocation strategy or chases returns).

2)  Core menus are largely missing important asset classes required to build efficient retirement-focused portfolios.

Efficient retirement portfolios can look very different than efficient accumulation portfolios given the more focused objective of generating an income stream.

The portfolio efficiency costs of these coverage gaps can be staggering, exceeding roughly 100 basis points on an alpha-equivalent basis.

The most notable gaps in asset class coverage include inflation-linked bonds, high-yield bonds, commodities and real estate, although adding other asset classes, such as long-term bonds, may be worth considering.

While some plan sponsors may be hesitant to expand core menus given past research on the topic (e.g. research noting negative relationship between core menu size and plan participation), it’s important to place past research in the correct context: It largely took place before the broad adoption of automatic enrollment and prepackaged asset allocation solutions, such as target-date funds, and may not be relevant today.

Core menus don’t necessarily need to be bigger, they just need to be smarter. By consolidating a few of the riskier (equity) options to make room for retirement-focused strategies, it is possible to both improve the core menu and reduce the total number of funds offered.

For example, instead of having a fund covering each of the nine common U.S. “style box” equity asset classes (which are highly correlated), consider combining (or eliminating) a few of these equity options and adding some key diversifiers such as real estate or an inflation-protected bond fund.

Creating a truly optimal DC core menu requires a certain degree of art and science that will vary by plan.

This new research suggests, though, that most core menus today should be revisited before they can truly be considered optimal for the participants who are most likely to use them.


David Blanchett is managing director and head of retirement research, PGIM DC Solutions. His commentary represents his own views and opinions regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced above and are not necessarily the views of PGIM DC Solutions.