Study: Defined Contribution Plans Quickly Changing

Once just a supplement to the pension system, defined-contribution plans such as 401(k)s are growing and changing fast as they evolve into a linchpin of Americans' retirement savings and offer increasingly innovative investment options, a new study indicates.

Boosted by a widespread shift to automatic enrollment and other factors, the defined-contribution market is estimated by McKinsey & Co. to double in size by 2015 to $7.5 trillion to $8.5 trillion in assets under management.

That will make it three times larger than the once-dominant market for defined-benefit pensions, the consulting firm found in the study released Thursday.

The changes and expanding market should be good news for beleaguered consumers, forced to increasingly fund their own retirements in an era of vanishing pensions and shrinking Social Security funds. McKinsey says the increased options bring not only a wider range of choices but more opportunities to obtain investment-related advice and invest in lower-fee funds.

"The confluence of changes we are seeing in the market is signaling huge progress toward increasing the retirement readiness of the broader U.S. population," said Onur Erzan, one of the report's authors. "Defined-contribution plans are playing a much more critical and increasingly bigger role in that."

The findings also defy the notion that the defined-contribution market will decline when baby boomers retire. The analysis, based on interviews with dozens of experts and McKinsey's modeling, concludes that the flow of more than $3 trillion out of defined-contribution plans will be more than offset by growth opportunities.

Reliance on defined-contribution plans has grown as companies have eliminated traditional, defined-benefit pensions. Congress helped spur defined-contribution plans' growth in 2006 with the Pension Protection Act. The act removed barriers that prevented companies from automatically enrolling their employees and also increased employees' access to professional advice about investing for retirement.

Providers and plan sponsors alike have since been moving to meet increased needs and demand, and the result is a proliferation of investment options, according to the study.

McKinsey cites "spectacular growth" in the offering of fund products such as asset allocation funds -- primarily life-cycle or target retirement date funds -- balanced funds and managed account programs.

Target-date funds, which shift allocations to more conservative as the individual ages, are "by far" the most popular because they are tailored to different age groups, are easy for participants to understand, require minimal involvement, and enable companies to address the issue of poor employee decision-making with their investments.

Erzan cites an "arms race" of target date products and says more advisers and consultants also are becoming involved in the defined-contribution market.

Some defined-contribution plan providers are integrating advice into their plans, including automated Web advice and planning tools, and call center support, as well as advice embedded into asset allocation funds. Others are assessing the need for advisers, the study said.

The most innovative providers are shifting toward more complex products, including annuities, income management funds and mutual funds with yearly payouts.