The Good and Bad of Large 401(k) Plans
Large 401(k) plans, ones with numerous investment choices, can be good for the employer, but bad for the employee, according to University of Mississippi Law School assistant professor Mercer Bullard. Citing both case law and various studies, Bullard says a paradox exists.
Retirement plans, including 401(k)s, are covered by the Employee Retirement Security Income Act of 1974 ERISA. ERISA requires employers to follow the “prudent man rule,” which means making decisions with care, skill and diligence. In simpler terms, the standard requires fiduciaries to make decisions similar to what a prudent person would otherwise make in the same situation. This requirement has been used in litigation over the construction of and fees within 401(k) plans.
Bullard observes a trend in such cases of allowing employers to argue a “large menu defense.” Courts have concluded a large selection of investment options places the employee in charge of his investment decisions. Under such rulings (including Hecker v. Deere & Co.), the employer cannot be held liable for the inclusion of expensive or poor-performing funds. Conversely, Wal-Mart was found liable of managing its plan imprudently for offering a “relatively limited menu of funds which were selected by Wal-Mart executives despite the ready availability of better options.” (This case was Braden v. Wal-Mart.)
Though employers may be able to reduce their liability by offering a bigger selection of investment choices, doing so may have an adverse effect on employees. Bullard cites a Columbia University study that found employee participation decreased as the number of investment choices increased. A plan with 11 options had a 70% participation rate, whereas a plan with 56 options had a 61% participation rate.
Studies by behavioral scientists suggest humans tend not to make decisions when confronted with too many choices. Bullard cites an oft-referenced study on jam, which found that as the number of flavors for sale increased, the number of purchases decreased. Emerging analysis on auto-enrollment retirement plans finds many employees do not alter either the default contribution amount or the default fund selection when opted into a 401(k) plan. Such aversion to decision-making can lead to a failure of adequate saving, which Bullard says can leave employees unprepared for retirement.
Source: “The Social Costs of Choice, Free Market Ideology and the Empirical Consequences of the 401(k) Plan Large Menu Defense,” Mercer Bullard, May 10, 2013.